If you’ve been following me on Twitter recently, you might have noticed I’m working on a new blogpost for the emerging LP. One that I’m poorly equipped personally to talk about, but one that I know many LPs are not. Hence, I’ve had the opportunity to sit down with a number of LPs (limited partners – people who invest in venture funds) and talk about what is the big question GPs need to answer to get LP money, specifically institutional LP money.
And it boils down to this question:
Why does the world need another venture fund?
Most LPs think it doesn’t. And it is up to the GP to convince those LPs why they should exist. For most institutional LPs, even those who mean to back emerging managers, to invest in a new manager, they have to say no to an existing manager. While data has historically shown that new managers and small funds often outperform larger, more established funds on TVPI, DPI, and IRR, when institutional LPs invest in a Fund I, it’s not just about the Fund I, but also the Fund II and Fund III.
For those who reading who are unfamiliar with those terms, TVPI is the total value to paid-in capital. In other words, paper returns and the actual distributions you give back to LPs. DPI, distributions to paid-in capital, is just the latter – the actual returns LPs get in hand. IRR, internal rate of return, is the time value of money – how much an LP’s capital appreciates every year.
It’s a long-term relationship. Assuming that you fully deploy a fund every three years, that’s a 19-year relationship for three funds. Three years times three funds, with each fund lasting ten years long. If you ask for extensions, that could mean an even longer relationship.
But the thing is… it’s not just about returns. After all, when you’re fundraising for a Fund I, you don’t have much of a track record as a fund manager to go on. Even if you were an active angel and/or syndicate lead, most have about 5-6 years of deals they’ve invested in. Most of which have yet to realize.
So, instead, it’s about the story. A narrative backed by numbers of what you see that others don’t see. Many institutional LPs who invest in emerging managers also invest directly into startups. I’ve seen anywhere from 50-50 to 80-20 (startups to funds). And as such, they want to learn and grow and stay ahead of the market. They know that the top firms a decade ago were not the top firms that are around today. In fact, a16z was an emerging fund once upon a time back in 2009.
Of course, anecdotally, from about 15-ish conversations with institutional LPs, they still want a 4-5x TVPI in your angel investing track record as table stakes, before they even consider your story.
The DGQ series is a series dedicated to my process of question discovery and execution. When curiosity is the why, DGQ is the how. It’s an inside scoop of what goes on in my noggin’. My hope is that it offers some illumination to you, my readers, so you can tackle the world and build relationships with my best tools at your disposal. It also happens to stand for damn good questions, or dumb and garbled questions. I’ll let you decide which it falls under.
Subscribe to more of my shenaniganery. Warning: Not all of it will be worth the subscription. But hey, it’s free. But even if you don’t, you can always come back at your own pace.
Any views expressed on this blog are mine and mine alone. They are not a representation of values held by On Deck, DECODE, or any other entity I am or have been associated with. They are for informational and entertainment purposes only. None of this is legal, investment, business, or tax advice. Please do your own diligence before investing in startups and consult your own adviser before making any investments.
As I am co-leading a VC fellowship with DECODE (and here’s another shameless plug), a few fellows asked me if I had a repository of questions to ask founders. Unfortunately, I didn’t. But it got me thinking.
There’s a certain element of “Gotcha!” when an investor asks a founder a question they don’t expect. A question out of left field that tests how well the founders know their product, team or market. In a way, that’s the sadist inside of me. But it’s not my job, nor the job of any investor, to force founders to stumble. It’s my job to help founders change the world for the better. By reducing friction and barriers to entry where I can, but still preparing them as best as I can for the challenges to come.
I’m going to spare you the usual questions you can find via a quick Google search, like:
What is your product? And who is your target audience?
How big is your market? What is your CAGR?
What is your traction so far?
How are you making money? What is your revenue model?
And many more where those come from.
Below are the nine questions I find the most insightful answers to. As well as my rationale behind each. Some are tried and true. Others reframe the perspective, but better help me reach a conclusion. I do want to note that the below questions are described in compartmentalized incidents, so your mileage may vary.
Here’s to forcing myself into obsolescence, but hopefully, empowering the founders reading this humble blog of mine to go further and faster.
The questions
I categorize each of the below questions into three categories:
The market (Why Now)
The product (Why This)
And, the team (Why You)
Together, they form my NTY thesis. The three letters ordered in such a way that it helps me recall my own thesis, in an unfortunate case of Alzheimer’s.
Why Now
What are your competitors doing right?
This is the lesser-known cousin of “What are your product’s differentiators?” and “Why and how do you offer a better solution than your competitors?”. Founders are usually prepared to answer both of the above questions. I love this question because it tests for market awareness. Too often are founders trapped in the narratives they create from their reality distortion fields. If you really understand your market, you’ll know where your weaknesses are, as well as where your competitors’ strengths are.
There have been a few times I’ve asked this question to founders, and they’d have an “A-ha!” moment when replying. “My competitors are killing it in X and Y-… Oh wait, Y is our value proposition. Maybe I should be prioritizing our company’s resources for Z.”
