Tag: venture capital

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How to Develop Intuition as a Rookie Startup Investor

intuition, how to develop intuition

In the month before I started this blog in 2019, I had written 20 odd blogposts as a safety net in case I ran out of ideas in my weekly cadence. Most of which never had the chance to stand in the limelight, including my first one on intuition. Particularly, my one on intuition. Over the years, I’ve honed my own “intuition” – if I may be bold enough to call it that – on vetting startups. My intuition today is very different beast from my intuition 2.5 years back. This essay is a product of such constantly evolving self-discovery.

The spark of my intuition

When I first started my career in VC at Berkeley’s SkyDeck, I reached out to about 70-80 investors for a coffee chat, in which I posed one of my now favorite questions. What is the difference between a good and a great VC? Unsurprisingly, but frustratingly enough, most of the answers came in the form of “intuition.” Or its cousin, “pattern recognition.”

To me, who was still so new to venture, that was the best and worst non-answer I could get. Yet despite knowing that there was truth in their answer, I was still directionless. It wasn’t until an afternoon walk through San Francisco’s South Park with a very generous, but curt gentleman who carried quite the luggage beneath both of his eyes that I got the answer I wasn’t looking for.

“See a shitload of startups. When you see 10, pick your top 2. Then see 100, pick your top 2. Then see 1000, and again, pick your top 2. You’re going to notice that your podium will look quite different the more founders you meet with and the more startups you see.”

Recently, Plexo‘s Lo Toney told our fellows at DECODE the exact same thing:

And so, in hopes to guide someone in my shoes when I first started, here’s how I think about building intuition. Of course, I am a human and will always be a work in progress. It’s likely that next year I will see things differently than I see them today. Nevertheless this essay is a record of my thoughts today in early 2022.

Where to find a “shitload” of startups

There are multiple avenues these days for deal flow, including, but not limited to:

When I first jumped into venture, I used to ask my friends who I knew were early adopters (a product of going to a school in the Bay Area, like Berkeley) of products to recommend me 3-5 startups/products every other week. When they did, I would treat them out to boba. And if they introduced me to the founders for those products that I’d be excited to talk to, I’d treat my friends out to a small meal – around $10-15. At the same time, at SkyDeck, I tried to sit in on as many meetings as I could, particularly the ones around deal evaluation at the beginning of every cohort.

While I do recommend all of the above, the best training grounds for developing intuition is when you talk to founders yourself.

The five senses

Google defines intuition as “the ability to understand something immediately, without the need for conscious reasoning.”

Source: Google

So, by definition, intuition is subconscious – built upon the brain’s natural ability to recognize patterns. An apt synonym, according to the trillion-plus dollar company… “sixth sense.” A sixth sense birthed from the intense neural processing of the five other senses. So, it was only logical for me to understand the sixth sense by first fully comprehending my five others. That said, I use the five-sense nomenclature loosely, but it nevertheless has become my guiding framework for venture decisions over the years.

Smell

“I invested based on my sense of smell.” These are the very words Softbank’s Masayoshi Son shared about his early investment in Alibaba. And he said the same about his investment into Yahoo! In fairness, his words make for good PR. And may just seem like smokes and mirrors. But for Son to have chosen Jack Ma out of the 20 prospective Chinese entrepreneurs he met with to invest in, he must be onto something.

There are two ways to develop an acute sense of smell as an investor, which you can develop in tandem.

  1. Spending a lot of time looking into the market
  2. Talking to many founders

On the former, we’ve been seeing a number of funds incubate their own startup ideas as a result of investors becoming deep subject-matter experts, but are discontent with the current ideas or teams on the market right now. Two examples include General Catalyst and Founders Fund. Draw market maps. Write research reports. Follow the experts on socials or on their blogs. Even better, talk to them as well. As a general warning, it’s hard being a generalist here. I would pick a few industries and/or functions you’re excited about or knowledgeable in already. Go deep before you go wide.

A few questions that have served me well include:

  1. What kind of inflection points are we at in the market? In what areas have headwinds become tailwinds?
  2. What are the technological, political, and/or socio-economic trends to be aware of right now? And where do these trends set up the world tomorrow to be?
    • I really encourage investors here to dream a little bit. To envision a world given these trends in which you’d be excited to have future generations live in.

On the latter, while Masayoshi talked to only 20, you can assume you he went through at least ten times that number of decks and business ideas. There’s no better practice than being in the field. Assuming you’ve taken step one (i.e. researching the market), one of the best litmus tests I’ve used to gauge a founder is their ability to riff on adjacent subjects to the business with me. Are they capable of going on tangents that really demonstrate domain expertise? Or are they caught up in the myopia of just their business?

Taste

There’s two kinds of tastes in which I look for, almost subconsciously, now.

  1. Have they tasted excellence?
  2. Have they tasted blood?

On excellence, many investors out there look for prior success in the field. For instance, previously founder of a unicorn exit, early employee or key executive at a now-successful company, or former big-time investor. Admittedly, there are only a small handful of these individuals out there. But I knew in my early days of scouting, I was at a massive disadvantage here for two major reasons.

  1. I didn’t have strong connections with most of this subset of the entrepreneurial market.
  2. This was also a founder persona I didn’t have unique insight to. In fact, it was general consensus to always take first meetings with these individuals in the venture industry. And as I learned early in my venture career, you make money either if you’re right on consensus or right on non-consensus. The latter of which is counted in multiples instead of percentages, which I’ve written about here and here.

In knowing so, I look for excellence, period. Have they tasted earned glory in any discipline? Do they know what it’s like to succeed in their field? And do they know what it takes to get there? On the flip side, do they know how hard it was to get there?

On the other hand, for blood, I want to know a founder’s propensity for conflict resolution. When was the last time they fundamentally disagreed with their co-founders? And how did they resolve it? Conflicts are inevitable. They’re bound to arise when you’re putting so much at stake for a common goal. I care less about the fact that they do come up, but more about that when they do, the team doesn’t just fall apart.

Every once in a while, I might disagree with the founder as well. And hear I look for the founder’s knee-jerk reaction and their ability to engage in thoughtful discussion. That does not mean they cannot disagree. Neither am I looking for another yes-person. But are they capable of helping me, and themselves, explore new horizons? Are they open-minded enough to entertain new possibilities, but still hold a remarkable level of focus to their 12-month horizon?

Touch

How high-touch or low-touch is this business? How much legwork does an investor need to do for this business to 10x its KPIs (within the next 12 months)?

For me, during my first meeting with the founder, ideally before, I try to answer two very simple questions:

  1. What is the biggest risk of this business?
  2. And is the person who can solve this risk on the team slide/in the room?

99% of the time, the person who can solve the biggest risk of the business has to be in the room. For instance, if it’s a machine-learning (ML) product, it’s a technical risk. So at least one of the co-founders must be a technical genius, not three MBAs. If it’s a B2B SaaS product, it’s a distribution risk. Meaning someone on the team must have deep connections to key decision makers to their target customers. In the early days, that’s really just at least one to two big-name customers. And ten other referenceable businesses. The second biggest risk is sales, and that I count on the founders’ ability to hustle.

1% of the time, and this is probably an exaggeration, you just have to really believe in the founder AND the product or market.

Hearing

Do founders spend more time talking, or more importantly, listening to their customers than they do in Rapunzel’s tower?

While I don’t ask all of them (since we’re guaranteed to run out of time before we run out of topics), here are the questions I consider when assessing how boots-on-the-ground a founder is:

What are customers saying about their product? The good? And the bad?

How did they acquire their first users/customers outside of their existing first degree network? Where from? What messaging do they use?

