The Warriors went through one hell of a season. Even as someone who doesn’t live and breathe basketball, watching Stephen Curry this past season, especially during the finals with the Celtics was a thrill out of this world. He is undeniably one of the greats! Yet it’s fascinating to think that the world didn’t always see him as such. From being a 3-star recruit to the 256th-ranked player in 2006 to 7th pick in 2009, Curry’s gone a long way.
Stephen Curry really went from a 3-star recruit and the 256th-ranked player in the 2006 class to a 4x NBA Champion and the best 3-pt shooter in history. Absolutely incredible. pic.twitter.com/LLb8J3O33K
Though he recently won an Academy Award for Best Original Score for his music on Dune, Hans Zimmer‘s early music career was not easy. He had been thrown out of eight schools and only had two weeks of piano lessons. Yet today he is undeniably one of the greatest composers of our time.
When Stan Lee first pitched Spider-Man, his publisher thought it was “the worst idea I have ever heard.” The publisher himself told one of the greatest storytellers: “First of all, people hate spiders, so you can’t call a book Spider-Man. Secondly he can’t be a teenager—teenagers can only be sidekicks. And third, he can’t have personal problems if he’s supposed to be a superhero—don’t you know who a superhero is?'” The rest… is history.
In the making of Star Wars, George Lucas was rejected time and time again – from Disney to United Artists to Universal. And the one bet that 20th Century Fox took on him was for only a budget of $8M, that eventually became a $10M budget, when at the time, the best blockbuster films all had budgets of $20-30M. Yet, today Star Wars stands as one of the greatest cultural assets of the 20th and 21st century.
In the world of startups, the world’s most valuable companies are worth more than four times and raised half as much as the world’s most funded companies. Funding, in many ways, is a proxy for investor optimism in the early days that this company will be the next big thing. But investors, like any other person, can be wrong. In fact, startup investors are often wrong more often than they’re right. But it also goes to say the world’s best companies are non-obvious, in the non-consensus. In other words, underestimated.
As the above graphic shows, even if one picks right, we still grossly underestimate the potential of outliers. After all, humans are terrible at tracking nonlinearities:
The Post-it note was an result of a failed experiment to create stronger adhesives. But Dr. Spencer Silver, its inventor, kept at it, which led to his nickname as “Mr. Persistent” because he wouldn’t give up. Today, Post-it notes are sold in more than 100 countries, and over 50 billion are produced every year.
Google, one of the most recognizable names today, struggled to raise capital and find customers in the early days. Who needed another search engine? For 1.5 years, every search company approached by Larry and Sergey to consider Google’s tech turned them down. The pair funded Google on their credit cards and couldn’t even afford to hire a designer so regressed to minimalism.
Tope Awotona, founder of Calendly, started three failed businesses and emptied his 401k to fund Calendly. Yet despite his hustle and persistence, most VCs he talked to turned him down. Despite starting in 2013, it wasn’t till 2021 that Calendly had their A-round. Calendly took much longer to get the attention of external funding than many of its counterparts. The company is now one of the most popular scheduling tools and worth $3B.
But even when people got it right, they still underestimated the upside.
Even when Kleiner eventually backed Google, legendary investor John Doerr couldn’t believe it when Larry Page believed that Google could get revenues of $10B.
When Bessemer invested in Shopify, Bessemer thought that the best possible outcome for Shopify was a 3% chance of the company exiting at $400M. As of the time of this essay, it’s worth over 100 times more with a market cap of $43B.
If you invested in Amazon on the first day in 1998 at $5, most people would have sold at $85 in 1999 – a 17x in less than two years. But if they held to today, they would have made a multiple north of 600x. That said, selling itself is more of an art than a science.
… And the list goes on.
As Warren Buffett says, “the rearview mirror is always clearer than the windshield.” Our fallacy with estimation is painfully obvious in hindsight, but dubitably unclear in foresight.
Early on in my venture career, an investor once told me a profound statement. One that I still remember to this day. The best ideas – and often the leaders of tomorrow – often seem crazy at first. And because they’re crazy, they’re nonobvious. They’re in the non-consensus.
As Steve Jobs says, “the ones who are crazy enough to think they can change the world, are the ones who do.” The world’s most transformative individuals and businesses take on many more headwinds than those optimizing for local maxima. But history shows us that those that dream big consistently outperform those optimizing for marginal improvement. While there is nothing wrong with the latter, I hope the above anecdotes serve as a reminder rejection is not a sign of failure. Rather, it’s a sign that most people have yet to see what you see.
Your job is to teach them to see what you see. After all, the only difference between a hallucination and a vision is that other people can see a vision.
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!
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.
I’ve been asked by many founders over the years, “How do I know it’s time to let it go?” And every single person asks me for some length of time. When I tell them I don’t have an “optimal” length of time that would do the question justice, they ask: “When do you usually see other founders you work with let go?” To which, the answer spans as far as the Pacific Ocean. I’ve known folks who work on it for six months before they called it quits. Others for seven years, without external validation. And then some who continue at it past the decade.
Who’s right? Who’s wrong? If I were to be honest, I don’t know. Rather I’ve always believed the independent variable here shouldn’t be time, but rather your emotional state. I’ll elaborate.
The “ideal” emotion to quit with
There’s a timeless apologue about a boiling frog. If you put a frog in boiling water, it’ll jump straight out. But if you put a frog in lukewarm water and slowly increase the heat, it won’t realize it’s dying until it’s too late. It goes to say that the more time you spend in the forest, the harder it is to see the forest itself. As such, this essay is for everyone who is stuck in the forest.
Andy Rachleff of Benchmark and Wealthfront fame has this great line. “I’d love to kill it and I’d hate to kill it. You know that emotion is exactly the emotion you feel when it’s time to shut it down.”
I really love this line because loving to kill something and hating to kill something are on two sides of a spectrum. Oftentimes, if you’d love to kill something, that means you haven’t spent enough time on it. It’s easy to give up on something you care little to nothing about. On the flip side, if you’d hate to kill something, you’ve spent too long on it. Often, an example of sunk cost fallacy. And it’s when these two distinct emotions meet at twilight that you know you’ve put your best effort in. It’s when you feel both of these emotions simultaneously that you can finally let it go.
As I rounding out this blogpost, I thought I’d post on Twitter to tap into the world’s greatest minds alive on Monday. And when my friend Sara shared the below line, I knew she had something better. Something I did not know that I would be remiss not to double click on.
My friend once looked me in the eyes and told me, “You know what your problem is? You’re not a quitter, but you needed to quit a long time ago.” I have a whole methodology about how not to end up back there again. Happy to share.
So I did. And I promise the next few paragraphs from deep within Sara’s mind will change the way you think about quitting.
“You’re not a quitter, but you needed to quit a long time ago.”
“One of the things I learned over the years is that your intuition is probably right. It’s hard to trust though, especially when there is a lot of chaos or noise. Anything unstable from market turbulence to a toxic relationship creates that noise. You need to find quiet time to let your mind relax enough to think clearly.
“Sometimes if you’re anxious, it is hard to be in a spot that’s quiet or still. Don’t feel obligated to be in Zen meditation mode. Personally, I’m not someone who can be still. Instead, I find my quiet time when I walk and think around the water, where I live a block from.
“When I find myself caught between a rock and a hard place, I find myself asking the below questions with neither judgement, shame or guilt:
“If this problem was a house fire, what is my first instinct? If I stay, am I going to get swallowed up in it? Do I want to get a hose to put it out or do I want to add gasoline to it?
