Jeff is a partner at Renaissance Venture Capital an innovative venture capital fund of funds. Jeff’s diverse background in venture capital and technology and his experience working in various start-up ventures uniquely position him to advise startups. In addition, Jeff is quite active in the Michigan start-up community, volunteering his time to mentor young entrepreneurs, judge pitch competitions, and guest lecture student classes and organizations. Through Jeff’s work on the Fund, his volunteer efforts, and his role as the chair of the Michigan Venture Capital Association’s board of directors, his passion for fostering a productive environment for venture capital investment in the State of Michigan is evident.
Martin Tobias is the Managing Partner and Founder of Incisive Ventures, an early-stage venture capital firm focused on investing in the first institutional round of technology companies that reduce friction at scale.
Martin was previously at Accenture and Microsoft and is a former Venture Partner at Ignition Partners. Martin is a 3X venture-funded CEO rising over $500M as CEO with two IPOs who has also invested in hundreds of companies and is a limited partner in over a dozen VC funds. Martin was an early investor in Google, Docusign, OpenSea, and over a dozen Unicorns.
Martin is the father of 3 daughters, a cyclist, surfer, poker player, and life hacker. Martin tinkers with motorcycles on the weekends. He writes about Venture Capital on Incisive Ventures blog and Twitter.
[00:00] Introducing Jeff Rinvelt and Martin Tobias [04:14] What was Jeff’s pitch to their LPs for Renaissance Capital? [06:30] Why did Jeff pivot from being a founder to an LP? [08:10] Renaissance Capital’s portfolio construction model [13:00] Jeff’s involvement in non-profits [15:56] How did Martin become an angel investor? [18:03] The big lesson from being an LP in SV Angel’s Fund I and II [20:10] Why is Martin starting a fund now? [26:07] A lesson on variable check sizes [28:53] What is Martin’s value add to founders? [33:29] What stood out about Martin’s deck and email when it arrived in Jeff’s inbox? [35:43] The 2 biggest worries Martin had in sharing his deck with Jeff [36:47] What does Jeff think about generalists? [40:49] What held Jeff back from making an investment in Incisive Ventures? [42:37] What kinds of conversations does Martin usually have with LPs? [47:05] One of the greatest professional lessons Jeff picked up as a manager [49:07] Martin’s greatest lesson from his days as a CEO [51:57] Thank you to Alchemist Accelerator for sponsoring! [54:33] Like, comment and share if you enjoyed the episode
“One of the things a lot of investors don’t do is go back and be honest about where they got fucking lucky and where they had a thesis that they could potentially replicate in future investments.”
In the process of catching up with a number of fund managers this week, I was reminded of two things:
That I still have an outstanding blogpost on intuition and discipline sitting on my desk, having gone through more revisions than I would like
That Fund I’s mostly start by drawing trendlines in your previous portfolio’s winners.
Now it’s not my job to call anyone out, but many of those I caught up with this week, told me in confidence (no longer in confidence now that I’m writing about it) that their best investments were simply due to being in the right place at the right time. That they were lucky. Others invested often off-thesis to accommodate for a brilliant founder that looked and sounded like nothing they had seen before. Then retroactively, went back to LPs in a subsequent fundraise armed with the knowledge to account for their previous outlier.
Chris Paik once wrote, ““Invest in companies that can’t be described in a single sentence.”
Invest in companies that can’t be described in a single sentence
Josh Wolfe said last year, “We believe before others understand.” And sometimes the investor themselves may not fully grasp what makes someone special other than that person is special.
Other times the company in which you initially bet on may not look like the company that earns you the most capital. As Mike Maples Jr. once said, “90% of our exit profits have come from pivots.
Of course, many LPs don’t want to hear that. They want to hear that you know exactly what you’re doing. That you can predict the future. But you can’t. In many ways, VCs invest in what stays the same. Not what changes. Human nature. Great hires. Network effects. Talent pools. Intellectual curiosity. Rigor. It’s a long list.
An amazing VC once told me. The job of a VC is to:
Have a wide enough aperture so enough light can come in
But have a fast enough trigger finger to catch the light, the reflections, the shadows just at the right time so that you get a good enough shot.
The rest is all done in the editing room, where you massage the photo with your expertise and experience to help it stand out.
I love that line. But simply put, the job of a VC is to:
Cast a wide enough net so that you can see as many great companies as you can,
Have the ability and awareness to know a great company when you see it.
After all, as an investor, you don’t have to invest in every great company, but every company you invest in must be great. Big anti-portfolios don’t mean much in this world if you can still get great returns.
All that to say, the job of an angel is to increase the surface area for luck to stick. And once enough do, a thesis blossoms.
A thesis, at the end of the day, is retroactive. And the best thing a fund manager can do is that the thesis the fund ends on is as close as possible to the initial. As LPs, it is our job to bet on the future of the thesis and the discipline of the fund manager. Both are equally as important. If things do change, a fund manager must preemptively communicate strategy drift and do so in the best interest of their investors.
It’s not ideal in many cases. For individual LPs and smaller family offices, strategy drift matters less. For large institutional LPs, it matters more. Because the latter don’t want you to be investing in the same underlying asset as other funds they’re invested into are.
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.