What is their customer win rate? In knowing so, what worked and what didn’t? At what point in the onboarding process do customers churn? What are their assumptions for why churn happens?

Do they know the numbers of their business (and ideally the market) like the back of their hand? For numbers of the market, are they able to recall the sources of most important numbers? For product metrics, how well do they know the main ones, like engagement, churn, monthly growth rates (over the past 3 months), net retention, and so on? Every so often, there’s a number or two, the founders are not aware of. And it’s fine. The test is once they realize their blind spot, how quickly do they move to patch it up? Subsequently, report back to me about their updated data measurements.

Of course, my job is not to distract founders. And I really try my best not to, so I don’t ask they measure superfluous metrics, unless I really do believe they’re crucial to the business.

Because I usually talk with founders who are pre-product-market fit, I usually lead with the question, “what does product-market fit look like to you?” Are they able to arrive at an actionable and measurable metric to optimize for? And can they back up why that metric is a good proxy for product-market fit?

(In)Sight

Can this founder teach me something new? Something that I never thought of or heard before, but makes complete sense. Is it a preposterous idea but backed by logic? Or does the founder have an original (and money-making) angle to what is already unoriginal? As an investor, especially as you see more startup ideas, the latter question is likely to surface more than the former.

Once the original insight is uncovered, it is then up to me to figure out the potential energy of the insight. How far can this insight take this team? Is it likely that this insight will uncover more insights down the road?

As an investor, you want to be right on the insight and team, not one or the other. Mike Maples Jr. articulates it best when he said, “We realize, oh no, this team doesn’t have the stuff to bend the arc of the present to that different future. Because I like to say, it’s not enough. […] I’d say that’s the first mistake we’ve made is we were right about the insight, but we were wrong about the team.”

“I’d say the reverse mistake we’ve made is the team just seems awesome, and we just can’t look past the fact that they didn’t articulate good inflections, and they can’t articulate a radically different future. They end up executing to a local maximum, and we have an okay, but not great outcome.”

In closing

Seedscout’s Mat Sherman wrote a great Twitter thread last month to help founders who are outsiders raise venture funding.

The fact of the matter is that despite the venture industry being a rather well-connected circle of individuals and firms, most entrepreneurs – both currently and aspiring – are outsiders. If you can’t hit up a close friend to write you a couple million dollars, you’re an outsider. This essay, while written for new investors, hopefully, is equally useful as a guide for founders looking for some insight as to how investors think. Or at the very minimum, how I think.

Photo by Liam Shaw on Unsplash

Any thoughts here are mine and mine alone. 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.

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How Do Investors Think About Early Dilution On The Cap Table?

dilution water investment

A founder recently asked me how investors would perceive her going through two different accelerator programs. Specifically, what would investors think if she took dilutive capital from two investors who care about ownership targets, yet have similar, if not the same, value adds to her business?

How each type of investor thinks about dilution

It’s a great question. Unsurprisingly, a nuanced one as well.

Honestly, a “messy” cap table or early dilution is an excuse investors give when they’re not sold on you or the business. Investors regress to the “why this”, or otherwise known as, traction, when you haven’t convinced them on “why you.”

Investors want to be excited about you. They want to brag about you to their partnership, colleagues and friends. But if you don’t give them a strong reason to, they’re going to regress to what they know will return them capital. Predictability. And that comes in the form of traction. But I digress.

If Max Levchin or Phil Libin or Elon Musk or Justin Kan – pick your favorite serial entrepreneur with unicorn exits under their belt – wanted to raise for a new startup, no matter what it is or how early, people are gonna jump on the opportunity to regardless of how saturated the cap table is.

Let’s stand in the shoes of an investor for a second. Of which there are three main kinds of early investors.

  1. Angels
  2. Non-lead VCs and syndicate leads
  3. VCs who lead rounds

For individual angels, ownership targets don’t matter. They just want a piece of the action. In fact, multiple sources of signal and validation give them more confidence to invest. Especially if you’ve taken previous or current checks from your small handful of top tier VCs. These angels’ check sizes are negligible on the cap table, so they won’t end up crowding anyone else out.

On the other hand, notice how I bucketed non-lead VCs and syndicate leads into the same category. Why? These investors are writing bigger checks. They won’t price the round. And they move a lot faster if someone with a great track record is leading the round. Once again, ownership also doesn’t matter, but great co-investors do. As long as ownership targets don’t matter, the excuse of dilution is merely lip service. The story here is “I just need to get in the best deals, so I can raise my next fund from LPs.” Or “I need build my track record as an investor, so I can raise a fund one day.” I’m going to generalize here really quickly. While it doesn’t apply to every non-lead investor, it does apply to the vast majority. I dare say, 90% of them. These investors move on the combination of three levers:

  1. Great traction
  2. Great team,
  3. And great co-investors – the last of which is often the most important.

The more of the above levers you have as a founder, the faster you’ll get a check from the above individuals and institutions. Why do great co-investors matter so much? Outside of branding and social rapport, their investors – their LPs – also want to invest in these top deals led by these funds, but often can’t invest into these top-tier funds since everyone wants to get into a16z or Sequoia. In fact, for many of these top-tier funds, there’s a massive waitlist of LPs.

Finally, lead VCs. Ownership does matter. Really, this is the only audience you need to worry about when it comes to the topic of early dilution. While you as a founder should be dilution-preserving, sometimes, taking the capital (and subsequently, the dilution) is the best option. Maybe you really need something from an accelerator or an early investor that would be hard to get for you yourself. At that point, their capital becomes optimization capital. Early checks can get you from A to B faster, with less burn potentially, and with less detours.

So, the question you have to figure out if you take subsequent capital injections is that each time you dilute the cap table, did you reach an important milestone? What’s worrying is if you keep diluting your cap table without making meaningful progress each time. Think in the framework of milestone-based financing. Raise what you need, while giving you and your team an appropriate margin of error.

In closing

As a footnote, it’s also important to consider how much equity you as the founder will have left upon exit. If you’re going through large amounts of early dilution, you’re going to have very little upside unless you go through a massive exit. Unlike investors who invest in many businesses and have diversified their risk appetite, you, the founder, have put all your eggs in one basket. So if you care about the upside, you want to reduce dilution unless there is an absolute necessity to raise capital.

Photo by Lucas Benjamin on Unsplash

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DGQ 11: Was the David from a month ago laughably stupid?

laugh fox smile

Was the David from a month ago laughably stupid?

I’m a big fan of self-deprecating humor, but this isn’t one of those moments. Rather it’s a learning moment. While the above question is a lagging indicator for personal growth, it nevertheless deserves to be measured. After all, as the great Peter Drucker would say, you cannot manage what you cannot measure.

The timeframe of evaluation

Why a month? Why not a week? Or not a year?

In the business world, there’s a concept called the rule of 72. Effectively, 72 divided by the growth rate is the time it takes to double. For instance, if you’re growing 30% month-over-month, 72 divided by 30 is 2.4. So, if you’re growing revenue at 30% every month, you’re going to double your revenue in roughly two and a half months.

It is equally as analogous for personal growth.

time it takes to shock yourself = 72 / rate of learning

Let’s say you’re a first-time founder, and you only knew 10 things about how to start a business. But every day, you learn one more thing – via podcasts, articles, blogs, classes, you name it. Give or take a 10% growth rate. You will double your knowledge in about a week. Hopefully enough to shock the you from a week prior. Or take another example, many self-help books ask you to commit to getting 1% better every day. Assuming you consistently do that, you would have doubled your experience in about 2.5 months.