“If the answer is gasoline, is it because you’re beyond frustrated? If the reaction is to dump more gasoline, roast marshmallows, and walk away, that means it’s the point of no return. It’s time to quit or bring in someone else to get a fresh perspective. In these situations, the individuals involved tend to want to pick fights out of frustration. They’re combative. They can’t see any way through the problem, and they’re exhausted. It’s time to step away at least temporarily.
“In scenario two, if I’m just sitting there and watching the fire burn while I think about it, I’m stuck in indecision. Create a list of pros and cons, and really think critically about it. If you’re in a team situation, you need to figure out where the rest of your team stands and what the core problem is that needs to be solved in order to be successful. Sometimes it’s a team shift. It’s just one person who wants to call it quits, and the others want to keep going. If you’re in a relationship, you need to be completely honest with yourself and each other about what you both need to do to get things back on track and if you actually want to. The hard part about a slow burn is if you just stay stuck, you have a hard time recognizing when it’s too late.
“Thirdly, there’s the situation where I am motivated to look for the hose. I want to fight the fire. You need to think about what you actually need to do in order to fix the problem. If you’re short on capital, can you extend your runway? Be it sales, outside capital, or cutting your burn. If you’re short on talent, can you bring in world-class talent? Other times, you need to ask yourself does the market really need your product in its current iteration? You need to be really honest and look at it from a third-party perspective. If you don’t know how to fix it, you can always ask others for help. It might not seem like it, but most people are willing to help.
“The takeaway from all of this is that you have to suspend your own judgment and ego. You have to be honest with yourself. The right answer is usually the first answer. Trust your gut with what’s right.
“Sometimes the honesty will hurt. If you’re running a company, at some point, that might mean you might not be the right CEO for your company anymore.”
In closing
The hardest parts about building anything – be it a house, business, relationship, career, family, or passion – are starting it… and ending it. If most people had to pick, they’d say the former is more difficult than the latter. But if you truly love or loved someone or something, the latter is always more difficult. And while the above may not solve all your problems, I hope when the nights are the darkest, that Andy and Sara’s thoughts may light the way.
Thank you Sara for sharing your thoughts with the broader world!
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!
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.
Given the impending, potentially larger market correction, I’ve been thinking a lot about liquidation preferences recently. And it seems I’m nottheonlyone.
Many reasons, two amongst them, concisely:
1) Liq pref results in lower FMV to option-holders, which ostensibly is net +ve for employee equity comp
2) Liq pref makes it so the startup needs to create value. Can't just raise money, immediately return capital, and profit from it
— Matt Levine .eth lol (@Matt_Levine_1) May 26, 2022
I’ve seen three major trends over the past two months:
Founders are raising on smaller multiples compared to the last round. Investors argue it’s come back to the fundamentals. Founders say it’s the market conditions. Regardless, we won’t see the same 2020 and 2021 multiples in the near future.
If a startup is still growing and is cash efficient, valuations won’t have changed as drastically. David Sacksput it best when he said that founders are still going to get well-funded, if they’re:
Cash is king. We’ve seen it in the news all of last month. Founders are extending their runways, by reducing burn. As Marc Andreessensaid 1.5 months ago, “The good big companies are overstaffed by 2x. The bad big companies are overstaffed by 4x or more.” Companies are buckling in for 18-24 month runways, if not longer.
So what?
That goes to say, if a startup isn’t growing as expected, has a high burn, AND still wants to raise an up-round a year out of their last raise, investors are adding in more downside protection provisions. Anti-dilution provisions, minimum hurdle rate expectations, blocks on IPO or M&A opportunities, and liquidation preferences. What Bill Gurley and some VCs call the “dirty term sheet.”
Now I know there’s nuance and reason behind why liquidation preferences were created. To align incentives between the founder and investor. It stops a founder from immediately “selling the business” as soon as the money is in the bank, as Matt Levine mentioned in the above tweet. It also leads to a lower fair market value in a 409a valuation as both Matt and Keith mentioned as well. A net positive for employees, who are looking for lower strike prices to exercise their options in the future.
But as an aggregate, it seems liquidation preferences are really a strategy not to lose rather than a strategy to win. Not just the 1x liquidation preference, but the 2-3x liquidation preferences I’ve been seeing in the side letters offered by VCs.
To put it into context, that means investors get 2-3x their money back before the founders and everyone else gets theirs. By the same token, investors believe that same startup is worth at least 2-3x the money they gave the founders. Again, downside protection.
How does venture differ from other asset classes?
Unlike real estate or public market stocks or bonds, venture capital is a hit-driven business. Success is not measured by percentages, but rather by multiples. High risk, high return.
In a successful venture portfolio of 50 companies, 49 could theoretically be a tax write-off, if one makes you 200 times your capital, you’ve quadrupled your fund. A respectable return for a seed stage fund. As such, liquidation preferences have little impact on fund returns. If you’ve done venture right, your biggest winners account 90% of the fund’s returns. And they are the best pieces of evidence you can use to raise a subsequent fund. Your fund returners are the greatest determinants of your ability to raise the next fund, not how much money you saved after making a bad bet. No one cares if you got your dollar back for dollars you’ve invested towards the bottom of your portfolio, or even 50 cents back on every dollar.
And when a startup wildly succeeds, liquidation preferences don’t matter since everyone is getting a massive check in the mail, far exceeding any downside protection provisions.
In closing
Of course, as always, I might be missing something here, but preferred shares feel like a vestigial part of venture capital – thanks to our history with other financial services businesses.
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!
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.
Humans are terrible at understanding percentages. I’m one of them. An investor I had the opportunity to work with on multiple occasions once told me. People can’t tell better; people can only tell different. It’s something I wrestle with all the time when I hear founder pitches. Everyone claims they’re better than the incumbent solution. Whatever is on the market now. Then founders tell me they improve team efficiency by 30% or that their platform helps you close 20% more leads per month. And I know, I know… that they have numbers to back it up. Or at least the better founders do. But most investors and customers can’t tell. Everything looks great on paper, but what do they mean?
When the world’s wrapped in percentages, and 73.6% of all statistics are made up, you have to be magnitudes better than the competition, not just 10%, 20%, 30% better. In fact, as Sarah Tavel puts it, you have to be 10x better (and cheaper). And to be that much better, you have to be different.
And keep it simple. As Steve Jobs famously said that if the Mac needed an instruction manual, they would have failed in design. Your value-add should be simple. Concise. “We all have busy lives, we have jobs, we have interests, and some of us have children. Everyone’s lives are just getting busier, not less busy, in this busy society. You just don’t have time to learn this stuff, and everything’s getting more complicated… We both don’t have a lot of time to learn how to use a washing machine or a phone.”
If you need someone to learn and sit down – listen, read, or watch you do something, you’ve lost yourself in complexity.
“Big-check” sales is a game of telephone. For enterprise sales or if you’re working with healthcare providers, the sales cycle is long. Six to nine months, maybe a year. The person you end up convincing has to shop the deal with the management team, the finance team, and other constituents.
For most VCs writing checks north of a million, they need to bring it to the partnership meeting. Persuade the other partners on the product and the vision you sold them.
And so if your product isn’t different and simple, it’ll get lost in translation. Think of it this way. Every new person in the food chain who needs to be convinced will retain 90% of what the person before them told them. A 10% packet loss. The tighter you keep your value prop, the more effective it’ll be. The longer you need to spend explaining it with buzzwords and percentages, the more likely the final decision maker will have no idea why you’re better.
Humans are terrible at tracking nonlinearities. While we think we can, we never fully comprehend the power law. Equally so, sometimes I find it hard to wrap my hear around the fact that 20% of my work lead to 80% of the results. While oddly enough, 80% of my inputs will only account for 20% of my results. The latter often feels inefficient. Like wasted energy. Why bother with most work if it isn’t going to lead to a high return on investment.