Samir Kaji is the CEO and Co-Founder of Allocate, a private markets technology company that pairs origination with portfolio management tools to allow investors to efficiently construct and manage their alternatives portfolios.
Prior to Allocate, Samir spent 22 years in venture banking between SVB and First Republic Bank and closely worked with and advised over 700 venture capital and private equity firms. During this time, he completed over $12B in structured debt transactions and has invested personally in over 75 funds and companies, including early-stage investments into Carta (seed), Side (seed), PolicyGenius (Series A), and FanDuel (Series B) as well as Growth investments into Reddit, Alto Pharmacy, and Carbon Health. He has also invested in over 40 funds across various investment types.
Samir completed a finance undergraduate degree at San Jose State University, a finance MBA from Santa Clara University, and completed the prestigious Kauffman Fellows venture program in 2017. Samir is also the host of Venture Unlocked, a top venture capital podcast available on Itunes, Spotify, and Substack.
[00:00] Intro [04:15] What will be the biggest change in the next decade for the LP universe? [08:45] Portfolio allocation for emerging LPs [12:32] How has Samir’s LP investment strategy evolved over the years? [16:04] Why Samir invested in Bullpen Capital’s Fund I [17:43] GP-business model fit [19:40] GP red flags [21:00] The one question Samir asks to see if GPs understand how to do portfolio math [23:31] The art of asking good questions [29:44] What is the Minimum Viable Fund? [36:14] How to pick 10 funds out of 4000 VC funds [42:19] How did Samir pitch Allocate to his investors? [48:11] The first hires at Allocate [50:53] How Samir defines work-life integration [56:38] The first two emerging fund managers Samir backed at First Republic Bank [59:41] The lesson Samir’s father shared with him when he thought about leaving SVB [1:02:41] What happens when you overanalyze [1:07:27] Thank you to Alchemist Accelerator for sponsoring! [1:10:02] If you liked it, give us a like or share!
“When you think about investing in any fund, you’re really looking at three main components.
It’s sourcing ability. Are you seeing the deals that fit within whatever business model you’re executing on?
Do you have some acumen for picking?
And then, the third is: what is your ability to win? Have you proven your ability to win, get into really interesting deals that might’ve been either oversubscribed or hard to get into? Were you able to do your pro rata into the next round because you added value?
“And we also look through the lens of: Does this person have some asymmetric edge on at least two of those three things?”
“When you’re investing in a fund, especially when you’re making an ex ante decision, meaning you’re not buying a secondary, you’re actually just looking at what’s the probability of success in the future. You want to focus on process, more than just outcomes in the past. The process is how they think.”
As people were coming back from the holidays, I had the chance to catch up with two friends earlier this week on two different occasions. One who built a company hundreds strong. The other is someone who’s seen the rise and fall of civilization again and again.
The former told me, “The greatest litmus test of a leader is their ability to train another leader.”
The latter told me something they had learned from a successful founder. “I lift as I climb.”
Both equally as profound. But to take it one at a time…
To train another
I’ve mentioned on this blog before that A-players hire A-players. And that B-players hire C-players. C’s hire D-players. And so on. A-players can tolerate working with B’s, but not C’s and D’s. So at the end of the day, the A’s leave, and all you’re left with are B’s and below.
While that statement makes sense in broad strokes, the truth is from an investor’s perspective — hell, just an outsider’s perspective — no one knows if you’re an A-player or not at first glance. Or at least it’s really hard to tell. Maybe there are people who are smarter than me out there who can tell at a glance. At the end of the day, seeing others execute is a great way to tell, but that takes more than one meeting usually.
And sometimes the easiest way to see is in doing reference checks. Seeing who else is on the team that they hired and trained. Seeing who they hired in previous roles. And if those other folks they’ve trained have gone to do amazing things, that’s usually a good sign that the person in question knows what an A-player looks like. And if it’s consistent enough, knows how to mint stellar leaders.
I lift as I climb
One of the greatest red flags I often see are founders hiring experienced (often expensive and brand-name) executives, sales reps, and product managers super-early in the startup lifecycle. Especially before product market fit. And often the biggest expectation for these early hires is to do:
What they themselves couldn’t do
And/or what they themselves don’t want to do
Both happen to be cardinal sins at the early stage. Why does the above matter?
Because if you’ve never done the job yourself, specifically building/managing the product and getting to your first customers:
You don’t know how to set realistic targets and benchmarks for that role
Given how crucial early customer feedback is to the product and the company, you’ll miss out on key customer insights if you’re not in the trenches yourself.
The goal of the afore-mentioned early hires is to refine your playbook, not build the playbook from scratch. And if that doesn’t appeal to you as the founder, then you might not be ready to be one.
And this is the exact reason I love the line “I lift as I climb.” For every time you figure something out, an inflection point for the company, a key customer discovery/insight, a sales script that closes twice as well as the last one, your rising tide raises all boats. But you cannot lift if you don’t climb first.
In closing
For those of you tuning in from the video and audio universes, you know I’ve been thinking a lot about succession planning as of late. Largely motivated by my conversations with Ben from Next Legacy.
So naturally, when I was catching up with both of my friends, their words found refuge in the questions I was seeking answers to.