That goes to say, the faster you want to grow, the shorter the timeframe should be for you to look back and reflect on your “stupidity.” For me, it is in my nature to be hungry for knowledge, and I really love learning about things I thought I knew and what I didn’t know. For now, as learning is a top priority for me, a month sounds like a reasonable timeframe to shock myself. I also use the term “stupidity” lightly and with notes of self-deprecating love.

The shock factor

But how do you measure personal growth? Something rather intangible. It isn’t a number like revenue or user acquisition. Some people might have a set of resolutions or goals that is tangible and quantitative – say read two books a month or exercise an hour four days a week. Great goals, but they are often based on the assumption that movement is progress. The two aren’t mutually exclusive, but neither are they synonymous. The former – movement – lacks retrospection.

There were, are, and will be days, weeks, and months, we may just be busy. Our schedule is packed. We’re a duck paddling furiously underwater. And we’re gasping for air. And while our body and mind are exhausted, our body and mind have not expanded. I know I’m not alone when I think to myself, “Wow, I did a lot, but I still feel like I’m not moving anywhere.”

Our brains are unfortunately also poor predictors of the future. We use past progress as indicators of future progress. But while history often rhymes, it does not repeat. Our predictions end up being guesstimates at best.

So I look into the past. I measure my own personal growth emotionally – by shock, very similar to how Tim Urban measures progress of the human race (which I included at the end of a previous essay). I don’t know what the future will hold and neither will I make many predictions of what the future will hold for me. If I knew, I’d have made a fortune on the stock market already, in startups, or on crypto already. What I can commit to is my relentless pursuit of taking risks, making mistakes, and trying things that scare the bejesus out of me. Since only by making new mistakes will I grow as a person. What I am equipped with now can be mapped out by the scar tissue I’ve accumulated.

Coming full circle, what’ll make me realize and appreciate my mistakes and failures more is knowing that as a greenhorn I was laughably stupid.

But if, in retrospect, David from a month ago sounds like quite the sensible person, my growth will have gone from exponential to linear. Or worse, flatlined.

For founders

And now that I’m thinking aloud – or rather, writing aloud (which may deserve its indictment into the #unfiltered series), this might be a great line of questions to ask founders as well.

As a founder, what was the last dumb thing you did? When was that?

And before that, what was the second most recent dumb thing you did?

And the third most recent?

There’s the commonly repeated saying in the venture world. Investors invest in lines, not dots. Two’s a line. Three’s a curve. I want to see how fast you’ve been growing and learning.

Why such a question?

  1. If we’re in it for the long run, I wanna assess how candid and self-aware you are. Pitch meetings often depict a portrait of perfection. But founders, like all humans, aren’t perfect. For that matter, neither are investors.
  2. Venture capital is impatient capital. We demand aggressive timelines, and honestly, quite toxic to most people in the world. Given that, if you’re going to learn how to hustle after investors invest, you’re going to have a tough time convincing investors. But if the hustle is already in your DNA, that bias to action lends much better to the venture model.

Photo by Peter Lloyd on Unsplash

Thank you to V. who inspired this blogpost.

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.

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No One Talks About Selling

Seemingly, everyone these days – from Twitter to podcasts to blogposts (including mine) – talk about buying and investing in startups. What are best practices for investment theses? How do I pick the best companies to invest in? Conversely, how do I get picked or get allocation into hot startups? But people rarely seem to be talking about selling positions. So, if you know me, I hit up two of the smartest people I know – one early-stage, the other growth-stage. Both of whom might be familiar faces on this blog. So I asked them:

How do you think about selling a position? How much does DPI matter for your investors?

The below insights include minor edits for clarity.

The notice that you’ve all seen a million times

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.

Shawn Merani (Parade Ventures)

Shawn was instrumental in my early career growth in venture. When I met him years ago, he was still running Flight Ventures, where he wrote early checks into Dollar Shave Club and Cruise Automation and was one of the first syndicates on AngelList. There he led a network-based model of syndicate leads, which I’ve heard been described by others as a “venture partner program on steroids.” Now he’s the solo GP at Parade Ventures, a seed stage venture fund investing in enterprise-themed companies.

“I would preface all of this with the fact we have never fully exited a position before a traditional liquidity event, but more so, have managed our position given the duration of our ownership and to generate returns for our LPs and manage risk. 

“We talk to founders all the time, and foster a relationship that grows. When I was writing check sizes for 1-5% of ownership, my engagement then is very different from my engagement with founders now, where we take more concentrated bets.

“When it comes to selling, it’s about influence and information. The larger our ownership, the more information we have access to. And if a company is doing well, we don’t think about selling. In fact, it’s the exact opposite; we buy more. If things are working, we take our pro rata. In some cases, we take more than my ownership target. And founders are willing since we’ve been helping them from the beginning. We know when there’s going to be a 3-4x uptick every 12-18 months. Compounding is powerful.

“Our investors back the fund because they trust us. They don’t talk to the founders as often as we do. They trust our decision when we say we should buy more or keep our shares. There are two ways to talk about DPI:

1. Making money for your current investors, and
2. Telling the story.

“Selling is really a case-by-case scenario, and it really depends on my relationship with the founder. All the equity in which I sold so far has been before Parade. But if we know the company is doing well, we buy more. There are also holding periods to consider under QSBS, which has huge tax benefits.”

For those that are unfamiliar with the terminology, DPI means distributions to paid-in capital. Effectively, how much money you actually return to your investors versus “paper returns”. QSBS, or qualified small business stock, tax exemption allows investors in qualified businesses to avoid 100% of the capital gains tax incurred if they hold their stock for more than 5 years.

Ratan Singh (Fort Ross Ventures)

I posed the same question to someone I’ve been a huge fan of the day I met him – Ratan Singh, Partner at Fort Ross Ventures. He’s an investor in some of the most recognizable businesses today, including the likes of Rescale and Clearcover, as well as holds board seats at Blueshift and Ridecell. You may remember Ratan from a previous essay about speed as a competitive advantage for investors. And you’ll likely see him a lot more on this blog. He summed it up best in our chat when he said, “There are two reasons why an investor needs to care about DPI: time horizon and fund strategy.” Both of which are variables, not constants, between early- and growth-stage investments.

“The true metric at the end of the day is DPI. DPI is turning in money to your investors. And there are two reasons why an investor needs to care about DPI: time horizon and fund strategy.

“Let’s start with time horizon. For a seed stage fund, as you get close to the end of your fund cycle, that’s when DPI matters. What type of vintage is the fund in? In 2021, it’s going to be the 2010 and 2011 funds.

“For the majority of the time, you want to ride your winners. At the end of your time horizon, ask for a one- to two-year extension. Usually LPs want more money or their shares distributed. They’ve already waited 10 years. Two more won’t make a difference, especially if you have some big fund returners in the making.

“For fund strategy, did you meet the objectives for your LPs already? If you have, and you want to sell some of your winnable deals in your portfolio to help raise your Fund II because those are the same LPs that would re-up in your next fund, then you might consider selling.

“The worst reason to sell is that you want to take the wins you currently have since you think the market is overvalued. ‘I’m at the peak.’ Or ‘I want to take chips off the table because there’s something bad that will happen, but that is very hard to predict.’

“There were a bunch of funds at the beginning of this year that sold their entire positions. They were desperate to lock in a win. They sold because they thought the market was at the top. And, they were wrong. I’m against it. Selling early doesn’t fully realize the strategy you have put forth. For us, at the growth stage, we shoot for 48 months to an exit. If it takes longer, did we underwrite it wrong? But even if it does, the case may be that the company is growing a little slower than expected.