Yet at the same time, it’s so far to tell what will go viral and what won’t. Time, energy, capital investments that we expect to perform end up not. While every once in a while, a small project will come out of left field and make all the work leading up to it worth it.
When I came out with my blogpost on the 99 pieces of unsolicited advice for founders last month, I had an assumption this would be a topic that my readers and the wider world would be interested in. At best, performing twice as well than my last “viral” blogpost.
Cup of Zhou readership as of April 2022
Needless to say, it blew my socks off and then some. My initial 99 “secrets”, as my friends would call it, accounted for 90% of the rightmost bar in the above graph. And the week after, I published my 99 “secrets” for investors. While it achieved some modest readership in the venture community and heartwarmingly enough was well-received by investors I respected, readership was within expectations of my previous blogposts.
My second piece wasn’t necessarily better or worse in the quality of its content, but it wasn’t different. While I wanted to leverage the momentum of the first, it just didn’t catch the wave like I expected it to.
Of course, as you might imagine, I’m not alone. Nikita Bier‘s tbh grew from zero to five million downloads in nine weeks. And sold to Facebook for $100 million. tbh literally seemed like an overnight success. Little do most of the public know that, Nikita and his team at Midnight Labs failed 14 times to create apps people wanted over seven years.
When Bessemer first invested in Shopify, they thought the best possible outcome for the company would be an exit value of $400 million. While not necessarily the best performing public stock, its market cap, as of the time I’m writing this blogpost, is still $42 billion. A 100 times bigger than the biggest possible outcome Bessemer could imagine.
Humans are terrible at committing to progress. The average person today is more likely to take one marshmallow now than two marshmallows later.
Between TikTok and a book, many will choose the former. Between a donut and a 30-minute HIT workout, the former is more likely to win again. Repeated offences of immediate gratification lead you down a path of short-term utility optimization. Simply put, between the option of improving 1% a day and regressing 1% a day, while not explicit, most will find more comfort in the latter alternative.
James Clear has this beautiful visualization of what it means to improve 1% every day for a year. If you focus on small improvements every day for a year, you’re going to be 37 times better than you were the day you started.
While the results of improving 1% aren’t apparent in close-up, they’re superhuman in long-shot.
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!
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.
A friend asked me the other day, “If you meet a founder that you think isn’t going to make it, do you tell that founder?”
So I responded:
“Say you have a 7-year old daughter. And her biggest dream is to be an WNBA all-star. Or to be the president. Would you tell her ‘statistically speaking, you have almost no chance of succeeding?’ Or would you encourage her to keep pursuing her dream in spite of the odds? It’s the pursuit of a greater purpose that makes the person we are today and the person we will be tomorrow.
“Maybe your daughter doesn’t end up becoming a basketball star, but her pursuit of it lands her in Harvard where she meets incredible friends who end up growing together to be the next PayPal mafia. It’s the relentless pursuit of a dream that builds grit. And that grit will aid her well in whatever path she ends up choosing. Because the world is tough – no matter what you do. You will get beaten down again and again. And the difference between the ultra successful and everyone else is that the former continues to get back up.
“So when I meet a founder who’s championing an idea I don’t believe in, I neither have the guts nor the conviction to tell that person that it won’t work out, just that I won’t invest. ‘Cause if I know anything about the venture business, it’s that it keeps us humble. And every day I live in this industry, I have the privilege of being proven wrong. And even if I’m right, their pursuit makes them a more resilient person than before they began to do so.
“After all, there’s a big difference between impossible and really, really hard.”
#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!
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.
Whether you’re a founder or investor or just friends of the afore-mentioned job titles, you’ve most likely been asked for warm intros. The sage advice in the world has always been, that it is better to ask for warm introductions than send cold outreach, leaving the latter to be severely underestimated. Anecdotally, some of my best friends and mentors today came and continue to come from cold outreach.
Most people in this world love to help others. They derive joy and fulfillment in doing so. It enriches their life just as much, if not more so than, it does yours. There are a number of academic studies, like this 2020 one, that show positive correlation between giving kindness and your own happiness. The Ben Franklin effect extrapolates that you are more likely to like someone by doing them a favor. In sum, people want to help others. Investors (and friends of investors) are no exception.
But… the world does not make it easy to do so.
I’m not here to preach kindness. Nor do I think I need to. There are plenty of more incredible individuals in the world who are more capable of relaying that message than I am. But as the title of this blogpost alludes to, what tactical advice is there to:
Help friends of investors/investors help you
Get investors excited to meet you
Why even bother with a forwardable
Founders often ask me: Do you know any investors you can introduce me to? Which, in fairness, is an understandable question when you don’t know who you don’t know. In a world where I’m only helping 10 or less founders total, it’s a great question.
The problem is I, like many other people in the venture ecosystem, am often trying to help more than 10 founders. For me, I’m helping founders I’m actively advising, On Deck founders, Techstars founders, Alchemist founders, founders who are intro-ed to me, founders who cold email me, and founders who come to my weekly office hours. The number varies, but in any given week, I’m sending between 20-40 founder intros. And given that, I face a few obstacles:
The colder the connection and the longer the time since we last spoke, the more likely I am to forget what you’re building. I’m sorry; I wish I had photographic memory.
As much as I would like, I physically don’t have time to write a curated intro to every person who asks me.
I don’t want to ping the same investor/advisor multiple times in a week without clear reasons why. The investors who have more social clout get more intros than others. And they only have so much time and attention they can give in their inbox/socials to new people.
Rather, I flip the question on founders. Build a preliminary list of people you would like to chat with. See who you know that’s connected with these individuals. Do note I did not say firms. Long term marriages begin with each human not their last name. If I’m a 1st degree connection to them, then reach out to me and ask:
“I’m currently raising for [startup], [context]. I saw you’re connected to [name], [name] and [name]. Would you be comfortable reaching out to them for a double opt-in intro? And if so, happy to send you forwardable to make your life easier.”
To which I respond…
What goes into a forwardable
While everyone has their own preference, I prefer all the forwardables I send to have three things – nothing more, nothing less. Nothing more, since busy individuals don’t have time to read essays. Nothing less, well, it is what I call the minimum viable forwardable. And yes, I just made that term up.
The one metric you think you’re doing better than 95% (99th percentile is ideal) of the industry. On the off chance that the afore-mentioned metric isn’t obvious as to why it’s crucial to the business, spend another sentence explaining why. For example, if you’re a marketplace, the metric you’re slaying at might be the percent of your demand who organically converts to supply. While it may not be obvious to most, it is one of the earliest signs of network effects. Your customers love your product so much they want to pay it forward.
1-2 sentences as to what your startup does
Why this recipient would be the best dollar on your cap table
The first two are things you, as a founder, should have readily on hand. The third is often the one I get the most questions on. What does “the best dollar on my cap table” mean? And how would I find that?
Why the best dollar is important
Fundraising is often seen as a numbers game. Analogously, so is networking. Both of which I agree and disagree with. I agree with the fact that you have to engineer serendipity. You have to increase the surface area for luck to stick. And to do that, you need to talk to a s**t ton of people. I get it. The part I disagree with is that a game optimized for quantity is often conflated with templated conversations. Or worse, purely transactional ones. Relationships don’t scale if you approach it from scale.
… which is why I need the third point in every forwardable. If you are unable to provide why an investor would be the best dollar on your cap table, then:
You don’t need a warm intro. And that’s fine. Some investors’ inboxes are less saturated than others. If it might help, here is also my cold email “template.”
