Tag: venture capital

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Not the White Knight in Shining Armor

startup fundraising

I hear so many founders in their pitch decks say: As soon as they raise funding, [blank] will happen. [blank] could be: hiring that CTO or lead developer or an operations lead, getting to X0,000 users, or going “all in” on growth (often heard as Facebook and/or Google ads). That line by itself really doesn’t mean much. So I always follow up, with: “How do you plan to achieve [blank] milestone after you extend your runway/receive venture backing?”

Then this is when I start thinking, “Oh no!”, especially as soon as I hear, after I partner with X investor, they will help me do Y, or worse, they will do Y for me.

And I’m not alone. So, what signals does that response give investors?

  1. Alright, Investor A, I’m planning for you to do the legwork for growing my business.
  2. I don’t know what I’m doing, but please invest in my naivety.
  3. I haven’t thought about that problem/milestone at all, and I’ll worry about it when I get there. So, take a big risk in me.

Why I love athletes, chefs and veterans

There is no white knight in shining armor when you’re raising a round.

This is the reason I love athletes. And for that matter, veterans and chefs, too. Each of them chose a career where they are forced to deal with adversity. Personally and collectively. To a level, most of us might call inhuman. While I’m sure I’ve missed many other industries that also sponsor such arduous growth, and yes, I know I’m generalizing here, these 3 industries seem to have a higher batting average of producing individuals who can find the internal grit to overcome almost any obstacle.

In the words of Y Combinator‘s Michael Seibel in a recent talk he gave with Saastr Annual @ Home,

“They’ve trained themselves to be better at doing things that are hard.”

While he wasn’t necessarily talking about professional athletes, chefs, or veterans, the same is true. The people who are better than you at doing something don’t have it any easier than you do. Rather, they’ve developed a system, or mental model, that helps them conquer extremely difficult obstacles. And because it’s become muscle memory for them, it seems easier for them to accomplish these goals. At the same time, we should never discount their blood, sweat, and tears, or what some of my colleagues call scar tissue, just because we cannot see them. It’s why we in venture call startups “10-year overnight successes“.

To founders

Bringing it back full circle, a great founder (as opposed to a good or okay founder) never completely relies on an external source for the growth of their company. By the same token, a great founder also never blames the failure of their startup because of an external source. A great founder – regardless of the business’s success or failure – learns quickly to not only repeat the same mistake again, but also develop insights and skills to push their business forward. While you as the founder isn’t required to be the best in the world of a particular skill, you will need to practice and accel at it until you can find the best in the world. But to hire the best in the world, you also have to be reasonably literate in the field to differentiate the best from the second best.

The solution

Here’s what investors are looking for instead:

  1. We’ve thought about the problem. We’ve A/B tested with these 3 strategies (and why we chose each strategy). Numbers-wise, Strategy B proves to: (a) have the most traction, and (b) is most closely aligned with our core metric – revenue.
  2. Here are the 2-3 core milestones we plan to hit once we get this injection of capital. And we will do what it takes to get there. In order to get there, we’ve thought about hiring an expert in operational efficiency and purchasing these 5 tools to help us hit these milestones. For the former, here’s who we’ve talked to, why we think they’re a perfect fit, and what each of their responses are so far. For the latter, each tool in this short list can help us save X amount of time and Y amount of burn. Do you think we’re approaching these goals in an optimal way?
    • Note: The signal you’re giving here is that you and your team are results-/goals-oriented, while the process of getting to those goals are fluid and stress-tested.

In both cases, you’re showing your potential investors that you’ve done your homework already (versus a Hail Mary). But at the end of the day, you are open and willing to entertain their suggestions, which, ideally, come with years of experience in operating and/or advising other founders who have gone through a similar journey.

So, stay curious out there! Always question the seemingly unquestionable!

Photo by gaspar manuel zaldo on Unsplash

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How Prospect Theory Relates to Venture Capital

economics, prospect theory, coins, venture capital

The other day, I saw a post on r/venturecapital (and now you know what my Reddit handle is) asking how prospect theory relates to venture capital. Admittedly, quite thought-provoking! Ever since college, I’ve been a huge behavioral economics buff – how human psychology dictates market motions. And, prospect theory happens to fall in that category.

First developed by Daniel Kahneman and Amos Tversky, prospect theory is a behavioral model that says humans are naturally loss-averse. Oh, you might know the former Nobel Prize bugger from authoring Thinking, Fast and Slow, a book I highly recommend if you’re curious about the intricacies of how our brain understands the data around us. Simply put, we react stronger to losing something than when we gain something.

*As you can see, this graph is safe for family-friendly programming

For example, I’m more likely to feel the loss after losing my $1500 cellphone than the ephemeral gain of winning a grand and a half in the lottery. On one end, you’re probably thinking that makes sense. On the other end, you’re probably calling me a loser for spending so much on a cellphone. Well, joke’s on you. I got my phone for $250 on Black Friday. But I digress. In another instance, if you look at kids, they’re more likely to throw a tantrum if you take away a marshmallow on their plate than give you a hug for giving them an extra marshmallow.

Similarly…

As you might expect, prospect theory informs many of my investing/sourcing decisions, including:

So, VCs and prospect theory

So, you’re probably now thinking: “Gimme the deets.”

While prospect theory suggests people typically weigh the impact of their losses more than they so their wins, VCs are humans at the end of the day. Just like your amateur naive stock trader will hold on to losses, and sell their wins, many VCs tend to do the same, as a reactionary measure.

It’s counterintuitive. But the name of the game in early-stage investing is not about how many losses you’ve sustained (especially when 7 out of every 10 go out of business, 2-3 break even, and hopefully 1 makes it), but about the magnitude of the wins an investor makes.

For instance, if you’ve invested in 100 companies, and 99 go out of business, and 1 makes 200x, you just doubled your fund. Of course, a successful fund typically makes 3-5x cash on cash multiple. Just our fancy way of saying your fund returns $3-5 for every dollar invested by a limited partner (LP). Although there are some nuances, many VC investors use cash on cash and multiple on invested capital (MOIC) quite interchangeably.

Guess for you to be counted as a successful investor, that one investment’s gotta go to 300x, at the minimum. In reality, you’re probably not going to have just one investment perform. Especially if you’re in the top quartile of VCs out there. You’re looking at a ~2.5% unicorn rate. So 2-3 investments of your 100 investments should be valued at over a billion dollars. Unless you’re Chris Sacca, who I hear returned 250x cash on cash for his first $8.4M seed fund, which included the likes of Uber, Twitter, and Instagram.

Of course, larger funds are harder to return. It’s easier to return a $10M fund than a $1B, much less a $100B. While I’m not supporting the only $100B vehicle known to date, the losses that fund sustained made the front page news a while back. And though by monetary value, they lost more than most other funds out there. Percentage-wise, they’re not alone. But in the public and media’s eyes, their losses are weighted more heavily than smaller funds.

In closing/Disclaimer

But hey, I’m no registered investment advisor. If you’re looking for which specific startups to invest in, please do consult with a professional. While I may share what startups have attracted my attention here and there, my thoughts are just my own thoughts. And, this post is merely me sharing the correlation between venture capital and prospect theory, plus a few digressions.

Photo by Josh Appel on Unsplash

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