“At the early stage, all funds will say 2 to 3x cash-on-cash in the LP presentation. Most funds return 1 to 1.5x, on average, with most funds total DPI at 1.2 to 1.5x, which barely returns the fund. Before your time horizon, everyone likes to cite unrealized gains and mark ups because TVPI’s all they have.

“DPI matters most for funds in the top quartile – the top returners, funds with more than $500 million, or nowadays, $1 billion mega-funds. For the bottom majority of funds, early DPI won’t matter. They would be limiting their upside.

venture returns
Author’s Note: Notice that 65% of financings lost money for their investors.
Source: Correlation Ventures

“The new interesting commentary is that – where the job is getting harder – a lot of crossover funds are making binary bets. Finding the one deal that’s the next Salesforce – the next industry-defining company. And putting a lot of capital to find that one or two companies. Tiger and Coatue, still maintain that 10-12% IRR, but spend a lot to find the company that’ll be the next Databricks. Every generation has their industry-defining companies. And, they’re willing to lose it all to find that one.

“You usually don’t see this at the growth stage. It’s bad for innovation. Everyone is trying to find investments that are scaling. 1000 investments in the past year became unicorns. And there are 3000+ unicorns. Yet, the top five to seven companies are still undercapitalized.”

In closing

As we closed the selling part of our conversation, Ratan shared a great quote from an Economist article:

“Flush with cash amid a deal frenzy, what is the industry to do? One option would be to liquidate portfolios, that is, to sell more assets than it buys, in effect trying to cash in some chips when prices are high. As yet, however, this does not seem to be happening. Take the figures for three big managers, Blackstone, Carlyle and KKR. So far this year for every $1 of assets, in aggregate, that they have sold, they have bought $1.30. Although Carlyle is being more cautious than the other two firms, these figures indicate that the industry overall thinks the good times will roll on.”

In fairness, as the saying goes, the high risk, high reward. Data does show that the funds with the greatest track records have more deals that lose money than those make them more money than they invested.

Interestingly enough, there’s also a huge differential between the world’s most valuable and most funded startups. According to Founder Collective, “the most valuable companies raised half as much capital and produced nearly 4X the value!” All of which echo Ratan’s words. “The top five to seven companies are still undercapitalized.”

Source: Founder Collective

The public often looks towards invested capital as a proxy of startup performance. But the data suggests that isn’t the case. In the words of the team at Founder Collective, “capital has no insights.” One of my favorite lines from Ashmeet Sidana of Engineering Capital frames it is still: “A company’s success makes a VC’s reputation; a VC’s success does not make a company’s reputation.”

But when DPI boils down to selling on multiples at the end of the day, I often reference Samir Kaji‘s tweet on the return hurdles expected of different stages of investors. As you might guess, the return expectations of each type of fund varies based on fund strategy.

As all things in the world, exiting is just as nuanced and complicated as entering. Hopefully, the above insights will be another set of tools for your toolkit.

If this essay has inspired more questions, here are some further reading materials, courtesy of Ratan:

Photo by Visual Stories || Micheile on Unsplash

Thank you Shawn and Ratan for reading over early drafts.

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!

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2021 Year in Review

Kintsugi.

The Japanese art of finding beauty in imperfection. More specifically, the art of mending broken pottery. Kintsugi finds an object’s value and beauty is a result of its imperfections, rather than the lack thereof.

Much like the year prior, and like for most, 2021 was a year of imperfections. What could have gone wrong went wrong. And what could have been weighed heavily on many people’s minds. It’s been a trying year for almost everyone. From Delta to Omicron, from the insurrection in January to military withdrawal from Afghanistan, from forest fires to the increase in crime in the Bay Area. Despite still wrestling with the constraints imposed by the pandemic and the broader socio-political-economic world, 2021 was the worst and best year I could have ever hoped for. The beauty was not that these events happened, but that these events led us to form deeper relationships, greater awareness for macro issues, and a general movement forward to change what hasn’t and will not work in tomorrow’s world. Simply put, I’ve never been more bullish on being human.

This year was the year of saying “Yes.” In contrast to my track record of regressing to “No.” And so far, I’m on a roll. That also means that I’m busier than ever. Nevertheless, because of my intentionality behind finding serendipitous moments in my life, I’ve had the pleasure of finding myself in a constant state of inspiration. To quote one of my good friends, who’ll appear in a blogpost soon enough: “Inspiration is the disciplined pursuit of unrelated [and unexpected] inputs.”

I wrote almost 90,000 words this year, excluding this blogpost, which for better or for worse, means I wrote just enough to fill the average nonfiction book and a half. In terms of the number of blogposts and words I’ve written, I’ve slipped in comparison to last year. Last year, I minted over 100 essays. And this year, I’m 20% shyer in quantity on both fronts. Yet, while recency bias may play a role, I’ve never been prouder of the content I’ve put out. Fundamentally, what I learned is that I have to take longer per blogpost.

My writing journey pre-2021

In 2019 and 2020, I took pride in minting a blogpost in under 24 hours at best. 48 hours at worst. I would start writing each piece during the night, right after my shower. Go to sleep. And finish editing the next morning before publishing.

Under those circumstances, while there were a number of pieces that I am still proud to have written to this date, there were many that would have been orders of magnitude better if I just let it sit for a few days longer. If I just let the content marinate a bit longer.

… In 2021

This year, unintentionally, I did just that. It started with a steep ramp up in my day-to-day schedule, rendering me unable to commit large chunks of time to sit down, write and edit. On average, each piece took 5-7 days before it went from conception to presentation. Of course, a small handful took 2-4 weeks. Equally so, there were a few on the other end of the spectrum that took less than 24 hours. But the more time I gave myself to think about each piece, the more robust each piece became. So, my process evolved as a function of my schedule.

Today, at least twice a week, I still allocate two hours to sit down, write and edit. I still find my creativity at its height right before I hit the haystack. And I still make the bulk of my edits in the morning. But I also give myself time to be bored. Time to just think with no intended purpose or goal, when I take long drives or in the shower or during a morning exercise routine. And as long as there seems to be a strong correlation between time to be bored and my creative output, I’ll continue this process in the foreseeable future.

2021’s Most Popular

Essays published in 2021, ranked by most views:

  1. How to Pitch VCs Without Ever Having to Send the Pitch Deck – One of the most insightful lessons I learned this year from an incredible serial founder. And especially useful for founders who don’t have a pre-existing investor network.
  2. Rolling Funds and the Emerging Fund Manager – A deeper dive to AngelList’s Rolling Funds and what that means for the emerging manager. Since then, I have learned some new insights on that front, which I’ll include in a future blogpost. That said, as an addendum to this blogpost, while much easier to raise capital from accredited investors, do beware of vintage quarters, especially for LPs. If you miss out on a quarter where the GP makes an incredible investment, you miss out on the carry there.
  3. Should you get an MBA as a founder? – Admittedly, this one’s ranking came as a surprise to me, but in hindsight, I know many founders, and professionals in general, wrestle with the pros and cons of advancement education as a means of career development.
  4. #unfiltered #57 True Vulnerability Is Messy – I’ve hosted a number of social experiments as well as vulnerability circles, but it wasn’t till my conversation with my good friend, Sam, that I realized what true vulnerability meant. Not the kind that’s been romanticized by Silicon Valley and the wider media.
  5. My Top Founder Interview Questions That Fly Under The Radar – Investors rarely share their rolodex of questions with founders. And understandably with good reason. But I’ve never been one to optimize for ‘gotcha’ moments. If you’re building a business that the world needs, the last thing you should be worried about is what kind of curveball questions investors can ask you. In this piece, I share my top 9 questions (outside of the usual few every investor asks) and my rationale behind each.
  6. The Smoke Signals of a Great Startup From the Lens of the Pitch Deck – From the perspective of an investor, I break down the foci points on the pitch deck depending on what stage your startup is fundraising at.
  7. Losing is Winning w/ Jeep Kline, General Partner at Translational Partners and Venture Partner at MrPink VC – One of my more contrarian posts from the insights of Jeep. What makes seemingly no sense at first glance carries a lot more depth than meets the eye.
  8. How to Find Product-Market Fit From Your Pricing Strategy – The broader business world has always found PMF through some cousin of the NPS score and/or usage metrics. While those are still extremely pertinent, I find it illuminating to view PMF through leading indicators like pricing, rather than lagging indicators, like usage.
  9. 14 Reasons For Me Not to Source This Deal – One of my more tongue-in-cheek posts about founder red flags. I imagine a large contributor to its current ranking is due to the fact that my buddy, DC, reposted this on his blog as well.
  10. #unfiltered #56 How Thirteen Technology and Thought Leaders Break Down Self-Doubt – One of my favorite blogposts I wrote this year, written during one of my most emotionally-turmoiled times. These 13 were my North Stars, when I found it hard to see the night sky. Hopefully, they might serve as yours in some capacity as well.