I’m not your person. I, like any other person facilitating an intro, am putting my social capital on the line to get you in front of the person you want. And if you don’t think it’s worth the time to tailor your email to one that I would be comfortable sending, then I just can’t be your champion.
Examples of the best dollar
Predictably and unpredictably so, there are many ways to make someone feel special. While I will list some of my favorite that I’ve seen over the years, the list is, by no means, all-inclusive. In fact, I’m sure some of the best and most timeless ways to showcase an investor’s value add is still out there waiting to be discovered. And for that, I leave it to you, my reader, to surprise me and the world. The below, hopefully, serves as inspiration for you to be tenaciously and idiosyncratically creative.
I’ll break it down into two parts: (1) what do you need help on, and (2) what help can they provide.
What is the 3 biggest risks of your business? The biggest one should be solved by you or someone on the team slide. The biggest risk should be the minimum viable assumption you need to prove that people want your product. At the early stages, sometimes that’s showing you have a waitlist of folks begging for your product. Sometimes, it’s just proving you can build the product (i.e. a deep tech product or AI startup). The next two risks, which aren’t as great in magnitude, but still prescient, requires you to be scrappy and at times, bring in external help.
What are your potential investors’ value adds? Where does their tactical expertise lie in? There’s no one-stop shop for every investor for this… yet (hit me up if you’re building something here). But nevertheless, I find it useful to search “databases” of value adds on:
Lunchclub profiles under “Ask [name] about…” Note: I forget if Polywork and Lunchclub are still invite-only, but if they are, feel free to use my invite codes here for Polywork and Lunchclub. For those curious, this is not a sponsored post.
Doom-scrolling to the bottom of their LinkedIn profile and reading their references
Who, of their existing investors, if they were to build a new business tomorrow in a similar sector, is the one person who would be a “no brainer” to bring back on their cap table? And why?
Who did they pitch to that turned them down for investment, but still was very helpful?
Subsequently, referencing (with the founders’ permission) those founders when reaching out/getting introed to those VCs. Note: Generally, Crunchbase and Pitchbook has more exhaustive lists of portfolio companies oftentimes than their website of “selected investments.”
Any publication/press release (i.e. Techcrunch, Forbes, etc.) where founders share how helpful their investors were. This may require a bit of digging.
As a general rule of thumb, the more specific you are, the better.
On the flip side, some examples of lackluster “best dollars” include:
Just stating which industry they invest in
Stating that they’re ideal because they work at X firm. You’re drafting individual team members for your all-star team, not brands.
Stating that they’re ideal because they USED to work at X firm
Using the recipient as a means to an ends. In other words, you want to get in touch with someone they know rather than they themselves. No one feels special when you like them only because they know someone else you like more. Either find a warmer connection to the “end” person or cold email.
Being generic
In closing
As my friend “James” says, “Do all of the leg work. Help them help you as much as possible. Everyone wants to be the hero that helps someone else, but people have lives – and if you’re the one that is getting the value, bring the value as much as possible.”
If you were the recipient of said email, what would make you say: “Absolutely?”
May 9th, 2022 Update: Added the “Why even both with a forwardable” section
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!
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.
Back in mid-2020, I started writing a piece on 99 Pieces of Unsolicited, (Possibly) Ungooglable Startup Advice. There was no ETA on the piece. I had no idea when I would publish it, other than the fact, that I would only do so once I hit the number 99. Yet, just like how I was inspired to write how similar founders and funders are, it finally dawned on me to start writing a similar piece for investors around mid-2021. The funny thing, is though I started this essay half a year later, I finished writing it one and a half months sooner while I was still on advice #95 for the former.
Of course, you can bet your socks I’ve started my next list of unsolicited advice for investors already. Once again, with no ETA. As I learn more, the subsequent insight that leads to an “A-ha!” moment will need to go deeper and more granular. And who knows, the format is likely to change.
I often find myself wasting many a calorie in starting from a simple idea and extrapolating into something more nuanced. And while many ideas deserve more nuance, if not more, some of the most important lessons in life are simple in nature. The 99 soundbites for investors below cover everything, in no particular order other than categorical resonance, including:
Unfortunately, many of the below advice came from private conversations so I’m unable to share their names. Unless they’ve publicly talked about it. Nevertheless, I promise you won’t be disappointed.
As any Rolodex of advice goes, you will not resonate with every single one, nor should you. Every piece of advice is a product of someone’s anecdotal experience. While each may differ in their gravitas, I hope that each of the below will serve as a tool in your toolkit for and if the time comes when you need it most.
To preface again, none of this is legal investment advice. This content is for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. Please consult your own adviser before making any investments.
General advice
1/ To be in venture capital, you fundamentally have to be an optimist. You have to believe in a better tomorrow than today.
2/ “Everyone has a plan until they get punched in the mouth.” – Mike Tyson. Told to me by an LP who invests in emerging and diverse managers.
3/ Have good fluidity of startup information. “No founder wants to meet a partner and have to answer the same questions again and again. Best partnerships sync and with every discussion, process the questioning.” – Harry Stebbings
4/ The lesson is to buy low, sell high. Not to buy lowest, sell highest.
5/ “The New York Times test. Don’t do anything you wouldn’t want to see on the front page of the NY Times.” – Peter Hebert
6/ “It takes 20 years to build a reputation and five minutes to ruin it.” – Warren Buffett
7/ When you’re starting off as an investor, bet on one non-obvious founder – a real underdog. Support them along their entire journey. Even if there’s no huge exit, the next one will be bigger. When their VPs go off and start their own businesses, they’ll think of you first as well.
8/ When planning for the next generation of your firm’s successors, hire and mentor a cohort of brilliant investors, instead of focusing on finding the best individual. Investing is often a lonely journey, and it’s much easier to grow into a role if they have people to grow together and commiserate with.
9/ “When exit prices are great, entry prices are lousy. When entry prices are great, exit prices are lousy.” – David Sacks
10/ Illiquidity is a feature, not a bug. – Samir Kaji
11/ Three left turns make a right turn. There is no one way to break into VC. Oftentimes, it’s the ones with the most colorful backgrounds that provide the most perspective forward.
12/ “Whenever you find yourself in the majority, it is time to pause and reflect.” As an early stage investor, I find Mark Twain’s quote to be quite insightful.
13/ “It’s not about figuring out what’s wrong; it’s about figuring out what is so right. The job of an investor is to figure out what is so overwhelmingly great, or so tantalizingly promising that it’s worth dealing with all the stuff that’s broken.” – Pat Grady retelling a story with Roelof Botha
15/ Track your deal flow. Here’s how I track mine. Another incredible syndicate lead with over 5x TVPI (total value to paid in capital) I met keeps it even simpler. A spreadsheet with just 4 columns.
Company
Valuation in
Valuation out
Co-investors – This is where you start sharing deal flow with each other here.
16/ One of your best sources of deal flow might not be from other investors, but those who are adjacent to the venture ecosystem, like startup lawyers and VC attorneys.
17/ A WhatsApp group with your portfolio is a great tool for diligencing investments, not as much for sourcing deals.
18/ “Decide once you have 70% conviction.” – Keith Rabois. Don’t make decisions with 40% conviction since that’s just gambling. Don’t wait till 90% conviction because you’ll miss the deal for being too slow.
19/ Ask questions to founders where they show grit over a repeated period of time. They need to show some form of excellence in their life, but it doesn’t have to be in their current field. From a pre-seed manager with 3 unicorns in a portfolio of 70.
20/ As an emerging manager, one of the best reasons for investing in emerging markets: Do you want to see the deals that the top 0.1% see? Or do you want to see the deals that the 0.1% passed on? From the same pre-seed manager with 3 unicorns in a portfolio of 70.