Why is now the perfect time for your product to enter the market?
As great as some ideas are, if the market isn’t ripe for disruption, there’s really no business to be made here… at least, not yet. What are the underlying political, technological, socio-economical trends that can catapult this idea into mass adoption?
For Uber, it was the smartphone and GPS. For WordPress and Squarespace, it was the dotcom boom. And, for Shopify, it was the gig economy. For many others, it could be user habits coming out of this pandemic that may have started during this black swan event, but will only proliferate in the future. As Winston Churchill once said, “Never let a good crisis go to waste.”
A great way to show this is with numbers. Especially your own product’s adoption and retention metrics. Numbers don’t lie.
What did your customers do/use before your product?
What are the incumbent solutions? Have those solutions become habitual practices already? How much time did/do they spend on such problems? What are your incumbents’ NPS scores? In answering the above questions, you’re measuring indirectly how willing they are to pay for such a product. If at all. Is it a need or a nice-to-have? A 10x better solution on a hypothetical problem won’t motivate anyone to pay for it. A 10x on an existing solution means there’s money to be made.
Before we can paint the picture of a Hawaiian paradise, there must have been several formative volcanic eruptions. It’s rare for companies to create new habits where there weren’t any before, or at least a breadcrumb trail that might lead to “new” habits. As Mark Twain says, “History doesn’t repeat itself, but it often rhymes.”
Why This
What does product-market fit look like to you?
Most founders I talk to are pre-product-market fit (PMF). The funny thing about PMF is that when you don’t have it, you know. People aren’t sticking around, and retention falls. Deals fall through. You feel you’re constantly trying to force the product into your users’ hands. It feels as if you’re the only person/team in the world who believes in your vision.
On the flip side, when you do have PMF, you also know it. Users are downloading your product left and right. People can’t stop using and talking about you. Reporters are calling in. Bigger players want to acquire you. The market pulls you. As Marc Andreessen, the namesake for a16z, wrote, “the market pulls product out of the startup.”
The problem is it’s often hard to define that cliff when pre- becomes post-PMF. While PMF is an art, it is also a science. Through this question, I try to figure out what metrics they are using to track their growth, and inevitably what could be the pull that draws customers in. What metric(s) are you optimizing for? I wouldn’t go for anything more than 2-3 metrics. If you’re focusing on everything, you’re focusing on nothing. And of these 1-3 metrics, what benchmark are you looking at that will illustrate PMF to you?
For example, Rahul Vohra of Superhuman defines PMF with a fresh take on the NPS score, which he borrows from Sean Ellis. In feedback forms, his team asks: “How would you feel if you could no longer use the product?” Users would have three choices: “very disappointed”, “somewhat disappointed”, and “not disappointed”. If 40% or more of the users said “very disappointed”, then you’ve got your PMF.
Founders don’t have to be 100% accurate in their forecasts. But you have to be able to explain why and how you are measuring these metrics. As well as how fluctuations in these metrics describe user habits. If founders are starting from first principles and measuring their value metric(s), they’ll have their priorities down for execution. Can you connect quantitative and qualitative data to tell a compelling narrative? How does your ability to recognize patterns rank against the best founders I’ve met?
If in 18 months, this product fails. What is the most likely reason why?
This isn’t exactly an original one. I don’t remember exactly where I stumbled across this question, but I remember it clicking right away. There are a million and one risks in starting a business. But as a founder, your greatest weakness is your distraction – a line in which the attribution goes to Tim Ferriss. Knowing how to prioritize your time and your resources is one of the greatest superpowers you can have. Not all risks are made equal.
As Alex Soktold me a while back, “You can’t win in the first quarter, but you can lose in the first quarter.” The inability to prioritize has been and will continue to be one of the key reasons a startup folds. Sometimes, I also walk down the second and third most likely reason as well, just to build some context and see if there are direct parallels as to what the potential investment will be used for.
On the flip side, one of my favorite follow-ups is: If in 18 months, this product wildly succeeds. What were its greatest contributing factors?
Similar to the former assessing the biggest threats to the business, the latter assesses the greatest strengths and opportunities of this business. Is there something here that I missed from just reading the pitch deck?
What has been some of the customer feedback? And when did you last iterate on them?
I’m zeroing in on two world-class traits:
Open-mindedness and a willingness to iterate based on your market’s feedback. As I mentioned earlier with Marc Andreessen’s line, “the market pulls product out of the startup.” Your product is rarely ever perfect from the get-go, but is an evolving beast that becomes more robust the better you can address your customer’s needs.
Product velocity. How fast are your iteration cycles? The shorter and faster the feedback loop the better. One of the greatest strengths to any startup is its speed. Your incumbents are juggernauts. They’ll need a massive push for them to even get the ball rolling. And almost all will be quite risk-averse. They won’t jump until they see where they can land. Use that to your advantage. Can you reach critical mass and product love before your incumbents double down with their seemingly endless supply of resources?
Why You
What do you know that everyone else doesn’t know, is underestimating, or is overlooking?