All-Time Most Popular

All the essays I’ve ever written, ranked by most views:

  1. 10 Letters of Thanks to 10 People who Changed my Life – Every year, during the holiday season, I write a plethora of letters of thanks to the people who changed my life in my short years of being alive so far. I wrote this piece back in 2019 sharing what I wrote word-for-word publicly for the first time. I never expected this essay alone to account for a plurality of your views. This is the only one of my now 200 blogposts that draws in readership almost every day since its inception. In 2021 alone, this one blogpost accounts for over a third of this blog’s viewership. The power law is truly incredible.
  2. #unfiltered #30 Inspiration and Frustration – The Honest Answers From Some of the Most Resilient People Going through a World of Uncertainty – Part one of two, where I ask 42 world-class professionals about their greatest motivators. I ask them two questions, but the catch is they’re only allowed to answer one of them.
  3. How to Pitch VCs Without Ever Having to Send the Pitch Deck – I imagine this one will be a repeat offender on this list. Time will tell.
  4. My Cold Email “Template” – I’ve had the fortune of meeting some of the most respectable people in the world and in their respective industries. Many of whom I met through a cold email. In this essay, I share my playbook as to how I did and do so.
  5. The Third Leg of the Race – An oldie, but a goodie. This notion is as true now as it was when I wrote it last year. The third leg of the race is always the hardest, but it’s the one that’ll decide if you win or lose.

My most memorable pieces in 2021

Because of this blog, I’ve had the chance to share my voice and thoughts, yet also pick the brains of some of the most brilliant people in the world. So I hesitate to even rank my favorites ’cause almost every blogpost I write has a special place in my heart. Nevertheless, if I had to pick and if I’m being honest, there are a handful that would go on my personal Mount Rushmore this year. In no particular order…

  • #unfiltered #56 How Thirteen Technology and Thought Leaders Break Down Self-Doubt – Same as above.
  • #unfiltered #57 True Vulnerability Is Messy – Same as above.
  • The Investor Purity Test – People in venture capital often take themselves as well as their work too seriously. And not that they shouldn’t, but everyone deserves a little satire about their job. Ours is no exception. So I created a mini quiz to see how pure you are from the woes of early-stage capitalism. Have fun!
  • #unfiltered #61 How To Host A Fireside Chat 101 – After hosting a series of fireside chats, panels, and podcast episodes (the latter yet to released), I share what I’ve learned in this essay. It includes not only how I think about asking questions during the chat, but also how I prepare for the conversation.
  • The Hype Rorschach Test: How To Interpret Startup Hype When Everything’s Hyped – In a market of noise, I break down how I think about finding the signal above it all.
  • Startup Growth Metrics that will Hocus Pocus an Investor Term Sheet – I always tell founders to lead with the metric that will “wow” an investor in every cold email and/or warm intro. Earlier this year, I broke down just what kinds of metrics and their respective benchmarks that will wow an investor.
  • Creativity is a Luxury – Back in May, I sat down with one of the most creative people I know – DJ Welch. And asked him how he regularly found inspiration. To this day, I still re-read this blogpost to help me out of a writer’s block when I’m in one.
  • #unfiltered #53 A Different Way To Count – Most people count their lives by the years that pass. But, what if our unit of measurement wasn’t years, but the number of presidents we live to see or the number of vacations we get to have with our significant other? You might see life quite differently.
  • #unfiltered #51 The Fickle Jar – I have a lot of ideas. Most of which are either completely silly, ludicrous or require time I am willing to prioritize. I’ve known anecdotally that very few actually make it past the Mendoza line. Nevertheless, thanks to my friend, I now have a visual way of tracking my promiscuity between ideas.

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The Investor Purity Test

Many investors often take their job quite seriously. And they should. Imagine if your surgeon didn’t take the utmost care to do her job in the operating theatre. Or if your defense attorney walked in a courtroom lacking preparation. Investors, while not as life critical as a surgeon or your defense attorney, are in the business of selling and appreciating money. It’s as simple as that. And yes, more often than not, we use niche jargon. Though I’m not quite sure if it’s to isolate outsiders or to make ourselves sound smarter. Or both. Most conversations I’ve had to date with other VCs while insightful, are often, to the layman, quite esoteric.

So as a welcome break from the bustle of Silicon Valley, VC Twitter, and 30-minute coffee chats, I created the Investor Purity Test. In part for the memes. In part as a reference guide to those who want to grow to be more active VC investors.

Your purity starts at 100. In this “quiz”, there’s a checklist of 100 items. And with every item you check off, you slowly lose your purity to capitalism, specifically around early-stage financing. In a way, think of it like a VC “personality” test.

Have fun!

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Three Types of Risk An Early-Stage Investor Takes

risk

From market risk to product risk to execution risk, I’ve written many a time the types of risks a founder takes, including here, here, and here. As well as shared that the first and foremost question founders need to answer is: What is the biggest risk of this business? Subsequently, is the person who can solve the biggest risk of this business in the room (or on the team slide)?

Over the weekend, I heard an incredible breakdown of the other side of the table. Rather than the founder, the three types of risks an investor takes. The same of which need to be addressed for LPs to invest. From Kanyi Maqubela on Venture Unlocked.

  1. Market risk as a function of ownership
  2. Judgment risk
  3. Win rate risk

Market risk as a function of ownership

If you’re investing in an consensus market – be it hot, growing, and is garnering a lot of attention, you don’t need a huge percentage. I mentioned before that every year there are only 20 companies that matter. And the goal of a great VC is to get into one of these 20 companies. Ownership doesn’t matter. Even 1% of a $10B outcome is a solid $100 million.

On the other hand, if you’re in a small or non-consensus market, you need a meaningful ownership to justify your bets. For the same $100 million return, you need to maintain 10% at the time of a unicorn exit.

Going back to economics 101, revenue is price multiplied by quantity. Revenue in this case is your returns, your DPI, or your TVPI. Price is the valuation of the business. Quantity is how much you own in that business. Valuation, as a function of market size, and percent ownership are inversely proportional to reach the same returns. The smaller the market, the more ownership matters. The bigger the market, the less it matters.

Judgment risk

At the top of the funnel, the job of any investor is to pick or to get picked. I’ll take the latter first. Getting picked is often far less risky. But far harder to get allocations for, especially if you’re a fund that has ownership targets, vis a vis the market risk above. At the same time, the larger your check size, the harder it is to squeeze into the round.