21/ Every day, open your calendar for just one hour (two 30-minute slots) to founders you wouldn’t have had otherwise. Your network will compound. From a manager who’s invested in multiple unicorns and does the above from 10-11PM every night.
22/ The bigger your check size, the harder you have to fight to get into the round.
23/ The best investors frontload their diligence so they can have smarter first conversations with founders.
24/ Perform immersion-based diligence. Become super consumers and super users of a category, as close as you can get to subject-matter experts. That way you know very quickly after meeting a founder if their product is differentiated or unique. While you’re at it, write 2-3 page bug report stress-testing the product. Founders really do appreciate it.
26/ When a founder can’t take no for an answer and pushes back, “I always have to accept the possibility that I’m making a mistake.” The venture business keeps me humble, but these are the benchmarks that the team and I all believe in. Inspired by JCal and Molly Wood.
27/ Win deals by “sucking the oxygen out of the air.” In investing there are two ways to invest: picking or getting picked. Picking is naturally in a non-competitive space. Getting picked is the exact opposite. You have to eat competition for breakfast. And when you’re competing for a deal everyone wants to get into, you have to be top-of-mind. You need to increase the surface area in which founders remember you, not just to take their time, but to be really, really valuable in as much time as you can spend with them. Inspired by Pat Grady on an anecdote about Sarah Guo.
Pitching to LPs
28/ Surprises suck. On Samir Kaji’s podcast, Guy Perelmuter of GRIDS Capital once said: “There’s only one thing that LPs hate more than losing money. It’s surprises.” More here.
29/ Fund I: You’re selling a promise. Fund II: You’re selling a strategy. And, Fund III: You’re selling the returns on Fund I.
30/ Steven Spielberg didn’t know what E.T. should look like, so he had everyone write down people they respected. And so E.T. looked a bit like everyone on that list, including Carl Sandburg, Albert Einstein and Ernest Hemingway. In a very similar way, come up with a list of your ideal LPs. And create a fund based on what they like to see and what you can bring to the table. Oftentimes, it’s easier to ask them for personal checks than checks out of their fund.
31/ Ask the founders you back for intros to their other investors as potential LPs in your fund.
32/ The return hurdles for LPs are different per fund type: *subject to market motions. Timestamped in Sept 2021 by Samir Kaji
Nano-fund (<$20M): 5-7x+
Seed fund: 3-5x+
Series A: 3x+
Growth: 2-2.5x+
Crossover/late growth (driven by IRR, not multiples): 10-12%+
33/ “If you know one family office, you know one family office.” Said by one of the largest LPs in venture funds. Each family office situation is uniquely different.
34/ Family offices are surprisingly closed off to cold emails, but often share a lot of deal flow with each other. Have co-investors or founders introduce you to them.
35/ It takes on average 2 months for an institutional LP to do diligence and reference checks. Plan accordingly.
36/ LPs look for:
Track record (could be as an individual angel as well)
Value add
Operational excellence
37/ Data shows that first-time/emerging managers are more likely to deliver outperformance than their counterparts, but as one, you still need to show you have experience investing.
38/ People, including LPs, tend to remember stories, more than they do data. Teach your LPs something interesting.
39/ LPs have started looking more into two trends: private investments and impact/ESG initiatives. By nature of you reading this blogpost, you’re most likely the former already. The latter is worth considering as part of your thesis.
40/ Every coffee is worthwhile in some form.
41/ LP diligence into VCs break down into two types: investment and operational DD.
Investment DD includes team, incentive alignment, strategy, performance, current market, and terms/fees.
Team: What does leadership look like? How diverse are you?
Alignment: Do you have performance-based compensation?
Strategy: What sectors are you investing into? What does your underwriting discipline look like?
Performance: What do your exits look like? Are you exits repeatable?
Market: What are the current industry valuations? Economies of scale?
Terms/fees: Are they LP friendly? Are the fees based on alphas or betas? Are they aligned with your value add?
Operational DD includes business model, operational controls, tech platforms, service providers, compliance and risk.
42/ If you’re pitching to other venture funds to be LPs, say for $250K checks, larger funds (i.e. $1B fund) typically have fund allocations because check size is negligible. And a value add as deal flow for them at the A. Whereas, smaller funds don’t because it is a meaningful size of their fund. So, GPs write personal checks.
43/ If you’re planning to raise a fund, think of it like raising 10 Series A rounds. For most Series A rounds, a founder talks to about 50 investors. So for a Fund I, you’re likely to talk to 500 LPs to close one.
44/ Send potential LPs quarterly LP updates, especially institutions. Institutions will most likely not invest in your Fund I or II, but keep them up to date on the latest deals you’re getting into, so you’re primed for Fund III.
45/ Family offices want to get in top funds but most can’t because top funds have huge waitlists. Yet they still want access to the same deals as top funds get access to. They’re in learning mode. Your best sell to family offices is, therefore, to have:
Tier 1 investors as your fund’s LPs
Tier 1 investors as co-investors
Deals that they wanted to get into anyway
46/ Your Fund I LPs are going to be mostly individual angels. They believe in you and your promise, and are less worried about financial returns.
47/ Institutional LPs are looking for returns and consistency. If you say you’ll do 70% core checks and 30% discovery checks, they’re checking to see if you stick to it. Institutions aren’t in learning mode, instead you as a fund manager fit into a very specific category in their portfolio. Subsequently, you’re competing with other funds with similar foci/theses as you do.
48/ Be transparent with your IRRs. If you know you have inflated IRRs due to massive markups that are annualized, let your (potential) LPs know. For early stage, that’s probably 25-30%+. Especially when you’re in today’s frothy market (timestamped Jan 2022). Or as Jason Calacanis says it for his first scout fund that had crazy IRRs, “It’s only down from here.”
49/ Don’t waste a disproportionate amount of time convincing potential LPs about the viability of your thesis. Shoot for folks who can already see your vision. If you manage to convince an LP that didn’t previously agree, they may or may not end up micromanaging you if your thesis doesn’t work out as “expected.” Inspired by Elizabeth Yin.
50/ “The irony for us was LPs asking about portfolio construction was a sign that the meeting was going poorly.” – Jarrid Tingle.
51/ Institutional LPs prefer you to have a concentrated startup portfolio – less than 30 companies. They already have diversification across funds, so they’re maximizing the chance that their portfolio has fund returners. That said, you’re probably not raising institutional capital until Fund III. Inspired by Jarrid Tingle.
52/ If you’re an emerging manager with a fund is less than 4 years old, boasting high IRR (i.e. 50%+) is meaningless to sophisticated and institutional LPs. Focus on real comparative advantages instead. – Samir Kaji.
53/ When raising early checks from LPs, ask for double the minimum check size. Some LPs will negotiate down, and when they only have to commit half of what they thought they had to, they leave feeling like they won.
54/ When potential LPs aren’t responding to your follow ups/LP updates, send one more follow up saying: “I am assuming you are not interested in investing into our fund. If I am wrong, please let me know or else this will be your last update.” Told to me by a Fund III manager who used this as her conversion strategy.
55/ It’s easier to have larger checkwriters ($500K+) commit than smaller checkwriters (<$100K). $500K is a much smaller proportion of larger checkwriters’ net worth than checkwriters who write $100K checks. And as such, smaller checkwriters write less checks, have less “disposable income”, and push back/negotiate a lot more with fund managers before committing. Told to me by a Fund III manager.
Fund strategy/management
56/ As an investor, if you want to maintain your ownership, you have to continue requesting pro-rata rights at each round.