Are you a critical thinker? Do you have contrarian viewpoints that make sense? Here, I’m betting on the non-consensus – the non-obvious. While it’s usually too early to tell if it’s right or not, I love founders who break down how they arrived at that conclusion. But if it’s already commonly accepted wisdom, while they may be right, it may be too late to make a meaningful financial return from that insight.
But if you do have something contrarian, how did you learn that? I’m not looking for X years of experience, while that would be nice, but not necessary. What I’m looking for is how deep founders have gone into the idea maze and what goodies they’ve emerged with.
Why did you start this business?
Here, unsurprisingly, I’m looking for two traits:
Your motivation. I’m measuring not just for passion, but for obsession and the likelihood of long-term grit. In other words, if there is founder-market fit. Do you have a chip on your shoulder? What are you trying to prove? And to whom? Do you have any regrets that you’re looking to undo?
Most people underestimate how bad it’s going to get, while overestimating the upside. The latter is fine since you are manifesting the upside that the wider population does not see yet. But when the going gets tough, you need something to that’ll still give you a line of sight to the light at the end of the tunnel. Selfless motivations keep you going on your best days. Selfish motivations keep you going on your worst days.
Your ability to tell stories. Before I even attempt to be sold by your product or your market, I want to be sold on you. I want to be your biggest champion, but I need a reason to believe in the product of you. You are the product I’m investing in. You’re constantly going to be selling – to customers, to potential hires, and to investors. As the leader of a business, you’re going to be the first and most important salesperson of the business.
What do you and your co-founders fundamentally disagree on?
No matter how similar you and your co-founders are, you all aren’t the same person. While many of your priorities will align, not all will. My greatest fear is when founders say they’ve never disagreed (because they agree on everything). To me, that sounds like a fragile relationship. Or a ticking time bomb. You might not have disagreed yet, but having a mental calculus of how you’ll reach a conclusion is important for your sanity, as well as the that of your team members. Do you default on the pecking order? Does the largest stakeholder in the project get the final say after listening to everyone’s thoughts?
Co-founder and CEO of Twilio, Jeff Lawson, once said: “If your exec team isn’t arguing, you’re not prioritizing.”
I find First Round’s recent interview with Dennis Yu, Chime’s VP of Program Management, useful. While his advice centers around high-impact managers, it’s equally as prescient for founding teams. Provide an onboarding guide to your co-founders as to what kind of person are you, as well as what kind of manager/leader you are. What does your work style look like? What motivates you? As well as, what are your values and expectations for the company? What feedback are you working through right now?
In closing
Whether you’re a founder or investor, I hope these questions and their respective rationale serve as insightful for you as they did for me. Godspeed!
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!
In the venture world, the word timing is thrown around in a very canonical way. Many investors and founders mythologize the concept of timing around a business. While there is some science and data that might be able to point in the general direction, success is a lagging indicator of timing. And arguably, the only way anyone can really determine if the timing is right or not is in hindsight. Investors that said they knew the exact timing of the market may just be attributing their success to survivorship bias.
To analogize it, it’s the same as knowing when to invest in the market or in a particular stock. Everyone wants to buy at the lowest, sell at the highest. Your ROI is positively correlated with the sell price, and negatively correlated with the buy price. But when is the lowest? No one really knows for certain. We can guesstimate a timeframe with reasonable confidence, but that’s the best we can do. The same is true for measuring timing in the market. Yet there is one thing that I’ve come to learn in my years in the venture world that’s as close as you can get to the “true” timing of the market. A miracle.
Let me explain.
One miracle
Every startup needs one miracle to succeed. One. No more. No less. Elad Gil said in an interview with James Currier at nfx, “Every startup needs to have a single miracle… If your startup needs zero miracles to work, it probably isn’t a defensible startup. If your startup needs multiple miracles, it probably isn’t going to work.” He further elaborates, “If you have more than one, you have compounding small odds and that means you’re very, very likely to fail.”
Before that miracle, if you’re truly creating a revolutionary business, by definition, you’re in the non-consensus. You have more non-believers than you do believers. If it were an obvious business, then everyone would do it. If everyone does it, economically-speaking, the ROI is low. In a situation, where every kid sells lemonade with the exact same recipe by the street corner, everyone is fighting for the exact same customers. Eventually, it’ll lead to a race to the bottom.
That single miracle is going to be that trial by fire. The true test of grit and founder obsession. That trial, whenever it is, predictable or not, determines if your product will stay a niche idea (and possible fizzle into obscurity) or a business that will change the world. For you and your business, that miracle could have been catalyzed by the pandemic, the GME short squeeze, ’08 recession (if you’re an older business), the inauguration, or something yet to come. The question is: How do you respond in the face of adversity?
Why is that miracle important?
Tim Ferriss once said, “Your superpower is very often right next to your wound, like your biggest wound. […] They’re often two sides of the same coin.” If you can survive and conquer that trial, the miracle – your superpower – becomes one of your strongest moats. The lessons you learned, the trust you (re)built, and the legacy you begin to construct. Those lessons – those earned secrets – while not impervious, will ideally be incredibly hard to obtain for others without walking through fire. A metamorphic journey from a vulnerable caterpillar to a beautiful monarch. What Joseph Campbell calls the “hero’s journey“.