To generate alphas from picking, there are two ways:

  1. Get in early.
  2. 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.

The question to ask yourself here is: What do you know that other investors are overlooking, underestimating, or altogether not seeing? And how did you reach that conclusion as a function of your experience and analysis?

As Kanyi said on the podcast, “We think we’ve got unusually good judgment and nobody else likes this, but we like it for reasons that are unfair.” The unfair part is key.

Win rate risk

Win rate risk breaks down to what unique advantage you, as an investor, bring to the table that will help the company win. In simpler terms, what is your value add? Of the businesses you say “yes” to, can you increase the number of those who win? As an early-stage investor – angel or VC, there are four main ways an investor can help founders:

  1. Access to downstream capital or capital from strategic investors
  2. Access to talent – How can you increase the output of the business?
  3. Sales pipeline – How can you help grow revenue directly?
  4. Strategy – Do you have unique insight into the industry, business model, product, GTM, or team management that will meaningfully move the business forward?

In closing

If you’re an investor, I hope you found the above as useful of a reframing as I did. If you’re a founder reading this, I often find it useful to stand in the shoes of your investors. And in understanding how your investors think, you can better formulate your pitch that’ll align your collective incentives.

The conversation around risk management, at the end of the day, is a conversation of prevention. A realm of prevention while useful to hedge your bets is a strategy to not lose. It’ll help your LPs find comfort in investing dollars into you. But to truly stand as a signal above the rest and to win, you have to look where other investors aren’t. The non-obvious. Specifically the non-obvious that’ll become obvious one day. And you have to do so consistently.

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Where Does Implicit Gender Bias In The Startup World Come From

Last Thursday, I had an extremely thought-provoking conversation with an attorney-turned-investor. Out of the incredible array of topics our open-ended exploration on the topic of diversity – geographically and demographically – led us to, there was one thing in particular that I had to double click on.

She shared, “Men typically get asked promotion questions. ‘What does your upside look like?’ Whereas women and other underrepresented founders get asked prevention questions. ‘How do you prevent your startup from going out of business?’ And promotion questions begets more promotion questions. Similarly, prevention questions leads to more prevention questions. Founders who are typically asked prevention questions raise less capital than those who are asked promotion questions.”

I found that inextricably fascinating. I’ve never thought about investing through those lens before. It makes complete sense. The more an investor asks how are you not going to fail, the more they has convinced themselves this won’t be a good investment. On the flip side, the more an investor asks how awesome will you be, the more they’ve convinced themselves that this will be an investment worth their time.

And subsequently, I ended up reexamining the way I ask questions. I’ve never tracked the way I ask questions by demographic. But I fear that I may, in the past, have done something along the same veins.

When we closed out our conversation, she left me with one name: Dana Kanze. And well, if you know me, I had to look into her.

Lack of Venture Dollars

Dana Kanze is an assistant professor of organizational behavior over at London Business School. She wrote a paper titled We Ask Men to Win and Women Not to Lose: Closing the Gender Gap in Startup Funding back in 2018 that won her the Academy of Management Journal’s Best Article of the Year award, which she inevitably did a TED talk on that I highly recommend checking out.

She cites in that research that “although women found 38% of US companies, they only get 2% of the venture funding.” While that metric is a few years old, recent trends echo the same notion. Despite the increase in conversations to include diversity at the table, in board rooms and as decision makers, Crunchbase found in a study back in August that women still only get 2.2% of venture funding, which is actually lower than any of the previous five years.

Source: Crunchbase

And despite larger round sizes, we don’t see a rise in round sizes to female-only and mixed-gender teams either.

Source: Crunchbase

Cynthia Franklin, director of entrepreneurship at Berkley’s Innovation Labs at NYU, did say, “The bets are being made, but they’re smaller.” Which accounts for the fact that 61% of total funding for female founders happens at the early stages. Frankly, it might be too early to tell. Nevertheless, Dana has a point.

Why female founders raise less capital

Originating from E. Tory Higgins‘ regulatory focus, Dana shares the bifurcation of questions that male and female founders get. Promotion and prevention questions, respectively. “A promotion focus is concerned with gains and emphasizes hopes, accomplishments, and advancement needs, while a prevention focus is concern with losses and emphasizes safety, responsibility, and security needs.”

After analyzing nearly 2,000 questions and answers asked at TechCrunch Disrupt to presenting founders, she found that investors often ask male founders promotion questions. And investors ask female founders prevention questions. Specifically, 67% of questions to males were promotion questions. And 66% to females were prevention ones.

Yet I found one notion Dana shared particularly fascinating. “All VCs displayed the same implicit gender bias manifested in the regulatory focus of the questions they posed to male versus female candidates.” That both female and male investors had the exact same implicit cognitive biases against females.

Promotion questions beget promotion answers, which beget more promotion questions, reinforcing favorable opinions. It becomes a virtuous feedback loop, which culminates often times in a “yes”. On the other hand, prevention questions beget prevention answers. Which leads to more prevention questions. This, subsequently, leads founders down a negative feedback loop, reinforcing loss-correlated opinions. When it came down to it, “startups who were asked predominantly promotion questions went on to raise seven times as much funding as those asked prevention questions.”

The silver lining, as Dana shares, is that if founders respond to prevention questions with promotion answers, they raise 14 times more funding than those who answer prevention with prevention. The lesson is reframe your answers positively, betting on the long term potential and vision. Or in Alex Sok‘s words, focus on a strategy to win rather than a strategy not to lose.

In closing

Investors invest in lines, not dots. And often times, VCs don’t realize they’re spending more time analyzing the y-intercept than the slope. And that mentality actualizes in the form of questions founders get.

As a founder, understand your investor intention – subconscious and conscious. Playing off of Matt Lerner‘s language/market fit, find your fundraising language/investor fit. Once you understand their intention, capture their attention. In a saturated market of information, attention is your audience’s scarcest resource. Frame the dialogue with a promotion focus to get your investors over the activation energy to book the next meeting.

As an investor, pay attention to your cognitive biases. Most of the time, and often the most detrimental, are the ones we don’t realize. If anything, this blogpost is me pinching myself to wake up.

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VCs Are Science Fiction, Not Non-Fiction Writers

science fiction, camera lens, city

With the crazy market we’re in today, VCs are frontloading their diligence. They’re having smarter conversations earlier. Before 2021, most investors would have intro conversations with founders before taking a deeper dive into the market to see if the opportunity is big enough. Nowadays, investors do most, if not all, their homework before they start conversations with founders. And when they’ve gotten a good understanding of the market and a more robust thesis, then:

  1. They go out finding and talking to the founders who are solving the problems and gaps in the market they know exist.
  2. They incubate their own companies that solve these same issues.

Subsequently, they are more exploratory than ever before. In frontloading their diligence, VCs have become more informed, if not better, predictors of not only where the market is today, but where the market is going to be tomorrow. They have a better grasp on the non-obvious. Or at the very minimum, have a much better understanding on the obvious, so that the boundaries of the non-obvious are pushed further. In turn, they can truly invest in the outliers. Outliers that are more than three standard deviations from the mean.

Startup ideas are often pushing the boundaries of our understanding of the world we live in. The team at Floodgate use an incredible breakdown to frame the amount of data that needs to be present to qualify the validity of a team and idea. “[W]e like to say some secrets are plausible, some are possible, and some are preposterous, all different types of insights. It matters what type it is because the type of team you need, the type of people you need to hire, the fundraising strategy, the risk profile, the amount of inflections that have to come together. All of those things vary, depending on the type of secret about future that you’re pursuing,” said Mike Maples Jr. recently on the Invest Like the Best podcast.

Science fiction is, by definition, preposterous. But so are the true outliers. And as any great investor knows, that’s where the greatest alphas are generated.