58/ “Opportunity funds are pre-established blind pool vehicles that eliminate the timing issues that come with deal-by-deal SPVs. Opportunity funds sometimes have reduced economics from traditional 2/20 structures, including management fees that are sometimes charged on deployed, not committed capital. Unlike individual SPVs, losses from one portfolio company in an opportunity fund offset gains from another when factoring in carried interest.” – Samir Kaji. See the full breakdown of pros and cons of opportunity funds here.
59/ There are two ways to generate alphas.
Get in early.
Go to where everyone else said it’ll rain, but it didn’t. Do the opposite of what people do. That said, being in the non-consensus means you’ll strike out a lot and it’ll be hard to find support.
60/ Sometimes being right is more important than being in the non-consensus. Inspired by Kanyi Maqubela.
Market risk as a function of ownership – What is the financial upside if exit happens? Is it meaningful enough to the fund size?
Judgment risk – Are you picking the right companies?
Win rate risk – How can you help your portfolio companies win? What is your value add?
62/ By Fund III, you should start having institutional capital in your investor base.
63/ The closer you get to investing in growth or startups post-product-market fit, the closer your capital is to optimization capital. Founders will likely succeed with or without you, but your name on the cap table will hopefully get them there faster and more efficiently.
64/ If you’re a traditional venture fund, you have to invest in venture-qualifying opportunities, like direct startup investments. But you can invest up to 20% of your fund’s capital in non-venture-qualifying opportunities, like tokens/SAFTs (simple agreement for future tokens), real estate, secondaries, and so on.
65/ If increased multiples coming out of various vintage funds, feel free to deviate from the normal 2-20. Many funds have 25 or 30% carry now, or accelerators where 20% scales with multiples (and often with a catch-up back to 1.0x at higher carry). – Samir Kaji
66/ Normally, fund managers take 2% management fees, usually over 10 years, totaling 20% over the lifetime of the fund. These days, I’m seeing a number of emerging managers take larger management fees over less years. For example, 10% as a one-off. Or 5% over 2-3 years.
67/ “The razor I apply to investing and startups is that every decision that increases your probability of wild outlier success should also increase your probability of total failure. If you want to be a shot at being a 10x returning fund? You’ll have to take on the higher likelihood of being a 1x. If you think you’re going to build the next Stripe? You’re going to have to run the risk of going nowhere.” – Finn Murphy
69/ The longer you delay/deprioritize having diverse partners, the harder it’ll be to hire your first one.
Advising founders/executives
70/ A founder’s greatest weakness is his/her/their distraction. Don’t contribute to the noise.
71/ It’s far more powerful to ask good questions to founders than give “good answers”. The founders have a larger dataset about the business than you do. Let them connect the dots, but help them reframe problems through questions.
72/ You are not in the driver’s seat. The founder is.
73/ A great reason for not taking a board seat is that if you disagree with the founders, disagree privately. Heard from a prolific late-stage VC.
74/ Advice is cheap. Differentiate between being a mentor and an ally. Mentors give free advice when founders ask. Allies go out of their way to help you. Be an ally.
75/ The best way to be recognized for your value-add is to be consistent. What is one thing you can help with? And stick to it.
76/ Productize your answers. Every time a founder asks you a question, it’s likely others have the same one. Build an FAQ. Ideally publicly.
77/ If you have the choice, always opt to be kind rather than to be nice. You will help founders so much more by telling them the truth (i.e. why you’re not excited about their business) than defaulting on an excuse outside of their control (i.e. I need to talk with my partners or I’ve already deployed all the capital in this fund). While the latter may be true, if you’re truly excited about a founder and their product, you’ll make it happen.
78/ Help founders with their firsts. It doesn’t have to be their first check, but could also be their first hire, engineer, office space, sale, co-founder, team dispute, and so on.
79/ There are four big ways you can help founders: fundraising, hiring, sales pipeline, and strategy. Figure out what you’re good at and double down on that.
80/ Focus on your check-size to helpfulness ratio (CS:H). What is your unique value add to founders that’ll help them get to their destination faster? Optimize for 5x as a VC. 10x as an angel.
81/ “The job of a board is to hire and fire the CEO. If you think I’m doing a bad job, you should fire me. Otherwise, I’m gonna have to ask you to stay out of my way.” – Frank Slootman to Doug Leone after he was hired as CEO of ServiceNow.
SPVs and syndicates
82/ The top syndicates out there all have 3 traits:
Great team
Great traction
Tier 1 VC
If your deal has all of the above, and if you raise on AngelList, your deal is shared with the Private Capital Network (PCN), which AngelList’s own community of LPs and investors, a lot of which are family offices, who allocate at lest $500K of capital per year.
83/ If you’re raising an AngelList syndicate, you need to raise a minimum of $80K or else the economics don’t really make sense. AL charges an $8K fee.
84/ If you want to include Canadian investors in your syndicate, for regulation purposes, you need to invest 2% of the allocation size or $10K.
85/ Investing a sizeable check as a syndicate lead (e.g. $10K+) is good signal for conviction in the deal, and often gets more attention.
86/ 99% of LPs in syndicates want to be passive capital because they’re investing in 50 other syndicates. You can build relationships individually with them over time, but don’t count on their strategic value.
87/ Historically, smaller checkwriters take up 99% of your time. Conversely, your biggest checkwriters will often take up almost no time. Even more true for syndicates.
88/ LPs don’t care for deals where syndicate leads have time commitment without cash commitment.
89/ Don’t give LPs time to take founders’ time. Most of the time LPs don’t ask good questions, so it’s not worth the effort to set up time for each to meet with founders individually. On the other hand, a good LP update would be to host a webinar or live Q&A session. One to many is better than one to one.
90/ There’s a lot of cannibalism in the syndicate market. The same LPs are in different syndicates.
91/ Choose whether you will or will not send LP updates. Set clear expectations on LP updates. And if you do, stick to that cadence. The people who write you the $1-5K checks are often the loudest and demand monthly updates. If you choose not to, one of my favorite syndicate leads says this to their LPs, “We won’t give any LP updates. I’ve done my diligence, and I won’t give information rights. I have a portfolio of hundreds of deals, and I can’t be expected to give deal-by-deal updates every month or every quarter. So if you are investing, just know you’re along for the ride.” Some LPs won’t like that and won’t invest, but mentioning that upfront will save you from a whole lot of headaches down the road.
92/ If you’re setting up an SPV to solely invest in a fund (or where more than 40% of the SPV is going into the fund), all your SPVs can’t against the 249 LPs cap on a fund <$10M and a 99 cap on a fund >$10. But you can invest in funds if you’re setting up an SPV to invest in more than one fund. Context from Samir Kaji and Mac Conwell.
Evergreen/Rolling funds
93/ Just like vintage years/funds are important for traditional funds, vintage quarters matter to your LPs. If they didn’t give you capital during, say Q2 of 2021, when you invested in the hottest startup on the market, your Q1 and your Q3 LPs don’t have access to those returns.
94/ Whereas GPs typically make capital calls to their LPs every 6 months, AngelList’s Rolling Funds just institutionalized the process by forcing GPs to make capital calls every 3 months.
Angel investing
95/ “The best way to get deal access isn’t to be great with founders—it’s to have other investors think you’re great with founders. Build a high NPS with investors, since they have meaningfully more reach than an operator. But of course, fight hard to be great with founders too or else this will all crash down.” – Aaron Schwartz
96/ Make most of your personal mistakes on your own money as an angel (before you raise a fund).
97/ When you’re starting off, be really good at one thing. Could be GTM, growth, product, sales hires, etc. Make sure the world knows the one thing you’re good at. From there, founders and investors will think of you when they think of that one thing. Unless you’re Sequoia or a16z, it’s far better to be a specialist than a generalist if you want to be top of mind for other investors sharing deal flow.