And in the longer time horizon, that you are no longer just the protagonist of that miracle, but that you are also a producer of miracles for others. You are then capable of minting miracles systematically. Be it your customers, your team members, and your investors.
Why #unfiltered?
You might be wondering why I tagged this essay as #unfiltered. Frankly, it’s a new unrefined hypothesis that I’ve been playing around with. While it’s been inspired by others, I believe there’s more nuance I still need to uncover as well. That I’ll need to test a bit more to see if it can be a more robust thesis.
Going forward, I will continue to ask founders questions like:
What is the origin story of this idea?
If you were to fail in 18 months, what would be the most likely reason why?
Conversely, if you were to wildly succeed in that same time frame, what would be the biggest contributor?
Why are you a different person today than when you started this business? Who/what catalyzed this/these change(s)?
Examples of who: customers, team, partners, investors
Examples of what: black swan events, market trends, socio-economic habits, new technologies, an inflection point in your life when you faced impossible odds, failures, etc.
But I’ll be particularly looking for the earned secret among a miracle of adversity. Simply put, I’m looking to hear this song play in the background. The beginning of a mythical legend in the making.
#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!
As a result of my commitment to provide feedback for every founder who wants a second (or third) pair of eyes on their pitch deck, I’ve been jumping on 30-minute to 1-hour calls with folks. Although I’ve had this internal commitment ever since I started in venture, I didn’t vocalize it until earlier this year. And you know, realistically, this is not gonna scale well… at all. But hey, I’ll worry about that bridge when I cross it.
Something I noticed fairly recently, which admittedly may partly be confirmation bias ever since I became cognizant of it, is that there have been a significant number of founders currently fundraising who complain to me about:
Many VCs don’t have their investment thesis online/public.
Of those that are, VCs have “too broad” of a thesis.
So, it got me thinking and asking some colleagues. And I will be the first to admit this is all anecdotal, limited by the scope of my network. But it makes sense. That said, if you think I missed, overlooked, over- or underestimated anything, let me know.
The Exclusionary Biases
By virtue of specificity, you are, by definition, excluding some population out there. For example, in focusing only on potential investments in the Bay, you are excluding everyone else outside or can’t reach the Bay in one way or another. Here’s another. Let’s say you look for founders that are graduates from X, Y, or Z university. You are, in effect, excluding graduates from other schools, but also, those who haven’t graduated or did not have the opportunity to graduate at all.
The seed market example
Here’s one last one. This is more of an implicit specificity around the market. The (pre-) seed market is designed for largely two populations of founders:
Serial entrepreneurs, who’ve had at least one exit;
And, single-digit (or low double) employees of wildly successful ventures.
Why? You, as a founder, are at a stage where you have yet to prove product-market fit. Sometimes, not even traction to back it up. And when you’re unable to play the numbers game (like during the stages at the A and up), VCs are betting on the you and your team. So, to start off, we (and I say that because I’ve been guilty of overemphasizing this before) look into your background.
What did your professional career look like before this?
Do you have the entrepreneurial bone in your body?
Here’s some context of what the idea maze might look like in another post I wrote.
The delta between a good investor and a great investor
Let’s say an investor were to be approached by two founders with the exact same product, almost identical team, same amount of traction, same years of experience, and let’s, for argument’s sake, have spent the same number of years contemplating the problem, but the only difference is where they came from. One is a first-time founder from [insert corporate America]. The other is the 5th employee of X amazing startup. Many VCs I’ve talked with would and have defaulted on the latter. And the answer is reinforced if the latter is a founder with an exit.
The question wasn’t made to be fair. And, it’s not fair. To the VCs’ credit, their job is to de-risk each of their investments. Or else, it’d be gambling. One way to do so is to check the founder’s professional track record. But the delta here that differentiates the good from the great investor is that great investors pause after given this information and right before they make a conclusion. That pause that gives them time to ask and weigh in on:
What is this founder(s)’ narrative beyond the LinkedIn resume?
Shifting the scope
It’s not about the quantitative, but about the qualitative. It’s not about the batting average, but about the number and distance of the home runs. So instead of the earlier question:
How long have you spent in the idea maze?
And instead…
What have you learned in your time in the idea maze?
Similarly, from what I’ve gathered from my friends in deep/frontier tech, instead of:
How many publications have you published?
And instead…
Where are you listed in the authorship of that research? The first? The second? The 20th?
For context of those outside of the industry, where one is listed defines how much that person has contributed towards the research.
As a slight nuance, there are some publications, where the “most important” individual is listed last. Usually a professor who mentored the researchers, but not always.
And, how many times has your research been cited?
Some more context onto specificity
Some other touch points on why (public) investment theses are broad:
FOMO. Investors are scared of the ‘whats if’s’. The market opportunity in aggregate is always smaller than the opportunity in the non-aggregate.