Preposterous ideas are backed by logic and insight

To quote PG from an essay he wrote earlier this year, “Most implausible-sounding ideas are in fact bad and could be safely dismissed. But not when they’re proposed by reasonable domain experts. If the person proposing the idea is reasonable, then they know how implausible it sounds. And yet they’re proposing it anyway. That suggests they know something you don’t. And if they have deep domain expertise, that’s probably the source of it.

“Such ideas are not merely unsafe to dismiss, but disproportionately likely to be interesting.”

But no matter how implausible your startup idea sounds, there still has to fundamentally be an audience. And while it may not be obvious today, the goal is that it will be obvious one day. Frankly, if it’s forever non-obvious and forever in the non-consensus, you just can’t make any money there. If Airbnb stuck only with the convention industry or Uber only with the black cab, or Shopify only with snowboards, they would never have the ability to be as big as they are today.

Shopify’s Alex Danco has this great line in his essay World Building. “If you can create a world that’s more clear and compelling than the complex, ambiguous real world, then people will be attracted to that story.”

As investors, we have to start from first principle thinking. Investors, in frontloading their diligence, find the answers to “why now” and “why this”. All they’re looking for after is the “why you.” The further down the line towards preposterous science fiction you are, the more you need to sell investors on “why you”.

Idea PlausibilityKey QuestionContext
PlausibleWhy this?Most people can see why this idea should exist. Because of the consensus, you’re competing in a saturated market of similar, if not the same ideas. Therefore, to stand out, you must show traction.
PossibleWhy now?It makes sense that this idea should exist, but it’s unclear whether there’s a market for this. To stand out, you have to convince investors on the market, and subsequently the market timing.
PreposterousWhy you?Hands down, this is just crazy. You’re clearly in the non-consensus. Now the only way you can redeem yourself is if you have incredible insight and foresight. What’s the future you see and why does that make sense given the information we have today? If an investor doesn’t walk out of that meeting having been mind-blown on your lesson from the future, you’ve got no chance.

And when answering the “why you”, it’s not just on your background and years of experience, but your expertise. As Sequoia’s Roelof Botha puts it, “So what was the insight? What is the problem that you’re addressing? And why is your solution compelling and unique in addressing that problem? Even if it’s compelling, if it’s not unique there’re going to be lots of competitors. And then you’re probably going to struggle to build a distinctive business. So it’s that unique and compelling value proposition that I look for.” So before anything else, the best investors, like Roelof, “think of value creation before value capture.”

In order to find that earned secret – that compelling and unique secret sauce – in the first place, you have to love what you’re working. And not just passionate, but obsessive. The problem you’re trying to solve keeps you up at night. You have to be more of a “missionary” than a “mercenary” as Roelof would put it. If you’re truly a missionary, even the most preposterous idea will sound plausible if you can break down why it truly matters.

The Regulatory Dilemma

The most important and arguably the hardest part about writing science fiction – and this is equally true for funders as it is for founders – is that we have to self-regulate. Regulation will always be a lagging indicator of technological development. Regulators won’t move until there’s enough momentum.

But, as we learned in high school physics, with every action, you need an equal and opposite reaction. The hard about momentum, and I imagine this’ll only be more true in a decentralized world, is that it’s second order derivative is positive. In other words, it’ll only get faster and faster. On the other hand, regulation follows the afterimage of innovation. It sees where the puck was or, at best, is at, but not, until much later, where the puck is going. And truth be told, innovation will eventually plateau, as it follows a rather step-wise function, as I’ve written before. And when it does, regulation will catch up.

S-Curves
Source: Tim Urban’s “The AI Revolution: The Road to Superintelligence“

So, in the high school physics example of Newtonian physics, the reaction, in this case, regulation, needs to be equal and opposite force comparative to where the puck will be. But as you’ve guessed, that will stop innovation. And I don’t think the vast majority of the world would want that. Progress fuels the human race.

Science fiction needs rules

Brandon Sanderson, one of my favorite fictional authors, has these three laws that govern great worldbuilding. To which, he coined as Sanderson’s Three Laws. The second of which reads:

Limitations > powers

In fantastical worlds, we are often used to how awesome things can be. Making the impossible possible. But as Brandon explains, “the truth is that it’s virtually impossible to come up with a magical effect that nobody else has thought of. Originality, I’ve seen, doesn’t come so often with the power itself as with the limitation.”

As the infamous line goes, “with great power comes great responsibility.” If you end up having access to every single person on this planet’s data, what makes you a company worth betting on isn’t your power, but how you use that power. How you self-regulate in using that power. Take, Open AI’s GPT-3. Instead of sharing the entire AI with the world, they limited that power to prevent malicious actors through an API.

What does self-regulation mean? Simply, aligning incentives so that all stakeholders win. When you have two people, you have a 2×2 matrix to account for four possible outcomes. There’s a situation where both people win, two situations where one wins, one loses, and another where both lose. Needless to say, we want to be maximizing for win-win situations.

As Balaji Srinivasan said on the Tim Ferriss Show recently, “When you have three people, it’s a 2x2x2, because there’s eight outcomes, win/lose times win/lose times win/lose. It’s a Cartesian product.. […] When you have N people, it’s two by two by two to the Nth power. It’s like this hypercube it as it gets very complicated.” Subsequently, the greater the organization, the more stakeholders there, and the harder it is to account for the “win” to the Nth power outcome. Nevertheless, it’s important for founder and funders at the frontier of technological and economic development to consider such outcomes. And at what point is there a divergence of incentives.

There’s usually a strict alignment in the value creation days. But as the business grows and evolves to worry more about value capture, there needs to be a recalibration of growth and an ownership of responsibility as the architects who willed a seemingly preposterous idea into existence.

In closing

We live in a day in age that is crazier than ever before. To use Tim Urban’s analogy, if you brought someone from 1750 to today and had them just observe the world we live in, that person will not only be mind-blown, but literally, die of shock. To get the same effect of having someone die of shock in 1750, you can’t just bring someone from 1500, but you’d have to go further back till 12,000 BC. The world is changing exponentially. And new technologies further that. Who knows? In 50 years, we in 2021, might die of shock from what the world will have become.

And rightly because of such velocity, innovators – founders and investors – will have to lead the charge not only technically and economically, but also morally.

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We’re More Similar Than You Think: The Founder and the Funder

Last weekend, I tuned into Samir Kaji’s recent episode with LPs (limited partners). Not once, but twice. And as you might’ve guessed, was damn inspired by their conversation. The more I listened to it, the more synonymous the paths of a founder and an emerging manager (EM) seemed to be. Or what I call the entrepreneur and the entrepreneurial VC. If you’re a regular here, you’ll know I love writing about the intellectual horsepower of both sides of the table. But in this post, rather than delineating the two, I’d love to share how similar founders and funders actually are.

Surprises suck, but pivots are okay

On Samir’s podcast, Guy Perelmuter of GRIDS Capital voiced: “There’s only one thing that LPs hate more than losing money. It’s surprises.”

Be transparent. Be clear on your expectations, and steer clear of left hooks. As a fund, something I’ve heard a number of GPs and LPs say is don’t deviate on your thesis. LPs invest in you for your strategy. But as soon as you deviate from that initial strategy, you become increasingly unpredictable.

Take, for example, you go to a steakhouse and order steak. But they serve you sushi instead. If it’s not good sushi, obviously you’re not coming back. Not only did they surprise you, but it was also a poorly executed one. This goes in the column of one-star Yelp reviews.

