November Thoughts
Between 2003 to 2010, an average of 58 seed funds were raised each year but in the past 7 years, that average spiked to 137 (or a 2.3x increase)
1) Larger seed funds, that are hyper-competitive (and often generalists due to fund size and scope creep).
2) Which means that seed funds need to tell founders that it is best for their business to only have them and no other meaningful checks in the round, so they can write $1.5M+ and get ~15%-20% ownership.
3) But unless you’re a top tier firm, your capital could be viewed as a commodity, and thus it’s clearly not dominant for a generalist firm to be the only investor (which is ok because…we’re humans, and we can’t be everything for everyone), and thus you are at massive risk of being pushed down in ownership and allocation.
4) And then in order to make the math work you’re reliant on multiple $1B+ outcomes, despite a large % of VC-backed M&A transactions happening below $300M.
5) So we now have some seed VCs telling investors that they will be able to increase ownership from seed to A/B or at worse do full pro-rata to maintain. The problem is that in reality, pro rata allocations from Series A+ remain increasingly difficult to maintain, as those $1B+ funds, that have infrastructure (and fees) to in theory actually be everything for everyone, need to put more money to work in their rounds. So you don’t get to defend ownership nearly as efficiently as even 5 years ago. And often any pre-empted offer for a pre-series A round could just turn into a pre-empted full series A process.
All of these things boil down to the core truth that most Seed stage firms today have to be small (either ridealong checks or non-hyper competitive leads), early, and/or different enough to be one top-priority thing for a subset of founders.
Private markets are going to continue to capture the returns in many sectors, and thus it will be attractive for LPs to be invested in a larger subset of tier 1, tier 2, and maybe even tier 3 VC firms from a returns perspective. This will be even more evident as we potentially enter tumultuous public market performance that shows lower yield over the next decade than the prior decade+ bull-run we’ve had.
The compounding effects of venture as an industry are unique vs. any other industry. Brand flywheels are strong absent of results due to opacity of quantitative measures (i.e. we both bury the dead slowly and quietly on failed startups, and cheer the good loudly on less-than-incredible fund exits/performance).
Brand signaling can create unfair advantages. I.e. If Sequoia invests in a company, statistically that company is more likely to raise money than if another investor does. Building a lasting brand matters.
With increase in number of pre-seed/seed funds, the top of the funnel has expanded significantly over the past decade. Despite this expansion at the top, the rest of the funnel has been largely unchanged. Looking ahead, this should allow outsized returns in the growth and later stages as they are now allowed to be much pickier with their checks.
Past a certain income the most difficult financial skill is getting the goalpost to stop moving.
-Morgan Housel
When looking at a team, VCs think that the most important qualities are, in order: ability, industry experience, passion, entrepreneurial experience, and teamwork.
With Google’s $2.1B acquisition of FitBit, FAMGA cos (Facebook, Apple, Microsoft, Google, and Amazon) have now made 27 billion-dollar acquisitions over the last 20 years.
“In 2020, we anticipate continued entrepreneurial activity and investor enthusiasm around the infrastructure and middleware layers within the fintech ecosystem that are enabling further rebundling and a rapid convergence of product themes and business models across the consumer fintech landscape. Many players now look like potential challenger bank models more akin to what we have seen unfold in Europe the past few years. Within consumer fintech, we at Bessemer are more focused on demographically-specific product offerings that tap into underserved themes, whether that be the financial problems facing the aging population in the US or new models to serve the underbanked or underserved population of consumers and small businesses.”
-Charles Birnbaum
“I suspect that many enterprise software companies become fintech companies over time — collecting payments on behalf of customers and growing revenues as your customers grow. We have seen this trend in many industries over the past few years. Business owners generally prefer a model that moves IT expenditures from Operating Expenses into Cost of Goods Sold, because they can increase prices and pass their entire budget onto the customer. On the consumer side, we have already made investments in branchless banking, insurance (auto, home, health, workers comp), cross-border payments, alternative investments, loyalty cards/services, and roboadvisor services. The companies we funded are already a few years old, and I think we will have some interesting follow-on activity there over the next few years. We have been picking spots where we think we have an unfair competitive advantage.
Our fintech portfolio is also more global than other sectors we invest in. This is because there are opportunities to achieve billion dollar outcomes in fintech, even in countries that are much smaller than the United States. That is not true in many other sectors. We have also seen trends emerge in the US and move abroad. As an example we seeded Flutterwave, which is similar to Stripe, and they have expanded across Africa. We were also the lead investor in Yeahka, which is similar to Square in China. These products are heavily localized — tin for instance Yeahka is the largest processor of QR code payments in the world, but QR code payments are not popular in the US yet.”
-Ian Sigalow
Moving fast and breaking things cannot be applied to PFM apps; building trust over time is essential to surviving
The best apps retain 70% of users after three days. Average mobile apps lose 80% of users within three days of download; apps that perform well must demonstrate value to users within a three day window to survive.
Design is the primary reason that people choose to trust or not trust a website or presentation
One of the key findings in the study was compelling data that venture funds <$250MM performed significantly better than venture funds >$250MM — Based on the report, 83% of large funds ($250MM+) exhibited a return multiple of less than 1.5X, while only 54% of sub-$250MM came in at a multiple of 1.5X or lower (clearly a huge delta, although perhaps a bit of “we suck less”).