Hyper-specific theses self-selects founders out who think they’re not a ‘perfect fit’. Very similar to job posts and their respective ‘requirements’.
Some keep their thesis broad in the beginning before refining it over time. This is more of a trend with generalist funds.
Theses are broad by firm, but more specific by partner. The latter of which isn’t always public, but can generally be tracked by tracking their previous investments, Twitter (or other social media) posts, and what makes them say no. Or simply, by asking them.
The pros of specificity
Up to this point, it may seem like specificity isn’t necessarily a good thing for an investor. At least to put out publicly.
But in many cases, it is. It helps with funneling out noise, which makes it easier to find the signals. It may mean less deal flow, which means less ‘busy’ work. But you get to focus more time on the ones you really care about. And hopefully lead to better capital and resource allocation. The important part is to check your biases when honing the thesis. Also, happens to be the reason why LPs (limited partners – investors who invest in VCs) love multi-GP funds (ideally of different backgrounds). Since there are others who will check your blind side.
Specificity also works in targeting specific populations that may historically be underrepresented or underestimated. Like a fund dedicated to female founders or BIPOC founders or drop-outs or immigrant founders. Broad theses, in this case, often inversely impact the diversity of investments for a fund. When you’re not focusing on anyone, you’re focusing on no one. Then, the default goes back to your track record of investments. And your track record is often self-perpetuating. If you’ve previously backed Stanford grads, you’re most likely going to continue to attract Stanford grads. If you’ve previously backed white male founders, that’ll most likely continue to be the case. In effect, you’re alienating those who don’t fit the founder archetype you’ve previously invested in.
In closing
We are, naturally, seekers of homogeneity. We naturally form cliques in our social and professional circles. And the more we seek it – consciously and subconsciously, the more it perpetuates in our lives. Focus on heterogeneity. I’m always working to consider biases – implicit and explicit – in my life and seeing how I’m self-selecting myself out of many social circles.
Whether you, my friend, are an investor or not. Our inputs define our outputs. Much like the food we put in our body. So, if there’s anything I hope you can take away from this post, I want you to:
Take a step back,
And examine what personal time, effort, social, and capital biases are we using to set the parameters of our investment theses.
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!
Last week I spent some time with my friend, who joined me in my recent social experiment, brainstorming and iterating on feedback. Specifically, how I could host better transitions between presentations. She left me with one final resonating note. “Maybe you would’ve liked a creative writing class.”
I’ve never taken any creative writing courses. I thought those courses were designed for aspiring writers. And given my career track, I never gave it a second thought. Well, until now. I recently finished a brilliant fictional masterpiece, Mistborn: The Final Empire written by #1 New York Times bestselling author, Brandon Sanderson. So, that’s where I began my creative journey.
In my homework, I came across his YouTube channel. One of his lectures for his 2020 BYU writing students particularly stood out. In it, he shares his very own Sanderson’s Laws.
The three laws that govern his scope of worldbuilding are as follows:
Your ability to solve problems with magic in a satisfying way is directly proportional to how well the reader understands said magic.
Flaws/limitations are more interesting than powers.
Before adding something new to your magic (setting), see if you can instead expand what you have.
Outside of his own books, Sanderson goes in much more depth, citing examples from Lord of the Rings, Star Wars, and more. So, if you have the time, I highly recommend taking one and one-fifth of an hour to hear his free class. Or if you’re more of a reader, he shares his thesis on his First Law, Second Law, and Third Law on his website.
But for the purpose of this post, the short form of the 3 laws suffices.
The First Law
Your ability to solve problems with magic in a satisfying way is directly proportional to how well the reader understands said magic.
The same is true in the world of entrepreneurship. Your ability to successfully fundraise is directly proportional to how well the investor understands your venture. Or more aptly put, how well you can explain the problem you are trying to solve. This is especially true for the 2 ends of the spectrum: deep tech/frontier tech startups and low-tech, or robust anti-fragile products/business models. Often times, the defensibility of your product comes down to how well people can understand what pain points you’re trying to solve. You may have the best product on the market, but if no one understands why it exists, it’s effectively non-existent.
Though not every investor will agree with me on this, I believe that too many founders jump straight into their product/solution at the beginning of their pitch deck. While it is important for a founder to concisely explain their product, I’m way more fascinated with the problem in the market and ‘why now?’.
You’re telling a story in your pitch. And before you jump into the plot (the product itself), I’d love to learn more about the setting and the characters involved (the underlying assumptions and trends, as well as the team behind the product). As my own NTY investment thesis goes (why Now, why This, why You, although not in that particular order), I’m particularly fascinated about the ‘why now’ and ‘why you’ before the ‘why this’. And if I can’t understand that, then it’s a NTY – or in millennial texting terms, no thank you.
My favorite proxy is if you can explain your product well to either a 7-year old, or someone who knows close to nothing about your industry. Brownie points if they’re excited about it too after your pitch. How contagious is your obsession?
The Second Law
Flaws/limitations are more interesting than powers.
