The Room Where it Happens: How We Make our Investment Decisions

In reference to “The Room Where It Happens” from Hamilton

In this post, we’re going to open the black box a bit on our process of making investment decisions.

First, we should say at the outset that we strive to be transparent: we are fairly explicit about what sorts of companies we look for — in fact, it’s the first sentence on our homepage: “We back technical teams working on breakthrough products”.

To be slightly more explicit, we invest in:

• Early stage (~70% seed; 20% Series A, 10% pre-seed)

Multi-sector, with the following composition (no B2C in any sector):

• 50% software: large cluster in AI applications (eg., computer vision, NLP, etc)
• 30% life sciences: large clusters in neuroscience and genetics
• 20% deep tech: large clusters in semiconductors and batteries
• Strong preference for technical founders, and products that have technical differentiation and moats.

We are fairly flexible with regard to verticals within each of our major segments, but we will spend some time approximately every two years on creating our next set of theses within each segment. We will normally publish out thoughts on our blog (here’s an example of our evaluation of how we did investing against our previous set of theses).

We work on a weekly cycle: deals come into our funnel through various channels, and we will schedule a “live” (usually Zoom) meeting with a group of partners and staff on our side. These meetings are normally ~45 minutes, and we will normally move to this stage if the deal fits our stage, sector and preferences, especially if the founding team has some indication of past success.

Out of the set of decks that get sent to us, we will take a first meeting with ~20% (although, if there is a warm introduction AND the deal is in scope (ie., right stage, right sector), we’ll usually do the “in person” meeting.

So, our process looks like the following:

First meeting

We normally schedule these to last 45 minutes. This gives us some slack time to do a debrief at the end (or, more commonly, the meeting lasts for the full hour, and we have to debrief at another time).

Usually, we’ll have 2–3 people representing Foothill at the meeting: either an Associate or Investment Director (these are staff positions that are on the front lines for all deals in their areas) and 1–2 Partners/ Venture Partners

• Venture Partners usually have full time jobs as operators, but work on a deal-by-deal basis with Foothill Ventures. They will typically be subject matter experts, and so will join the screening meetings for companies in their fields

The core of the meeting will normally be to walk through the presentation deck from the start-up. We find that founders are well-served by actually using their deck as a guide. Occasionally, founders will insist that they can just talk about the business to “make it more interactive”, or will just skip around in the slides. This is often confusing and distracting, so using the deck as a primary guide to the meeting is almost always the right choice.

In this meeting, we are trying to establish the basics:

• What is the product, and how does it solve a critical problem in the world
• What is the value of solving this problem? How difficult is it to solve (ie., what is to prevent others from doing the same thing)
• What does the go-to-market motion look like? How much uncertainty is there in channels, pricing/ willingness to pay, etc?
• Who are the likely customers, and how much traction do they already have?
• What is the competitive landscape?
• How strong/ appropriate is the team?
• Funding and corporate history
• What are the round dynamics (how much is the raise? At what valuation? Is anything already committed, etc)

During this meeting, we’re collecting pieces of structured data that we’ll use for later analysis.

Also, we’ve written about the first pitch meeting from the point-of-view of an entrepreneur: what topics to dive into, what to avoid.

Weekly review discussion

To efficiently manage our investment process, we separate our deal flow into three subcommittees: software, hardware, and life sciences (biotech). Every week, each subcommittee holds an hour-long review meeting to discuss all active deals and potential next steps. These subcommittee reviews are usually attended by ~5–7 people, including partners, associates and investment directors for their respective area of focus, and venture partners who are subject matter experts for the specific subcommittee field.

During these review discussions, we normally go through the list of active deals one-by-one, with the deal lead leading the discussion about their impressions of the first meeting and team and the results of any basic due diligence such as customer meetings. We try to collect as much feedback from diverse sources as possible, so we will often refer deals to friendly VC’s with familiarity in the industry to gage their optimism in moving forward, or consult with related portfolio companies and knowledgeable venture partners about the company’s chances of success.

After all the information is presented, the subcommittee will collectively make a decision for next steps. We will either:

• Move forward, and arrange for a second follow-on meeting
• “Watch-list” the deal, by declining to invest at the moment but continuing to monitor the company
• Reject the deal, and explain our reasons why

Every deal is somewhat different, but our most common discussion points will include (in rough order of importance)

• Team strength: how impressive is the current team (especially the founder/ CEO). We already had some assessment of this on paper before we even took the meeting, but the in-person meeting is important for understanding the team dynamic, the style/ presence of the founder, etc.
• Product strength: put simply: “is this a good idea? Does anyone want this?” We are very product-centered in our evaluation
• Defensibility: this is a big one, and it comes up a lot at this stage — we’re often asking “why can this team accomplish something that others can’t? And, if others decide to follow, why would this team win?”
• Market: surprisingly, this is ranked lower than defensibility. We believe that markets are often created by winners, and so spending too much time on market sizing exercises at an early stage may be a waste of time. However, there are times where the size of the market just won’t justify a “venture scale” opportunity.

Regardless of our decision, we try to make working with us as smooth as possible and generally let founders that we take a first meeting with know about the discussion results within a week. If we do choose to move forward with the deal, the subcommittee will also outline a set of key questions or additional areas of clarification that we will focus on in follow-on meetings with the founder team.