“Success in VC is probably about 10% picking and 90% about sourcing the right deals and having entrepreneurs choose your firm.”
-Chris Dixon
Unless you are one of the top couple hundred angels or super early seed fund investors in the U.S. the most promising startups run by the strongest teams will not come to you. You will suffer from adverse selection. Capital is far more readily available than opportunities to invest in good startups.
Why is the startup taking my money?
- The startups that you see in your deal flow aren’t as good as the startups better investors look at. There’s so much negative selection out there…
- Your deal flow is way earlier then the startups that the super-angels look to invest in. You can get in because it’s *still* below their radar (a good thing)
- Your diligence process and selection speed is faster than that of other investors
focus on petal diagrams rather than X-Y competitive analysis charts
If you’re in a market that previously ate up a lot of investor dollars:
- Investors have longer memories of failures than new entrepreneurs
- When you’re describing the future, most of them are remembering the past
Improvement opportunities in proptech:
- real estate transaction process
-brokerage, financing, closing process remains largely analogue, complicated, and inefficient - rise of alternative or professional living arrangements
-provide solutions for the mismatch between the way consumers want to live today and the aging housing supply that was built for a previous era with different needs and demographics - spend around the home
-large costs in time, effort, and money of designing, building, and maintaining a home provide an opportunity for tech-enabled solutions in construction, home management, and home maintenance
VC associates who do well:
- are startup enthusiasts and inspire to be entrepreneurs one day
- they work hard and long hours understanding core business, themes, spaces, and themes
- they do their research in spaces they are looking into to sound genuinely knowledgable and thoughtful when they have conversations
- they know their limitations and are upfront about their intentions
Value propositions should:
- Acknowledge the problem and pains felt by your target audience.
- Display an understanding of the their requirements.
- Quantify the benefits of your product(s)/service(s).
- Highlight the differentiation between your solution and the competition.
People are generally more honest when they are physically tired and/or stressed
“If you want to be interesting, be interested.”
-Dale Carnegie
The smarter a person is, the faster that person thinks; some of the smartest people have the sloppiest handwriting
in addition to tech diligence having questionable value, many seed stage founders consider it overbearing and passively resist it. Given that engineering resources are scarce and that there are plenty of investors who write $100k+ checks after one or two short meetings, founders often prioritize “lighter-diligence investors” instead of submitting to an hour or two of technical grilling.)
Reasons why technical diligence is a waste at the seed stage:
- Early versions of a product are often prototypes that are intentionally meant to be rewritten or heavily refactored in the near future.
- Because getting a product in the hands of users is a top priority, even great engineers will intentionally take shortcuts and accumulate technical debt in order to launch sooner.
- The ability to scale with success is important, but designing products for high scalability from Day 1 is usually a mistake. (“Premature optimization is the root of all evil.” — Donald Knuth)
- “CTO” is an ambiguous title at small companies. A CTO might be a great coder who is a mediocre manager, or a great manager who is a mediocre coder, or simply a founding engineer who assumes the CTO title to make the founding team appear more well-rounded. Because CTOs often evolve in very different directions after a company hits 5–10 engineers, it’s not clear what bar they should be held to. Is it better to have someone who’s good at building prototypes quickly? Someone who is a slow prototyper but great at releasing robust software? Someone who may not be a great coder, but who is great at recruiting and managing engineers? It’s hard to pigeonhole different types of CTOs into a standardized tech diligence process.
In today’s world of SaaS tools, APIs, and cloud infrastructure, most startups do not have significant levels of technical risk. Only 5% of postmortems referenced a lack of technical ability/execution.
Technical execution enables great software products to exist, but in my experience it doesn’t significantly contribute to success or failure for most early-stage companies. The things that lead to success are generally non-technical: being good at understanding customers’ needs, being able to design a product that addresses those needs, being good at hiring, being good at customer acquisition, and so on. A well-built product that doesn’t solve a problem will always be inferior to an ugly, buggy product that addresses a burning need.
Now, for the first time in our nation’s history, the opposite is true: People are moving from high productivity regions to low productivity regions, largely to pursue cheaper costs of living. It’s what economics columnist Ryan Avent has dubbed “moving to stagnation.”
In a perpetual license business, the R&D (and support) teams are often maintaining multiple versions of the software, with multiple versions running in the wild. This generally doesn’t happen in SaaS because all customers are running on the same hosted version of the software: one version to maintain, one version to upgrade, one version on which to fix bugs, and one physical environment (storage, networking, etc.) to support. Given that software companies at maturity often spend 12–15% of their revenue in R&D, this cost advantage is very significant and further enables SaaS companies to be even more profitable at scale — particularly if they use multi-tenant architectures.
- It’s very difficult to switch SaaS vendors once they’re embedded into business workflow.
- Budgets are much more decentralized now, because departments often adopt SaaS technologies and make purchasing decisions independent of the centralized IT organization.
- Because SaaS usage is at the departmental level, there are often many more users in a company than there have historically been from traditional software products, making switching costs even higher.