Investors invest in superheroes. The underdogs. The gems still in the rough. And especially now, at the advent of another recession and the COVID crisis, the question is:
How much can you do with what little you have?
And, can you make the aggressive decisions to do so?
I realize that this is no easy ask of entrepreneurs. But when you’re strapped for cash, talent, solid pipelines, are you a hustler or are you not? Can you sell your business regardless? To investors? New team members? Clients/paying users?
On the flip side, sometimes you know what you need to do, but just don’t have the conviction to do so, especially for aggressive decisions. You may not want to lay off your passionate team members. Or, let go of that really great deal of a lease you got last year. You may not want to cut the budget in half. But you need to. If you need to extend what little you have to another 12-18 months, you’ve got to read why you should cut now and not later. Whether we like it or not, we’re heading into some rough patches. So brace yourselves.
But as an investor once said to me:
“Companies are built in the downturns; returns are realized in the upturns.”
The Third Law
Before adding something new to your magic (setting), see if you can instead expand what you have.
And finally consider:
Can you reach profitability with what you have without taking additional injections of capital?
Can you extend your runway by cutting your budget now?
But if you need capital to continue, do you need venture capital funding? I’m of the belief, that 90% of businesses out there aren’t fit for the aggressive venture capital model.
How scrappy are you? How creatively can you find solutions to your most pressing problems? And maybe in that pressure, you may find something that the market has never seen before.
In closing
Like a captivating fantastical story, your startup, your team, your investors, and especially you yourself, need that compelling narrative. The hardest moments in building a business is when there’s no hope in sight – when you’re on the third leg of the race. In times of trial, you need to convince yourself, before you can convince others. To all founders out there, godspeed!
And as Sanderson’s Zeroth Law goes:
Always err on the side of what’s awesome.
If you’re interested in the world of creative writing or drawing parallels where I could not, check out Brandon Sanderson’s completely (and surprisingly) free series of lectures on his YouTube channel.
When I first entered venture, I asked a number of VCs:
How do you tell the difference between a good startup and a great startup?
The answer I received from multiple investors was: intuition, which, admittedly, confounded me to no ends. Maybe it is true, that it is intuition, especially after seeing such a large sample size of startups over their careers – that in a heartbeat, they can reasonably tell the difference between a good and a great one. But I didn’t have that sample size. In fact I had a very small, and very biased sample to extrapolate from. The best investors out there were, quite frankly, unconsciously competent, but I was very aware that I was and am consciously incompetent, seeking competency.
So I figured, with enough data points in my sample, as econometrics has taught me through the law of large numbers, eventually I’ll have a sample that’s more or less representative of the population. So, for the past three years, I met with 10-15 tech entrepreneurs every week – self-proclaimed, venture-backed, and anyone in between – in an effort to figure out what intuition as an investor meant. What I found, pre-product-market fit and even pre-unit economics, is that it all stems from what many VCs and angel investors call ‘passion’, or rather what I like to call: obsession.
Why obsession? While I do briefly explain it in my investment thesis, it is a proxy for grit and domain expertise of a founder or founding team, which is strongly correlated with the growth potential of a venture. Obsession keeps you up at night; passion keeps you active during the day. Obsession is a lifestyle; passion is a hobby. Through chatting and tracking various founders and startups at various points in their founding journey – from idea to scale to exit, here are the three telltale signs I found of obsession:
Honesty,
Details,
And a personal vendetta.
Honesty
What do you know? What don’t you know?
The founder(s) are radically honest. They’re readily willing to admit what they know and what they don’t, as well as how they plan to figure out what they don’t. The more obsessed you are, the more you realize there are more questions than answers. What kind of questions do the founders ask themselves? How are they prioritizing and allocating their time?
Entrepreneurship has never been a solo sport, and every founding team could always use as much help as they can get. The only way investors, advisors, and a company board can help is if they know what part needs help. Unfortunately, in the Bay Area, there’s a heavy aura of “fake it till you make it” that’s not only true for founders and investors, myself included at one point in time, but professionals across the board, like a duck swimming across a lake, furiously paddling beneath the surface of the water, but appearing calm and collected above. This facade led to stress, anxiety, and eventually a cycle of depression for many brilliant folks out there, which has only recently gained some awareness in the public eye. Mental health, especially founders’ mental health, is one of the areas I’m tracking pretty closely, in diligence, scouting, and when hosting peer mentorship circles. I don’t require founders to know everything about starting a business or tackling a market risk, nor do I expect them to know everything. All I require is the conviction to solve the seemingly unsolvable, and the honesty to admit it and work together to solve it.
Details
What are your customers telling you?
Just as important as the questions founders ask themselves are the answers they’ve found so far. What have they tested? What are they testing? What will they do if they get X result? Y result? And the customers feel it all. What is resonating with their customers – explicitly and implicitly? What isn’t? And how granular can the founders go?