And when all’s said and done, what I look for in a founder who’ll create a multi-generational company is the same in what I look for in an emerging manager who’s planning to build a multi-fund firm. And in a way, what a young professional might look at when betting their career on a startup.
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.
Howard Lindzon has over 20 years of experience in both public and private market investing. He previously founded and managed the hedge fund Lindzon Capital, and is currently the founder and General Partner of the early-stage venture capital firm Social Leverage. Through Social Leverage, he and his partners have been seed investors in startups like Robinhood, Beehiiv, and Manscaped to name a few. Howard was the founder of Wallstrip (acquired by CBS), and is the the co-founder and Chairman of Stocktwits, the leading social platform for traders and investors. Throughout his career, Howard has strongly advocated for and helped drive the decentralization and democratization of investing. He resides in Phoenix, AZ and Coronado, California.
[00:00] Intro [01:51] Howard’s biggest misses as a startup investor [06:21] What happens when you trust a single reference too much in the diligence process? [10:24] What kind of company does Howard think Carta should be? [14:52] Howard’s two beliefs on selling positions [24:29] What types of fund managers did Howard invest in as an individual LP? [30:46] How did Howard write a $150K LP check in Multicoin [36:06] Why Howard likes GPs who struggle to fundraise [41:16] How Howard raised his fund of funds [44:19] Howard’s LP investment thesis [47:16] How much of investing is luck vs skill? [51:57] Reframing curiosity and risk [57:37] Market risk vs execution risk in your career [59:18] Howard’s advice to young professionals [1:03:40] A founder or GP’s first interactions with Social Leverage [1:08:25] Does succession planning matter to Social Leverage? [1:10:16] The big lesson about follow-on financing from Social Leverage’s Fund I [1:14:49] Thank you to Alchemist Accelerator for sponsoring! [1:17:25] Legal disclaimer
“You can’t be a good investor if you haven’t been in there and go ‘Ahhh, that was a dumb idea.’”
“Sell when you can, not when you have to.”
“They gave me money because I’m weird. They gave me money because they trusted me, but they also know that I’m weird. Therefore, if I start to think like them, we’re all screwed. So I have to think like me.”
“If you’re curious, it’s pretty hard not to stand out over time.”
Ben Choi manages over $3B investments with many of the world’s premier venture capital firms as well as directly in early stage startups. He brings to Next Legacy a distinguished track record spanning over two decades founding and investing in early-stage technology businesses. Ben’s love for technology products formed the basis for his successful venture track record, including early stage investments in Marketo (acquired for $4.75B) and CourseHero (last valued at $3.6B). He previously ran product for Adobe’s Creative Cloud offerings and founded CoffeeTable, where he raised venture capital financing, built a team, and ultimately sold the company.
Ben is an engaged member of the Society of Kauffman Fellows and has been named to the Board of Directors for the San Francisco Chinese Culture Center and Children’s Health Council. Ben studied Computer Science at Harvard University before Mark Zuckerberg made it cool and received his MBA from Columbia Business School. Born in Peoria, raised in San Francisco, and educated in Cambridge, Ben now lives in Palo Alto with his wife, Lydia, and three very active sons.
[00:00] Intro [02:44] Ben’s childhood [07:54] What is Ben’s superpower? [16:58] What aspect of being a VC do most founders fail to appreciate? [18:46] What do GPs fail to appreciate about LPs? [21:24] The similarities between VC and the intelligence industry [24:00] What’s changed about being a VC since 2006? [27:14] How does Ben tell signal from noise? [32:46] Past track record portability [37:24] A case study on how a syndicate investor became a lead investor [41:00] Ben and David nerd out about free T-shirts [44:26] An example of how a GP convinced Ben to invest in their fund [47:53] Succession planning in a VC firm [56:51] How Legacy Venture started [1:01:28] Next Play + Legacy Venture = Next Legacy [1:04:05] Which non-profits do the carry go to? [1:05:48] What kind of GP impresses Ben? [1:07:58] Ben’s biggest professional lesson in 1998 [1:12:56] Thank you to Alchemist Accelerator for sponsoring! [1:15:32] Legal disclaimer
“The integrity of information. Does this actually stand on its own not because someone said so, but because the mechanics behind it make sense. Does this have internal integrity to it?”
“If you see a thread and you pull it, does it come out as a single piece of thread? There’s no integrity right there. If you pull it and the whole fabric starts to warp–… if you pull it and other pieces start to move, there are connections. That thread is actually holding this together.”
I wrote a blogpost last year, where I went a level deeper into my NTY thesis. In short, in what situations and in front of what kind of ideas do I ask founders: Why now? Why this? And why you?
But let’s go a step deeper. As I’m writing another blogpost slated to come out next year, I’ve had the chance to sit down with some amazing multi-cycle investors. And a common thread across all those conversations has been that they chose to be the first check in companies that would be big, if true.
Which got me thinking…
If ‘big if true’ is for the preposterous ideas out there, then possible ideas would be ‘big when true.’ And plausible ideas would be ‘big AND true.’
Let’s break it down.
Big AND true
Not too long ago, the amazing Chris Douvosshared with me that the prerequisite to being “right and alone”, where fortune and glory lie, is to be “wrong and alone.”