Approximately 20% of the new companies reviewed will make it to the next stage (follow on meetings)

Follow-on meetings

If we decide to move forward with the deal, the deal lead will arrange a second 45–60 minutes follow-on meeting with the founding team and all critical partners who participated in the subcommittee discussion or have relevant industry experience. We approach these follow-on meetings with the explicit goal of addressing our key concerns raised in the review discussion, and collecting the information needed to start creating an investment memo.

In the follow-on meeting, we try to dig much deeper and focus on specific areas that will affect an eventual investment thesis and counter-investment thesis:

• Who are the current competitors, and what are their weaknesses?
• What has user feedback looked like so far? What type of value are they gaining?
• How strong is the defensibility of the idea?
• How smoothly is the team executing on a development road map? Is the road map realistic?
• Does the team have a good sense of scaling or unit economics?
• What is the likely exit, and exit multiple? How can they justify this value?

In addition to the above information, we are also very curious about the company’s existing “operating systems”, because we find that many highly technical or inexperienced founders often struggle with maintaining company operating systems and good documentation. As a result, we highly value teams that can demonstrate to us that they have invested the time to maintain regular product and sales plans, accurate periodic financial reporting, and regular external communication with investors.

If we are still positive about the deal after conducting more follow-on meetings, our investment team then moves ahead with creating the investment memo. The process of drafting the investment memo will trigger a number of workstreams: customer interviews, competitive analysis, market sizing/ research, financial projections, etc.

Approximately 25% of companies that we move forward with customer references, etc., will move to Investment Memo stage

Investment memo

Our investment memos are first written before extensive due diligence is conducted, and are then constantly updated with new information as we do more customer meetings, investor calls, and industry research. Generally, we try to have a 2–3 week turnaround time on our investment memos, which gives us enough time to conduct a considerable amount of due diligence while still accommodating investment timelines.

In this respect, we are a little different from many VCs, which start the IM process when they are already essentially sure that they will make the investment. We use the process as a forcing function to answer a set of questions, and then serve as a living document that records our findings. This will serve as a basis for our investment committee’s discussion.

In the body of the memo, we dive deep into various aspects of the company such as:

• The core technology and innovation that the company possesses, and its defensibility
• The market size and growth opportunities in the industry
• Current state of customer traction, and if the company has realistic or working plans for customer pipelines
• Go-to-market strategies and evidence of well-thought out sales cycles
• Existing competition to the company, from established industry giants to other startups
• The existence of barriers and meaningful defensibility to the company’s product
• Basic financial projections for future costs and revenue, and future funding plans

While our investment memos can also be sent out to co-investors to explain the reasons why we chose to ultimately invest, they are primarily written to help the investment committee have a productive debate and come to an informed conclusion about the deal. Therefore, we consolidate all of the above information into a clear investment thesis with reasons to invest, and a counter-investment thesis with reasons not to invest along with possible mitigating factors that could resolve our concerns. Once the memo is done and the theses are prepared, we move into the investment committee phase.

Investment committee

Our managing partners normally meet every week as an investment committee for at least an hour, which is also attended by Investment Directors and Venture Partners (and any other members of a particular deal team) if a memo is ready to be debated. Usually, the deal lead or author of the memo will open by presenting the investment theses and summarizing their own opinion on whether to invest or not, before allowing all the committee members to debate the deal and give their final thoughts on a possible investment.

During the committee meetings, we use a basic scale from 1 to 4 to rank our willingness to invest, from 1 corresponding to “definitely should invest” to 4 being a veto (“definitely pass”). We don’t need unanimity to invest, but if there are any “4’s”, we will pass. Likewise, if a deal receives multiple 1’s, we will very likely choose to invest. For companies that receive a mix of 2’s and 3’s, we either pass, or will work on a plan to move consensus towards a conclusion. This 1–4 system was adapted from one of our LPs — we used to have a binary “invest” or “don’t invest” vote, and required unanimity. This led to some unhelpful dynamics by forcing certainty in a process which is inherently uncertain.

Our goal is to optimize the balance between having enough information to make a high quality decision while still moving with appropriate velocity. Entrepreneurs’ time is incredibly precious, and we try to be respectful of that. In addition, it is frustrating that many entrepreneurs get “ghosted” by investors, or never given a “real” reason why their deal was not approved. We try to give clear answers as quickly as possible.

We approve a little more than 50% of the investments that make it to the IC*

Once the approval has been gained, the real work begins. Obviously, at this point, we haven’t even “won” the deal, so we don’t know if this will become a portfolio company. The real work, though, is starting to partner with the company to make them successful. Once we have made the decision to invest, we are already trying to think like insiders: how much money, what talents, what assistance will be needed to get this company to a great result.

We hope that this description of our decision-making process is helpful to entrepreneurs who wonder how VCs operate. We are always happy to hear from entrepreneurs on how we can further improve our process and our decision-quality, by the way, so just drop us a line!

*As a side note, many of our LPs have felt that this 50% pass rate seems low… ie, why would we go through the trouble of writing an investment memo, holding an IC meeting, debating, etc., only to have a fairly high probability of rejection? We believe that the memo should be written from a very early phase — that it is a place to organize thoughts, not to record a decision that is already made.