Each action taken is purposeful and holds some kind of predicted value. These founders are obsessed with details – even the ones that aren’t sexy or won’t wow at face value, yet crucial to the survival and growth of their business. For example, Rahul Vohra, CEO of Superhuman, the world’s fastest email client, takes his feedback surveys extremely seriously. While he goes more in depth in this brilliant podcast episode on 20-Minute VC, he’s able to dissect four questions to be able to assess product-market fit and strategic offerings of features to his product. From a simple question, “How would you feel if you could no longer use Superhuman?”, if 40% or more say ‘Very Disappointed” (out of three options: Very Disappointed, Somewhat Disappointed, and Not Disappointed), then he would have achieved initial product-market fit. Whereas most companies track lagging indicators of interest, like NPS scores, where customers would have made their decision by the time they take the survey, Rahul is obsessed with leading indicators, before customers make their “decision”.
Personal Vendetta
What was your “Eureka!” moment?
Building a business starts with the self, and ends with others. Is it their personal problem? Are they taking revenge on the scar tissue they’ve grown from being bogged down by this problem? Or maybe it’s a problem that means a great deal to someone who means a great deal to them?
I’m always incredibly curious as to why someone would want to be an entrepreneur. It seems to go against the very psychological grain of being a human. Founders are risking the food on the dinner table, sleep, a social life, money, years worth of opportunity costs, sanity, and much much more. Effectively, they’re taking Maslow’s Hierarchy of Needs and flipping it on its head. So I’m always dying to know what compels them to push forward. As one of my mentors back in college once asked me: “What is your selfish motivation?”
Behind all of the fancy-shmancy market maps and industry/trend analysis, where markets start with B as in billion (and one day, we’ll see more markets that start with T as in trillion), or, in 2017, it was crypto-this or blockchain-that, what drives these founders? Don’t get me wrong. All the afore-mentioned analysis is on the forefront of my mind when I look into a startup. What underlying infrastructure or social trend makes this product/service inevitable? How antiquated and/or fragmented is the knowledge or resource acquisition process in this targeted industry? But the truth is, more often than not, I see multiple ventures tackling the same space with almost the same solution. So who’s the winner? In my opinion, the one who’s more obsessed. From the lens of essentialism, instead of “How much do you value this opportunity?”, I’m more interested in “How much would you sacrifice to obtain this opportunity?” Though I’m not looking for a blood ritual, nor do I want to ever get involved in one, I’m looking for founders’ willingness to pursue this full-time over part-time and their resourcefulness (on a limited budget) to get shit done, like when Brian and the team at Airbnb took to photographing their first few living spaces or packing each box of Obama O’s themselves.
And you know you have a winning story to my initial “Eureka!” question when you have the full, undivided attention longer than the first minute of people who are notorious for having low attention spans. A story about a personal vendetta is compelling, inspiring, and most importantly, contagious. And I’ll know this when my eyes start sparkling just like the founders. I may not drop everything in my life and tackle this new dilemma full-time, but I’d be damned if I don’t make sure that founder’s dream becomes a reality.
Final Thoughts
At the end of the day, obsession is inefficient – a human element artificial intelligence has yet to be able to replicate. It’s scrappy. It’s doubling down on things that may not succeed. As the saying goes, you’re wrong until you’re right. But damn, it is magnetic. After all, obsession is human error, at its finest.
I jumped into the fascinating world of venture capital about three years ago. It’s not like I planned it out or had a life-long dream of being in VC. Maybe it was a result of too many bedtime stories from my dad or maybe it was my admiration of Remy from Pixar’s Ratatouille. Either way, I just knew I was enamored innovators and their stories.
Three years in, I don’t claim to know everything, or even anything. After all, a brilliant veteran investor once told me:
“You won’t know if you’re good at it until you’re ten years in.”
And it just so happens that ten years is the average lifetime of a fund. As of now, I’ve accrued quite a bit of unrealized IRR – less so monetarily, but more so in terms of pattern recognition. In this cycle (as I believe, rather than psychology’s four linear stages of competence) of incompetence and competence, I know what I don’t know – my conscious incompetence. But here is what I do know – my (hypo)thesis after reading thousands of pitch decks, meeting 700+ founders and learning from 100+ investors. Granted, a mix of pre-seed, seed, and Series A folks.
Why this?
The first leg of my thesis happens to be the most explicit, and often times, the easiest for founders to answer. Why are you pursuing this problem? What makes your solution appealing to people currently facing this dilemma? And, how are you different from your direct and indirect competitors?
‘Why this?’ is, simultaneously, a question about product and market. How does this product fit in the larger picture of the market? Is the market well-defined, growing, or nascent? How saturated is the market? What is everyone else missing entirely or underestimating?
Why now?
What market forces, technological advancements, and/or social dynamics have made this problem ripe for the taking? Timing is crucial for startups. Too early, the stage has yet to be set. Had Uber or Lyft been founded prior to the smartphone, it would have folded in the blink of an eye against the looming giant of taxis. Same if coding bootcamps came before demand exceeded supply of software engineer roles in technology. Too late, and you’re feeding on scraps, if at all.
Often times, there’s more than one team that realizes the intersection of social, technological, political, and economic trends at the same time. But each might have a unique perspective on why the intersection came to be. The question I ask myself when looking at each potential investment is: What did you catch that makes money, which everyone else underestimating or missing entirely? Of course, it does make it easier when the founder(s) help spell that out for me.