Imagine a two-by-two matrix. On one axis, right and wrong. On the other axis, alone and in the crowd. You obviously don’t want to be wrong and in the crowd. But you do want to be in the right and alone quadrant. Because that’s where fortune and glory are at. Most people think that to get there, you must first start in the right and in the crowd quadrant. But it’s important to note, that once you’re in the crowd, and you get the dopamine hits of validation, it’s really hard to stray away from the crowd. So really, the only way to get to fortune and glory is to be wrong and alone. To be willing to go against the grain.
Unfortunately, for big AND true, you’re in the crowd. And while you can usually make money on the margins, it’s hard to be world-defining. ‘Cause you’re too late.
The thing to be wary of here if it is any investor’s strategy to deploy capital here is to not be the last money in. Hype and compounding are dangerous. And for many companies that exist here, they have a short half life. If you’re the last one holding the bag, that’s it.
Big WHEN true
You know that saying, “It’s a matter of when, not if…” it’s just as true in the innovation space. There are some things in life that are bound to happen. Recessions. Hype cycles. Rain. First snowfall. Summer heat. Progress. Maturity. When one’s baby teeth fall out. Wrinkles. Gray hair. Some with more predictability than others.
These ideas are defined as those with early commercial traction, likely with a niche audience or only your 1000 true fans. And that’s okay. Usually happens to be some of the toughest pre-seed and seed rounds to raise. There’s clearly traction, but no clear sense of rocket ship growth.
Timing matters. Is the larger market ready to adopt the beliefs and culture and habits of the few?
For some investors, it’s why they target quality of life improvements to the wealthy made ready for the masses. Living a wealthy lifestyle is, after all, aspirational for many. On the flip side, if you have a niche audience and are looking to expand, are there underlying beliefs and traits that the broader market has but has instead applied those beliefs and habits in other parts of their life?
Big IF true
Sam Altman put out a blogpost just yesterday, titled “What I Wish Someone Had Told Me.” And out of the 17 lessons he shares, one in particular resonated the most with me:
“It is easier for a team to do a hard thing that really matters than to do an easy thing that doesn’t really matter; audacious ideas motivate people.”
While the stories of Airbnb or Coinbase or Canva seem to suggest that these are nigh impossible ideas to raise on, anecdotally, I seem to find that the most transcendent companies with CEOs who are able to acquire world-class talent to their companies have less trouble fundraising than the ‘big when true’ ideas. But more difficulty raising than the ‘big and true’ ideas.
That said, instead of many smaller checks, you just need to find one big believer. In other words, the Garry Tan for your Coinbase or the Fred Wilson for your Twitter. One way to look at it, though not the only way, is what Paul Grahamputs as the “reasonable domain expert proposing something that sounds wrong.” Crazy, but reasonable. Simply, why you?
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 was listening to a fascinatingly thoughtful conversation between Tim Ferriss and Kindred’s Steve Jang, where Tim said one line that stood out in particular: “I’ve been paying a lot of attention, but I’ll be honest, I don’t know how to pay proper attention.”
And well, it got me thinking. About the difference between knowing what to look at and knowing how to look at it.
One of my favorite TED talks is by Will Guidara (quite honestly I think it deserves more views on YouTube than it has). Will is probably best known for co-founding one of New York’s hottest fine dining restaurants, Eleven Madison Park, and for writing the book, Unreasonable Hospitality. And in it, he talks about how just listening to the conversations that are happening at the tables and delivering these small, unexpected pockets of joy can create experiences that transcend money and time.
In the afore-mentioned talk, he talks about how there are four diners at Eleven Madison Park. That they went to all the top restaurants in NYC. Le Bernardin. Per se. And so on. And Eleven Madison Park was the last on their to-do list. But the only regret they had was that they never got to try a New York hot dog. Of course, upon hearing that, Will storms out the door to buy a $2 dog, brings it back to the kitchen and convinces the chef to serve it over the aged duck that took years to perfect. And when he finally delivered the next course on the menu as the hot dog he just bought, the four guests went bonkers. That despite on the multiple courses and the brilliant food, that their favorite dish was the NYC hot dog.
That it was because Will paid proper attention to his guests that he was able to deliver a truly unforgettable experience.
The truth is how to pay proper attention to anything that deserves our attention is the million-dollar question.
Paying proper attention
There’s the famous selective attention test, where viewers are asked to count the number of times the ball is being passed between the players, only to fail to realize that there is gorilla that walks across the screen. We’re told to pay attention to the ball passes, but only by paying proper attention to the purpose of why the test is being administered, do we catch what is hiding in plain sight.
Similarly, Raymond Joseph Teller (or better known for being half of the dynamic magic duo Penn & Teller) did a fascinating talk a decade and a half ago about the illusion of expectation. That magic in all of its novel facets feeds off of the expectations of its onlookers. When one tries to pay attention to the coins that are “magically” jumping from one hand to the next, you might fail to catch the sleight of hand in between. But only after he reveals his secrets is the simple magic act all the more impressive. In other words, in the second half, he teaches you how to pay proper attention.
If you have eight minutes in your day, would highly recommend watching the below video.