But, say it was great sushi. You had one great dining experience and you’re a happy customer. Some time in the future, you think of getting sushi again. And you remember what a great experience you had at the steakhouse. So you go back to the steakhouse, only to realize it was a fluke and the sushi wasn’t like the last time you’ve had it. Your inability to replicate surprises scares LPs, which limits your ability to raise a subsequent fund.

Nevertheless, these days markets are changing quickly. And sometimes your initial thesis may not serve you as well in today’s market as it did yesterday. As John Maynard Keynes, father of Keynesian economics, once said, “When the facts change, I change my mind.” But, if you do need to deviate, communicate it clearly, formulate a new strategy, and preemptively tell your LPs. Then at that point, it’s no longer a surprise, but a strategy. Great examples include:

  • Accelerators making discovery checks part of their core business
    • Note: LPs historically dislike GPs (general partners) writing discovery checks because they’re:
      1. Not investing via their fund strategy (i.e. typically ad hoc),
      2. Require less diligence and therefore less conviction,
      3. Send negative signals to other investors if the GP doesn’t do a follow-on check at the next round, and
      4. Because of (2) and (3) are usually cash sinks.
  • The On Deck Accelerator (ODX) – Backing founders at the earliest stages (i.e. pre-product, pre-revenue) as long as they have deep conviction in their own business.
  • The recent announcement of The Sequoia Fund – a systematic and predictable strategy to invest in not just startups, but venture funds backing incredible founders as well.

The same holds for founders. Don’t get me wrong. Startups pivot. And they should. Mike Maples Jr., founder of one of the best performing seed stage venture firms, recently shared: “Most investors are going to look at what the company does and evaluate the business for what it is, but 90% of our exit profits have come from pivots.” And just like fund managers, clearly convey why, how, and what you’re pivoting to to your shareholders. It’s always better to preempt these conversations than leave these as surprises. Often times, you’ll find your investors, having seen as many pivots as they have and knowing that is the name of the game, can offer you much more feedback and insight than you imagined for your pivot.

Optimize for the “Oh shit! moment*

In every conversation, your goal should just be to teach your investors something. An earned secret. A unique insight. What do you know that other people don’t, overlook, or underestimate? What do you know that other people would find it very hard to learn organically? This is especially true for consensus ideas – or obvious ideas. The best obvious products may seem obvious at first glance, but usually have non-obvious insights to back them up.

If you’re a fund, what is your insight – your access point – that’ll win you an asymmetric upside?

I’ve talked to too many founders and EMs that claim to be experts with X years of experience in a particular field. Yet after 30 minutes, I realized I learned nothing from them. I realize that for half an hour straight I ended up with a prep book full of buzzwords and vague jargon that would rival the SAT vocab section. But let’s be real. The SAT doesn’t get me excited to want to retake the test.

The best founders and funders out there are able to break down deep, technical, esoteric, and sometimes crazy concepts into simple bitesize ideas. The equivalent of taking the whole universe and simplifying it to its origin. A single point. The Big Bang.

I’ve also realized over the years that the world’s smartest teachers – and when you’re trying to convince people to join you in a non-obvious vision, you are teaching – lead with analogies. And the best analogies lead investors to that “Oh Shit! moment.”

COVID made capital cheaper

Equally true for startups and funds. Capital is digital. If you think about capital in the frame of investor acquisition cost, you no longer have to travel to your investors to pitch to them. This means you can take far more meetings than before. Less travel and more meetings mean your investor acquisition cost goes down.

Founders no longer have to book a week to Sand Hill Road or South Park to have introductory conversations with investors. Only to have 80-90% turn down a second conversation. This becomes even more costly the earlier you are in your startup journey. You have to have a lot more first conversations as a pre-seed founder than you do as a founder raising an A. At the same time, you have many more options for raising capital today: accelerators, syndicates, equity crowdfunding, and roll-up vehicles (RUVs). While it’s not that these resources didn’t exist before COVID, the pandemic made it much more apparent that VC money didn’t have to be the only way to raise capital. And that you can also leverage speed and your community to help you grow.

Similarly, EMs no longer have to travel across the states to talk to institutional capital. Even more so, as an EM, you’re most likely raising from individual investors. Raising a rolling fund or a 506c lets you generally solicit investments, where you couldn’t with a 506b. Subsequently, Twitter and having a community became your superpower. Mac at Rarebreed, Packy’s Not Boring Fund I, and Harry at 20VC all raised during the time of COVID, leveraging the power of their following and community to do so.

Keep it simple

“There’s no favorable wind for the sailor who doesn’t know where to go.” – Seneca

Two Saturdays ago, I caught up with my ridiculously smart engineer friend from college – “Fred”. We were reminiscing about the “good ol’ days” when we first started punching above our weight class. Particularly in regards to cold outreaches to individuals we really admired. While I was an operator at two startups that shaped my entrepreneurial career, I spent many a night struggling on how to best position our products in the market. Many hours of copy and rephrasing and reframing. In both we were competing against the existing saturation of information and solutions on the market. How do we tell our customers and investors the reason we’re awesome is because of A and B and C, and also D?

Most people, friends, customers, and investors didn’t understand the value we thought we were obviously conveying. And subsequently, we were rejected more often than I would have liked to admit. In the early days, we didn’t lose on price nor on quality, but on brand and messaging. And while we thought and strove to prove we were better in areas that mattered, both startups eventually ended up having exceedingly simple one-liners.

On the other hand, “Fred” was working on something related to liquid fuel and cold fires. Something extremely technical. But he was able to win proportionally more yes’s than I was able to. When I asked him how, he said it was simple. “We’re putting a rocket into space. That’s it. And that’s really exciting.”

I made something extraordinarily simple into something extraordinarily complex. In all honesty, I sounded really, really smart. And I felt like I was the shit. Except no one else did. “Fred” took something extraordinarily complex and made it extraordinarily simple. He didn’t sound as smart. But celebrities, sponsors, companies – people just got it.

The true value of a product is usually exceedingly simple. The fallacy of including a Rolodex of esoteric jargon comes in two-fold. Either you’re trying to sound smarter than you actually are. Or you’re trying to cram too many things in too little space. As economist Herbert A. Simon said, “A wealth of information creates of poverty of attention.”

In closing

Whether you’re an entrepreneur or an emerging manager, you’re swinging for the fences. I was chatting with an investor yesterday who had an incredible analogy. “It’s like a pinball machine. The ball goes up, and you never know how it’ll fall down. You don’t know how many bounce pads and flippers it will hit. You don’t know how many points you’re going to get. But no matter how many points you’ll get, the ball has to go up first.” Similarly, whether you start a company or a fund, you have to step up to the plate to bat. You don’t know what the upside will be. You don’t know if you’re going to return your investors 2x, 5x or a 100x.

You’re taking an asymmetric bet on the compelling future you bring. Your valuation as a startup is not how much your startups is worth, which is why the 409a valuation is always different from the valuation your investors set for you. Your valuation is a bet your investors made that you will be as big as the major players in the market. If you’re valued at $10M today, your investors are saying you are 10 in 1000, or a 1% chance, to be a unicorn. And a 0.1% chance to be a decacorn.

Valuations might seem crazy today. VC firms are also raising larger and larger funds, which lead many to be skeptical on their ability to return capital. In fairness, most funds will return a modest 2-3x over their lifetime, if at all. Most startups are and will be overvalued. On the same token, the best ones, despite their crazy price, are still undervalued. Imagine if you were an investor who could invest in Facebook’s then-unicorn valuation. You’d have made a lot of money. But we’re in an optimistic market.

At the end of the day, both parties are just managing someone else’s capital. And as such, through a fiduciary responsibility, in that regard, both are cut from the same cloth.

Photo by Luke Leung on Unsplash

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