98/ “As an angel investor, it’s more important to be swimming in a pool of good potential investments than to be an exceptionally good picker. Obviously if you’re able to be both, it’s better 🙂 but if you had to choose between being in a position to see great deals and then picking randomly, or coming across average deals and picking expertly, choose the former.” – Jack Altman
99/ “Just like the only way to get good at wine is to drink a lot of wine. The only way to get good at investing is to see a lot of deals.” – Lo Toney.
Disclaimer: None of this is investment advice. This content is for informational purposes only, and should not be relied upon as legal, business, investment, or tax advice. Please consult your own adviser before making any investments.
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!
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 or investment advice. Please do your own diligence before investing in startups and consult your own adviser before making any investments.
I had a founder ask me yesterday, “How much money does an investor expect you to bootstrap with?”
The short answer I gave him, “It depends.”
The longer answer… well, there is no one number or specific range that investors look at. It’s a case-by-case scenario. Of course that’s not the answer he, nor you my reader, were hoping to hear. If I left you on that alone, I’d imagine this essay would be the single greatest contributor to my unsubscribe rate.
The real answer is that capital is not the unit of measurement. It can be, and may seem to be in today’s ever-increasing pace of development. Rather, it starts from a question. What is your minimum viable assumption? Something I’ve also alluded to before.
What is the minimum viable assumption? The big assumption you must prove in order to catalyze your startup’s growth. Or as Gagan Biyani, founder of Maven, puts it in the frame of minimum viable tests – “a specific test of an assumption that must be true for the business to succeed.”
Oftentimes, that assumption is synonymous to your the biggest risks of your business. Or in other cases, your biggest barriers to entry.
One of the questions we investors try to answer when we meet with a founder is: What is the biggest risk of this business? And is the person who can solve this risk in the room (or on the team slide)? It is one of a handful of risks we must underwrite to move forward with an investment.
Your ability to raise capital is directly correlated with your ability to inspire confidence in your investors that you will need little to no help getting to your next milestone. An unfortunate, but true paradox.
Circling back to the question that catalyzed this essay, how much money does an investor expect you to bootstrap with? The answer, as much as you need to prove your minimum viable assumption. Can you conquer the biggest risk of your business on your own capital? If you can, you’re halfway there. That may take $50K. Or maybe $10K. Or $100. Airbnb had to go through three different launches, and selling Obama O’s and Cap’n McCains for $40 per box, before Paul Graham noticed their traction. On the other hand, you have Mailchimp that’s 100% bootstrapped till the day they exited. Each business is different and unique in its own way.
The only addendum I would add here is that this same calculus will most likely not apply if you’re building something in deep tech – be it biotech or general AI or otherwise.
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!
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 or investment advice. Please do your own diligence before investing in startups and consult your own adviser before making any investments.
Earlier this week, Zach Coelius shared his path to running a fund with the On Deck Angels community. And near the end of the session, one of our fellows asked something along the lines of: How do you pick great founders? To which, Zach responded, and I’m paraphrasing: I look for really smart people I want to be around. And every person has something different that makes them smart.
I’ve heard many variations of Zach’s closing comment over the years. “I look for someone I want to work for.” “I look for someone who gets me excited about a space I didn’t I’d get excited about.” “A really sharp individual who teaches me something new almost every time we talk.” The common thread, in all these statements, is that the thing that drives early-stage investors to conviction is not quantitative, but qualitative in nature. Moreover, given that the next Steve Jobs or Elon Musk will look nothing like either of the afore-mentioned, it’s hard to build the search for outliers into a reliable mental model, other than the openness to be amazed.
Fred Wilson wrote a great piece at the beginning of this week about his rationale for investing in Coinbase, Twitter, and Dapper. His title, which sums it all up really well, is: Keeping It Simple. His lesson: “That’s keeping it simple. It doesn’t always work. We get more wrong than we get right. But when we get it right, amazing things can happen.”
Along a similar vein, I jumped on a call with a buddy of mine who’s raising his first fund after having an enviable track record as an angel. On this said call, we talked about how junior investors, the bottom 75% of investors, late-stage investors, and investors that have yet to find their own way to get to conviction, spend more time on the quantitative. A very analytical, repeatable, quantifiable approach. For better or for worse, cerebral. On the flip side, the best early-stage investors out there, by track record of consistent top-notch returns, don’t spend nearly as much time obsessing over the numbers. Or evidence. In fact, before you invest at the A, for most businesses, there really isn’t any hard metric that is going to get you from 50 to 90% conviction.
Even in my own personal journey, when I started off, I found myself sticking to the “tried and true” questions:
What are your unit economics?
How many customers do you have? How are they using your product?
What percent of your customers are coming back to use the product on the second day?
What do your retention curves look like?
Your monthly growth rate for the past three months?
All of which, you may notice, are quantitative in nature. In fact, this best part of this blog is that you can literally track my thinking over the past few years. I went from writing about metrics (morehere, just to name a few) I look for in startups to writing about intuition. In fact, even my attempt to codify intuition is, by definition, using my frontal lobe.
All I need to worry about are moments when a founder teaches me something new that I didn’t know I would love. A simple, but surprisingly rare happenstance. I see a lot of good startup ideas and teams, even some great ones. But it’s rare I meet an “Oh sh*t!” one. Subsequently, that probably also means, at my current stage, I’d make a poor fund manager, since I don’t have enough consistently high-quality deal flow. Consistent, yes. High-quality, in my humble opinion, yes. But consistently high-quality, I’m still too early. At least in the scope of “Oh sh*t!”
One of the greatest sobering facts about venture is that it’s a business that’s designed to keep you humble. Like Fred mentioned, I am wrong way more often than I’m right. And the times I trusted my head over my gut are times I find most regretful. To better illustrate this, let me share an anecdote.
Back in 2018, one of my good friends introduced me to a set of co-founders. Scratch that. Even before they started working on the business idea. And I’m going to abstract the name of the startup. But if you’re a frequent reader of this blog, you’ve probably already seen the trail of cookie crumbs.
I met them for the first time at their beautiful, well-furnished SF apartment with Scandinavian furniture that definitely warranted a pretty price tag. Out of curiosity, I asked how much it cost to live there. And for four bedrooms and three baths, they shared a ridiculously low number. A third of the price I imagined they’d be paying. Then of course, I had to ask how much the furniture cost. “$100, just to ship them over. Otherwise, they’re all free.”
Apparently, they networked their way into a community of office managers. They learned that so many venture-backed startups in the Bay, upon receiving funding, want to look like Airbnb. Founders buy the most expensive furniture – modern layouts, quirky chairs, rustic-looking tables. They also bring the creme de la creme of interior designers to help them set it all up.
But as statistics show, most of these fold every year. When they do, the last thing they want to worry about is their reminder of frivolous spending. As such, office managers end up with so many pieces of high-end furniture they just need to get rid of. Those same pieces of artisanal furniture now sat in these three founders’ living room. And it’s even crazier to know that they weren’t from the Bay. They didn’t have connections coming here, nor jobs lined up initially.
The stories didn’t stop there. In subsequent catchups, I learned of their previous hustles. Each blew my mind more than the last.
When it finally came down to it, and I had the chance to invest, I fell into the comfort of the shackles of borrowed mental models, demand for traction, metrics, the whole nine yards of what made me sound like a really smart, possibly high-browed, VC. And I said no. Today, they’re worth over nine figures, with 8-figure revenue numbers at their last funding round.
I amassed a massive anti-portfolio in my early days trusting my brain over my gut. A brain, like most, was and continues to be incapable of fully understanding the effects of the power law.