I can’t speak for every topic, industry, relationship, and so on out there, but at least for the cottage industry of venture capital, why I choose to write an angel or an LP check is similar. I don’t really look for what will change. ‘Cause damn, it’s so hard to predict what will change and how things will change. If I knew, and if one day, I know, please invest in my public markets fund, which will be the best performing fund of all time. But I don’t. We, as pundits sitting around the table, might draw predictions. But even the smartest of us (not sure why I say us, ’cause not sure if I can put myself in that category yet) would be lying if we knew what would happen in foresight.
Instead, I look at what doesn’t change.
What doesn’t change?
The great Charlie Munger passed away last week at the age of 99. And without question, a great loss to the world we live in today. Just half a year prior, he and Warren Buffett were hosting their 2023 annual meeting. And just two weeks prior, he was still doing CNBC interviews. And one of my favorite lines from that May annual meeting was:
“Well, it’s so simple to spend less than you earn, and invest shrewdly, and avoid toxic people and toxic activities, and try and keep learning all your life, et cetera, et cetera, and do a lot of deferred gratification because you prefer life that way. And if you do all those things, you are almost certain to succeed. If you don’t, you’re going to need a lot of luck. And you don’t want to need a lot of luck. You want to go into a game where you’re very likely to win without having any unusual luck.”
In reducing the requirement to need luck, one of the most effective ways to find what is constant in life. That despite changing times and technologies, these stay true. Or as Morgan Housel and Naval Ravikantput it, If you lived your life 1000 times, what would be true in 999 of them? In investing jargon, pattern recognition. Across my investments and more, where have I seen outperformance? What characteristics do they all share? What about human nature won’t change?
In fairness, pattern recognition gets a bad rap. And for a lot of investors, that’s because they choose to only invest in their comfort zone, and what they know best. Their former colleagues. Their Stanford GSB classmates. People who look like them, think like them, act like them. But recognizing thematic threads stretch across all facets of our life. We learn that not brushing our teeth well can lead to cavities. We learn that after stubbing our toe on the kitchen counter numerous times, we take a wider turn before turning into the kitchen. And we learn that eating piping hot foods kills your tastebuds for the next few days.
The venture corollary
In venture, we’re always taught to look at the team, product, and market. And that all are important. But if you tell a new grad or an ex-founder or an emerging angel to do just that. To them, that means nothing. They wouldn’t know how to judge. They have no benchmarks, nor do they know what’s right versus wrong. Now I don’t want to sound like a broken record, but I do believe previous blogposts like this and this are quite comprehensive for how I pay proper attention as an investor.
Emerging LPs are not immune to the lack of perspective as well. My hope and my goal is for how to be just as important if not more than the what. And for the why to be just as or more important than the how. It’s because of that, I write essays like this and this. And of course, it’s why I started Superclusters because I, too, am looking for how to pay proper attention to the next generation of venture investors. (Stay tuned for the coming Monday for episode four where we unpack the bull and bear case of early distributions in a fund!)
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.
Soooooooo… (I know, what a great word to start a blogpost) I started this essay, with some familiarity on one subject. Little did I know I was going to learn about an entirely different industry, and be endlessly fascinated about that.
The analogy that kicked off this essay is that re-upping on a portfolio company is very much like re-signing a current player on a sports team. That was it. Simple as it was supposed to sound. The goal of any analogy was to frame a new or nuanced concept, in this case, the science of re-upping, under an umbrella of knowledge we were already familiar with.
But, I soon learned of the complexity behind re-upping players’ contracts, as one might assume. And while I will claim no authority over the knowledge and calculations that go into contracts in the sports arena, I want to thank Brian Anderson and everyone else who’s got more miles on their odometer in the world of professional sports for lending me their brains. Thank you!
As well as Arkady Kulik, Dave McClure, and all the LPs and GPs for their patience and willingness to go through all the revisions of this blogpost!
While this was a team effort here, many of this blogpost’s contributors chose to stay off the record.
The year was 1997.
Nomar Garciaparra was an instantaneous star, after batting an amazing .306/.342/.534. For the uninitiated, those are phenomenal stats. On top of batting 30 home runs and 11 triples – the latter of which was a cut above the rest of the league, it won him Rookie of the Year. And those numbers only trended upwards in the years after, especially in 1999 and 2000. Garciaparra became the hope for so many fans to end the curse of the Bambino – a curse that started when the Red Sox traded the legendary Babe Ruth to the Yankees in 1918.
Then 2001 hit. A wrist injury. An injured Achilles tendon. And the fact he needed to miss “significant time” earned him a prime spot to be traded. Garciaparra was still a phenomenal hitter when he was on, but there was one other variable that led to the Garciaparra trade. To Theo Epstein, above all else, that was his “fatal flaw.”
Someone that endlessly draws my fascination is Theo Epstein. Someone that comes from the world of baseball. A sport that venture draws a lot of inspiration, at least in analogy, like one of my fav sayings, Venture is one of the only types of investments where it’s not about the batting average but about the magnitude of the home runs you hit.