Why you?
Early-stage investing is mostly about the founders, especially when there’s so little numeric evidence the earlier the stage is. Their obsession (similar, but not the same as passion), their grit, their domain expertise, their chemistry, and their ambition.
Obsession. Passion is what keeps you going during the day and when you have free time. It’s what you love. For example, there are many things in this world that I love: swimming, art, travelling, and eating, among many others, but I would never throw away my life to pursue these. After meeting with hundreds of founders, I learned it’s easy to mistake eagerness for passion, especially during the first 30-minute coffee chat. Obsession, on the other hand, is what keeps you going during the night, while burning the midnight oil. It’s what you hate. It’s a personal vendetta, which is catalyzed by a problem that you face first-hand, rather than through market diligence. As one of my good founder buddies, Mike, prompts it:
“How you sleeping?”
On the same token, obsession is contagious and inspiring. It is a key quality I look for, which can reasonably help predict how proficient an entrepreneur is and will be in hiring early team members, as well as onboarding future stakeholders.
Grit is a function of obsession. The more obsessed you are, the easier it is to weather through obstacles during the founding journey. It’s a trait I learned to recognize as a former competitive swimmer. The more obsessed I became with a achieving a certain time, the easier it was for me to overlook the short-term pain for the long-term gain. I could put in 40-hour swim weeks and still be as eager and excited coming out of them. Similarly, I’ve seen obsessed founders be able to pull off cup ramen meals, moving from comfortable houses to stuffy 2-room apartments, and taking rejection after rejection from investors, friends, and family. With limited resources, how much cognitive flexibility does the founding team have? I’m not saying that founders need to live in a garage and have cold pizza to be successful, but I do want to see founders’ ability to be scrappy and resourceful, like Brian Chesky and his team at Airbnb went to each of host’s house to take high-quality pictures for the site or when Michelin created the Michelin Guide for restaurants to help sell their tires.
Domain expertise. One of my favorite questions to ask founders is: “What is each of your competitors doing right?” It’s easy to get bogged down in the thought process of “I’m right, you’re wrong” and many founders that I’ve seen do end up living in a bubble of how “unique” (whether true or not) they are. What separates a good entrepreneur from a great entrepreneur is the ability is to ability to adapt and be open-minded about the changing landscape, which includes getting to know your market, and subsequently, competitors, like the back of your hand. Domain expertise isn’t just understanding the market, the product and the team, but also having accumulated deep, unique insights into all the above and being able to defend each insight. It is one of the few traits that I look for that cannot be static and should grow over time.
Chemistry. Rather than asking how long co-founders have known or worked with each other, I found it more insightful to ask how co-founders would resolve problems between themselves and their first impressions of each other. Both provided me with context on whether pressure and friction can create gems or mashed potatoes.
Ambition. When I first entered the world of venture capital, I thought ambition was a given. I mean, who would want to create a startup if they weren’t ambitious? Over time, I learned there were varying degrees of ambition. Some envisioned transforming an industry, some wanted to be acquired, and some just wanted to be their own boss. None are better or worse than the others, but not all are suited for VC financing. VCs bet big to win big. I’ve watched VCs turn down many great ventures, just because they couldn’t justify their potential ROI to their team, fund, and/or limited partners (LPs for short – the folks who invest in VC funds). Why? VCs take on big, but calculated risks. Because of that philosophy, they expect many misses, but for each investment, they’re hoping that that venture makes back a majority of their fund, if not more. Of course, there are a few other factors that determine VCs return on any investment, but at the very early stages, it’s the first check mark entrepreneurs have to check. You can only catch as much fish as how wide the net you cast.
Conclusion
The uncomfortable truth, especially in the San Francisco Bay Area, where people from around the world come to build a dream, is that not all ventures are meant for the venture capital model. VCs ask founders to tackle aggressive schedules and metrics, whether it’s the Rule of 40 for SaaS startups, or the minimum Month-over-Month growth of 30%, as I was first taught. There are many profitable startups and brilliant builders out there that are excluded from the VC model.
My friends and colleagues call it my NTY thesis – the millennial abbreviation for “No thank you”. When I first started scouting, it was all about finding the best ones out there. It was saying “yes” to each opportunity to each conversation – quantity. But when I reached critical mass, had started developing an investment thesis, in conjunction with learning how other theses came to be, it wasn’t about quantity anymore; it was about quality. It wasn’t about finding; it was about eliminating. The hardest part for me was turning my eager “yes’s” to reluctant, but necessary “no’s.” A good mentor of mine once said:
“If you can’t say no, don’t invest.”
Although I have yet to invest in these startups, the calculus is the same. I really boil it into one final question: Am I willing to risk my political or social capital with my connections for your venture? Is there something about the founder and/or startup I can nerd out about? It could be an extraordinary track record for getting shit done. It could be brilliant traction. It could be a unique insight. What really tips the scale is the secret sauce.