To borrow a Pat Grady lesson, any person with a head above two shoulders – in other words, a recurring practitioner of logic and reasoning – is capable of figuring out what’s wrong. But as an early-stage investor, one of the biggest mental hurdles you have to overcome, is spending more time imagining what can go really, really right. And not its counterpart.
As an investor before product-market fit, you invest belief capital, not optimization capital. You’re not putting fuel on the fire. You’re putting faith in a person – in a team – and in an insight.
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!
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 or investment advice. Please do your own diligence before investing in startups and consult your own adviser before making any investments.
Recently, I stumbled across a captivating perspective on aphorisms via Tim Ferriss’ 5-Bullet Fridays. The Procrustean Bed. To be fair, before reading it on Tim’s newlsetter, I haven’t even heard of the concept. In one of his newsletters, he cites two incredible sources:
” ‘Something designed to produce conformity by unnatural or violent means. In Greek mythology, Procrustes was a robber who tied his victims to a bed, either stretching or cutting off their legs in order to make them fit it.’ (Source: Oxford Dictionary of English Idioms).
“Nassim Taleb has a related book of aphorisms titled The Bed of Procrustes. He explains the title thusly: ‘Every aphorism here is about a Procrustean bed of sorts—we humans, facing limits of knowledge, and things we do not observe, the unseen and the unknown, resolve tension by squeezing life and the world into crisp commoditized ideas, reductive categories, specific vocabularies, and prepackaged narratives, which, on the occasion, has explosive consequences.’ “
Down the investing rabbithole
There exist a number of aphorisms in the investing world. Chief of which reads “buy low, sell high.” Public market assets are quite liquid. Hypothetically, you can cash out whenever you want. Such liquidity has paved way for psychological inconsistencies to maximize gratification. In language with unnecessary jargon redacted, the option to sell is less motivated by rational thinking but more by fear of losing money – loss aversion. If you invest $100 into the public market, you can choose if you want to cash out at $95, $90, or $120 or $200. While there is a non-zero chance of you losing your entire principal, chances are you’ll liquidate your positions before that happens.
On the other hand, private market investments are illiquid. Upon investment, there is no liquid market in which you can sell immediately. At best, you have to wait 3-5 years before a rapidly marked-up investment creates opportunities for distributions in the secondary market. In other words, cash money while companies are still private. In the private markets, your principal either appreciates in multiples, rather than percentages, or bottoms out. Any in-betweens will neither make or break your investment strategy, and are often out of your immediate control. So in this case, illiquidity is a feature, not a bug.
The notion of exiting positions as a private market investor, therefore, gravitates towards a singularity – when you make a damn good investment. The only time you really have an option to choose whether you can sell or not, when otherwise, it becomes a tax write-off or a small exit outside of your immediate control.
When should you sell?
Should you ever sell?
And if you sell, how much should you sell?
To answer all the above questions…
With the help of Shawn and Ratan, I wrote a blogpost on how to think about exiting positions at the beginning of this year. A topic of which I am still very much a rookie at, which may be quite apparent in this essay as well. Nevertheless I’m going to try to elaborate more on the notion of selling positions as an early-stage investor.
In a memo earlier this year, Howard Marks wrote that there are two main reasons people choose to sell: “because they’re up and because they’re down.”
When “they’re down”
Let’s start with the latter. When “they’re down.” Like I mentioned before, there are often very few options to sell when things are down. While I’m not proud that these investors exist in the early-stage private markets, I’ve seen and heard of some investors who try to make a last ditch effort to regain some of their principal when the startup goes south. Selling off IP. As well as assets. Or forcing the founders to make a modest exit, so that the investors cap their downside. Maybe at best, this returns them 2x on their capital (rarely the case).
But let’s say that’s the “best” case scenario. And let’s say it’s a $25M Fund I, writing $250K checks. A 2x net return means they got back $750K. $750K is far from returning the $25M fund. Not even close to doing so. You need over 30 of those “exits” to just break even for your fund. So, if you’re an investor penny pinching here, you’re in the wrong game AND you’re going to lose out on the relationships with the founding team.
Why the wrong game?
Venture is a hit-driven business. It’s not about your batting average but about the magnitude of the home runs you hit. We bat for 100x returns, which also increases the probability of misses, determined by ability to return the fund or not. If you’re optimizing for local maximums, you’d probably do better as a public market investor.
And why do relationships matter?
One, the startup world is a smaller world than you think. People gossip.
Two, statistically, first swings at bat rarely work out. In research done by Cowboy Ventures, they found 80% of unicorns had at least one co-founder with previous founding experience. Paris Innovation Review also found that “86% started their project with a partner, after having created other companies.” Two of many otherstudies. So, even though this venture didn’t achieve financial success for an investor, the next might. Or the one after that. Assuming you bet on the right people, it’ll just take a couple iterations before timing, market, and product also match up. If you leave on bad terms on this deal, you won’t be able to get in when things do work out.
Three, what makes early-stage investing incredible is the relationships you build along the way. The ability to learn and grow with really smart people.
When “they’re up”
The question of if to sell often leads to controversial debate. I know of some investors who never sell any of their stock. And that if they sell, to them, it is a measure of their lack of faith in a founder. And they would never want to feel that they’re betting against the founders. That’s okay if you’re an angel. But if you’re a VC, you have a fiduciary responsibility to your investors, which means you’ll eventually have to sell.
The question of when to sell is often answered in broad strokes with laws around QSBS, which states that if you hold a qualified small business stock for longer than five years, you’re not subject to capital gains taxes in the US. But should you sell in the 6th year or 10th year? And under what market conditions? Do you sell in a boom market or on the precipice of a bust market? For a company you believe in the long-term potential, regardless of short-term fluctuations, I’m a big fan of what Bill Miller said in his Q3 2021 Market Letter. “We believe time, not timing, is the key to building wealth in the [market].”
But when things are going really, really, really well, it’s okay to take money off the table, even ahead of the end of the fund’s 10-year lifespan. In fact, Union Square Ventures generally sells 15-30% of their position in their top portfolio companies to distribute back to their LPs. Fred Wilson‘s personal framework lies around “[selling] one third of the position immediately, put one third away for a long term hold, and actively manage the other third.”
To most, including myself, the goalposts for selling how much seem arbitrary. USV sold 30% of their position in Twitter to return twice the entire fund. Menlo Ventures sold almost half of their stake in Uber when Softbank offered to buy. Whereas, Benchmark sold 15% of its Uber shares. I also have really smart friends who liquidate 50% of their stake in a token if a single cryptocurrency reaches double digit percentages of their net worth.
It’s all about the opportunity cost
In a game where arbitrage matters, and the “why” matter more than the “what”, it was love at first sight when Howard Marks shared his mental model on selling. He boils it down to the simple economic concept of opportunity cost:
“If your investment thesis seems less valid than it did previously and/or the probability that it will prove accurate has declined, selling some or all of the holding is probably appropriate.
“Likewise, if another investment comes along that appears to have more promise – to offer a superior risk-adjusted prospective return – it’s reasonable to reduce or eliminate existing holdings to make room for it.”
In sum, the option to sell is not an isolated decision, but rather one which considers the other investment opportunities you have available to you. For a number of VCs, this breaks into the calculus of recycling carry and what to use early distributions to invest in next. If you’re a VC with consistent AND high-quality deal flow, you’d probably want to reinvest. If you’re a VC without either of the two (i.e. only consistency or quality) or an emerging angel, your goal is to get both. In having both, you then have access to relative selection.
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!
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 or investment advice. Please do your own diligence before investing in startups and consult your own adviser before making any investments.