If you don’t follow baseball, Theo Epstein is the youngest general manager in the history of major league baseball at 26. But better known for ending the Curse of the Bambino, an 86-year curse that led the Red Sox down a championship drought that started when the Red Sox traded Babe Ruth to the Yankees. Theo as soon as he became general manager traded Nomar Garciaparra, a 5-time All-star shortstop, to the Cubs, and won key contracts with both third baseman Bill Mueller and pitcher Curt Schilling. All key decisions that led the Red Sox to eventually win the World Series 3 years later.
And when Theo left the Red Sox to join the Chicago Cubs, he also ended another curse – The Curse of the Billy Goat, ending with Theo leading them to a win in the 2016 World Series. You see, in baseball, they measure everything. From fly ball rates to hits per nine innings to pitches per plate appearance. Literally everything on the field.
But what made Theo different was that he looked at things off the field. It’s why he chose to bet on younger players than rely on the current all-stars. It’s why he measures how a teammate can help a team win in the dugout. And, it’s why he traded Nomar, a 5-time All Star, as soon as he joined, because Nomar’s “fatal flaw” was despite his prowess, held deep resentment to his own team, the Sox, when they tried to trade him just the year prior for Alex Rodriguez but failed to.
So, when Danny Meyer, best known for his success with Shake Shack, asked Theo what Danny called a “stupid question”, after the Cubs lost to the Dodgers in the playoffs, and right after Houston was hit by a massive hurricane, “Theo, who are you rooting for? The Dodgers so you can say you lost to the winning team, or Houston (Astros), because you want something good to happen to a city that was recently ravaged by a hurricane.”
Theo said, “Neither. But I’m rooting for the Dodgers because if they win, they’ll do whatever every championship team does and not work on the things they need to work on during the off season. And the good news is that we have to play them 8 times in the next season.”
You see, everyone in VC largely has access to the same data. The same Pitchbook and Crunchbase stat sheet. The same cap table. And the same financials. But as Howard Marks once said in response how you gain a knowledge advantage:
“You have to either:
Somehow do a better job of massaging the current data, which is challenging; or you have to
Be better at making qualitative judgments; or you have to
Be better at figuring out what the future holds.”
For the purpose of this blogpost, we’re going to focus on the first one of the three.
What is value?
To begin, we have to first define a term that’ll be booking its frequent flier miles for the rest of this piece – expected value.
Some defined it as the expectation of future worth. Others, a prediction of future utility. Investopedia defines it as the long-term average value of a variable. Merriam-Webster has the most rudimentary definition:
The sum of the values of a random variable with each value multiplied by its probability of occurrence
On the other hand, venture is an industry where the beta is arguably one of the highest. The risk associated with outperformance is massive as well. And the greatest returns, in following the power law, are unpredictable.
We’re often blessed with hindsight bias, but every early-stage investor in foresight struggles with predicting outlier performance. Any investor that says otherwise is either deluding you or themselves or both. At the same time, that’s what makes modeling exercises so difficult in venture, unlike our friends in hedge funds and private equity. Even the best severely underestimate the outcomes of their best performers. For instance, Bessemer thought the best possible outcome for Shopify was $400M with only a 3% chance of occurring.
Similarly, who would have thought that jumping in a stranger’s car or home, or live streaming gameplay would become as big as they are today. As Strauss Zelnick recently said, “The biggest hits are by their nature, unexpected, which means you can’t organize around them with AI.” Take the word AI out, and the sentence is equally as profound replaced with the word “model.” And it is equally echoed by others. Chris Paik at Pace has made it his mission to “invest in companies that can’t be described in a single sentence.”
But I digress.
Value itself is a huge topic – a juggernaut of a topic – and I, in no illusion, find myself explaining it in a short blogpost, but that of which I plan to spend the next couple of months, if not years, digging deeper into, including a couple more blogposts that are in the blast furnace right now. But for the purpose of this one, I’ll triangulate on one subset of it – future value as a function of probability and market benchmarks.
In other words, doubling down. Or re-upping.
For the world of startups, the best way to explain that is through a formula:
E(v) = (probability of outcome) X (outcome)
E(v) = (graduation rate) X (valuation step up from last round) X (dilution)
For the sake of this blogpost and model, let’s call E(v), appreciation value. So, let’s break down each of the variables.
Graduation rates
What percent of your companies graduate to the next round? I shared general benchmarks in this blogpost, but the truth is it’s a bit more nuanced. Each vertical, each sub-vertical, each vintage – they all look different. Additionally, Sapphire’s Beezer recently said that it’s normal to expect a 20-30% loss ratio in the first five years of your fund. Not all your companies will make it, but that’s the game we play.
On a similar note, institutional LPs often plan to build a multi-fund, multi-decade relationship with their GPs. If they invest in a Fund I, they also expect to be there by Fund III.
Valuation step ups
How much greater is the next round’s valuation in comparison to the one in which you invested? Twice as high? Thrice? By definition, if you double down on the same company, rather than allocate to a net new company, you’re decreasing your TVPI. And as valuations grow, the cost of doubling down may be too much for your portfolio construction model to handle, especially if you’re a smaller sub-$100M fund.
It’s for the same reason that in the world of professional sports, there are salary caps. In fact, most leagues have them. And only the teams who:
Have a real chance at the championship title.
Have a lot in their coffers. This comes down to the composition of the ownership group, and their willingness to pay that tax.
And/or have a city who’s willing to pay the premium.
… can pay the luxury tax. Not to be too much of a homer, but the Golden State Warriors have a phenomenal team and are well-positioned to win again (at least at the time of this blogpost going out). So the Warriors can afford to pay the luxury tax, but smaller teams or teams focused on rebuilding can’t.
The Bulls didn’t re-sign the legendary Michael Jordan because they needed to rebuild. Indianapolis didn’t extend Peyton Manning’s contract ‘cause they didn’t have the team that would support Peyton’s talents. So, they needed to rebuild with a new cast of players.
Similarly, Sequoia and a16z might be able to afford to pay the “luxury tax” when betting on the world’s greatest AI talent and for them to acquire the best generative AI talent. Those who have a real chance to grow to $100M ARR, given adoption rates, retention rates, and customer demand. But as a smaller fund or a fund that has a new cast of GPs (where the old guard retired)… can you?
Dilution
If a star player is prone to injury or can only play 60 minutes of a game (rather than 90 minutes), a team needs to re-evaluate the value of said player, no matter how talented they are. How much of a player’s health, motivation, and/or collaborativeness – harkening back to the anecdote of Nomar Garciaparra at the beginning – will affect their ability to perform in the coming season?
Take, for instance, the durability of a player. If there ‘s a 60% chance of a player getting injured if he/she plays longer than 60 minutes in a game and a 50% of tearing their ACL, while they may your highest scorer this season, they’re not very durable. If that player missed 25% of practices and 30% of games, they just don’t have it in them to see the season through. And you can also benchmark that player against the rest of the team. How’s that compared with the team’s average?
Of course, there’s a parallel here to also say, every decision you make should be relative to industry and portfolio benchmarks.
How great of a percentage are you getting diluted with the next round if you don’t maintain your ownership? This is the true value of your stake in the company as the company grows.
How does one use the appreciation value equation?
E(v) = (graduation rate) X (valuation step up from last round) X (dilution)
If the expected value is greater than one, the company is probably not worth re-upping. And that probably means the company is overhyped, or that that market is seeing extremely deflated loss ratios. In other words, more companies than should be, are graduating to the next stage; when in reality, the market is either a winner-take-all or a few-take-all market. If it is less than or equal to one, then it’s ripe to double down on. In other words, the company may be undervalued.
And to understand the above equation or for it to be actually useful (outside of an abstract concept), you need market data. Specifically, around valuation step ups as a function of industry and vertical.
If you happen to have internal data across decades and hundreds of companies, then it’s worth plugging in your own dataset as well. It’s the closest you can get to the efficient market frontier.
But if you lack a large enough sample size, I’d recommend the below model constructed from data pulled from Carta, Pitchbook, and Preqin and came from the minds of Arkady Kulik and Dave McClure.
The model
The purpose of this model is to help your team filter what portfolio companies are worth diving deeper into and which ones you may not have to (because they didn’t pass the litmus test) BEFORE you evaluate additional growth metrics.
It is also important to note that the data we’ve used is bucketed by industry. And in doing so, assumptions were made in broad strokes. For example, deep tech is broad by design but includes niche-er markets that have their own fair share of pricing nuances in battery or longevity biotech or energy or AI/ML. Or B2B which include subsectors in cybersecurity or infrastructure or PLG growth.
Take for instance…
Energy
Energy sector appreciation values and follow-on recommendations
The energy sector sees a large drop in appreciation value at the seed stage, where all three factors contribute to such an output. Valuation step-up is just 1.71X, graduation rates are less than 50% and dilution is 38% on average.
Second phase where re-upping might be a good idea is Series B. Main drivers as to such a decision are that dilution hovers around 35% and about 50% of companies graduate from Series A to Series B. Mark ups are less significant where we generally see only an increase in valuation at about 2.5X, which sits around the middle of the pack.
Biotech
Biotech sector appreciation values and follow-on recommendations
The biotech sector sees a large drop in appreciation value at the Seed stage. This time, whereas dilution seems to match the pace of the rest of the pack (at an average of 25%), the two other factors shine greater in making a follow-on decision. Valuation step up are rather low, sitting at 1.5X. And less than 50% graduate to the next stage.
In the late 2023 market, one might also consider re-upping at the Series C round. Main driver is the unexpectedly low step-up function of 1.5X, which matches the slow pace of deployment for growth and late stage VCs. On the flip side, a dilution of 17% and graduation rate of 60% are quite the norm at this stage.
In closing
All in all, the same exercise is useful in evaluating two scenarios – either as an LP or as a GP:
Is your entry point a good entry point?
Between two stages, where should you deploy more capital?
For the former, too often, emerging GPs take the stance of the earlier, the better. Almost as if it’s a biblical line. It’s not. Or at least not always, as a blanket statement. The point of the above exercise is also to evaluate, what is the average value of a company if you were to jump in at the pre-seed? Do enough graduate and at a high enough price for it to make sense? While earlier may be true for many industries, it isn’t true for all, and the model above can serve as your litmus test for it. You may be better off entering at a stage with a higher scoring entry point.
For the latter, this is where the discussion of follow on strategies and if you should have reserves come into play. If you’re a seed stage firm, say for biotech, using the above example, by the A, your asset might have appreciated too much for you to double down. In that case, as a fund manager, you may not need to deploy reserves into the current market. Or you may not need as large of a reserve pool as you might suspect. It’s for this reason that many fund managers often underallocate because they overestimate how much in reserves they need.
If you’re curious to play around with the model yourself, ping Arkady at ak@rpv.global, and you can mention you found out about it through here. 😉
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.
Recently, I’ve been chatting with a number of GPs and LPs looking to make their first hires. Many of whom hadn’t built a team prior. Now I’m no expert, nor would I ever claim to be one. But I’ve been very lucky to hire and work with some stellar talent.
They asked me how I think about interviewing, selecting, as well as onboarding. I’ll save the last of which for a future blogpost, but for the purpose of this one, if you frequent this blog, you’ll know I love good questions. And well, I get really really nerdy about them. So, as I shared my four favorite, nonobvious interview questions as of late with them (some I’ve used more than others), I will also share them with you.
I won’t cover the table stakes. Why are you excited to be here? What skills are you a B+/A- at? And what are you A+++ in? Why you? Etc.
If you had to hire everyone based only on you knowing how good they are at a certain video game, what video game would you pick?
I recently heard Patrick O’Shaughnessy ask that question to a guest on his podcast, and I found it inextricably profound. While the question was directed at Palmer Luckey, who has a past in video games, the words “video game” can easily be replaced by any other activity or topic of choice and be equally as revealing. Be it sports. Or an art form. Or how they grasp a certain topic. Even, putting them in front of a Nobel Prize winner and see how quickly they realize they’re in front of one.
The last example may be stretching it a bit, but has its origin in one of my favorite fun facts about the CRT — the cognitive reflection test. Effectively, a test designed to ask the minimum number of questions in order to determine someone’s intelligence. But in a parodical interpretation of the test, two of the smartest minds in the world, Daniel Kahneman and Amos Tversky, decided to make an even shorter version of the test to measure one’s intelligence. The test would be to see that if one were to put you in front of Amos Tversky, one of the most humble human beings out there despite his intelligence, how long it would take you to realize that the person sitting across from you was smarter than you. The shorter it took you, the smarter you were. But I digress (although there’s your fun fact for the day).
The reality is that any activity that requires a great amount of detail, nuance, resilience, frustration and failure probably qualify to be mad-libbed into that question. Nevertheless, it’s quite interesting to see what someone would suggest, and a great way of:
Assessing how deep a candidate can go deep on a particular subject,
How well they can relay that depth of knowledge to a layperson, and
How they build a framework around that.
I hate surprises. Can you tell me something that might go wrong now so that I’m not surprised when it happens?
Simon Sinek has always been one for great soundbites. And the above question is no exception. It’s a great way of asking what is one of your weaknesses. Without asking what is your weakness? Most, if not all hiring managers are probably accustomed to getting a rose-tinted “weakness” that turns out is a strength when asking the weakness question to candidates. It is, after all, in the candidate’s best interest to appear the most suitable for the job description as possible. And the JD doesn’t include anything about having weaknesses. Only strengths… and responsibilities.
At the same time, while the weakness question makes sense, when there is an honest answer, I’ve seen as many hiring managers use the associated answer to discount a candidate’s ability to succeed in the role, before given the chance. While this is still throwing caution to the wind, for one to be open-minded when asking this question, at the very least, you’re more likely to get an honest one. At least until this question becomes extremely popular.
Another version, thought a lot more subtle, is: What three adjectives would you use to describe your sibling?
I won’t get into the nuances here, but if you’re curious for a deeper dive, would recommend reading this blogpost. The TL;DR is that when we describe others (especially those we know well), we often use adjectives that juxtapose how we see ourselves in relation to them.
What did you do in your last role that no one else in that role has ever done?
This is one of my favorite professors, Janet Brady’s, favorite questions, and ever since I learned of it, it’s been mine as well. Your mileage may vary. Of particular note, I look for talent with entrepreneurial natures to them. Most of what I work on are usually pre-product-market fit in nature. In other times, and not mutually exclusive to the former, requires us to re-examine the status quo. What got us here — as a team, as a company, as an industry, or as a citizen of the world — may not get us there.
And there is bias here in that I enjoy working with people who push the boundaries rather than let the boundaries push them. And I love people who have asked the question “What if?” in the past and has successfully executed against that, even if it meant they had to try, try again.
What haven’t you achieved that you want to achieve?
Steven Rosenblatt has always been world-class at hiring. By far, one of the best minds when it comes to scaling teams. For a deeper dive, and some of his other go-to questions, I highly recommend checking out this blogpost.
When you’re building a world-class team, you need people to self-select themselves in and out of the culture in which you want to build. Whether it’s Pulley’s culture of move fast and ruthlessly prioritize to build a high-performance “sports team or orchestra” or On Deck’s non-values, it’s about making it clear that you’re in not because you’re peeking through rose-tinted glasses, but that you know full well, that you will be confronted by reality, yet you still remain optimistic. To do that, you need:
A tight knit team who hold the same values
And folks with a chip on their shoulder
The latter is the essence of what Steven gets at with the above question. And does one’s selfish motivation align with where the company wants to go and what the role will entail.
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.
