LionBird Bites Aggregation

Jonathan Friedman
Feb 18, 2019 · 28 min read

All the past main body portions of LionBird Bites newsletter in one giant blog post. Sign up here for future editions.

Bite #1

Are you an a**hole?

Some VCs are perceived as a**holes.

Not you obviously. But maybe your partners are?

You can use our survey template to start measuring your firm’s NPS today by sending it out at the end of each month to all the founders who pitched you. Typeform allows you to copy the template to customize it to your needs, just let me know if you’d like me to share this with you.

If it turns out that your NPS is crap, what can you do about it?

Angela Kingyens @ VersionOne released the results of their post-pitch survey, and found that the three actions that most impact an entrepreneur’s likelihood to recommend them are:

  • Decreasing response time and spending time with the entrepreneur
  • Giving the entrepreneurs helpful feedback (even if you know less about the topic than they do)
  • Clearly communicating their investment thesis was the single factor that most affected NPS

Communication, constructive feedback and responsiveness? I agree, sounds too hard

Bite #2

Who Knew?

Noam Wasserman @ HBS studied equity splits adopted by 3,700 founders and found that willingness to have hard conversations around items which are critical for founder relationship success is a long-term indicator of enterprise value.

Ok, obviously. But as we all know, founders are really good at covering up issues among themselves during the fundraising process. So how can you dig deeper into founder dynamics without intruding?

Rishi Garg @ Mayfield had some smart suggestions when interviewed on the Twenty Minute VC (paraphrased by me):
There are a few key questions you can ask that are leading questions which help in understanding how much time did they spend on making hard decisions.
So some simple questions:

- How did you guys divide the pie and how long did it take to divide the pie?

- What’s been the biggest question or issue that’s come between you?

- Have you been able to have authentic conversations about your strengths and weaknesses?

What should you be looking for?
Just knowing that the founders discussed hard issues such as equity splits transparently among themselves (even if they ended up just dividing it 50/50) is a good sign.

Bite #3

Market adoption in slow moving industries

When evaluating startups targeting technologically conservative end users (think shipping brokers, small business owners, etc), being able to assess likely speed of adoption is critical.

But market timing is notoriously tricky. How can you better predict the diffusion of innovations in slow moving markets?

Before Crossing the Chasm

Ok, so nobody can consistently predict market timing. But what about rate of adoption?

The book “Diffusion of Innovations” (which is the more academic predecessor to “Crossing the Chasm”) does a good job verbalizing the key characteristics of innovations that predict their different rates of adoption. In particular, it advises us to examine how an innovation stacks up against the following five qualities:

1) Relative advantage
The degree to which new items are perceived as better than an existing, established idea (not only in objective economic terms, but also in feelings like social prestige and satisfaction).

2) Compatibility
How much change in behavior does the innovation represent and is it interoperable with previous practices? Includes fit with sociocultural values, previously introduced ideas and problem/solution fit.

3) Complexity
The degree to which an innovation is perceived as difficult to understand and use.

4) Trialability
Can the target market try your item out without much consequence if they decide to back out?

5) Observability
The degree to which the results of an innovation are visible to others (ie easy to observe and communicate).

These five elements predict about half of the adoption curve. To learn more about the other half, check out a great summary of the book here.

Bite #5

We never lose

I met an investor recently who, as part of his introduction, proudly mentioned his firm has invested in 15 companies in the past years, none of which have gone out of business to date.

How embarrassing for him.

Cockroaches and Zombies

Here’s the short version of an interesting study from Industry Ventures on VC loss ratios:
- Of 500 investments made by 20 early-stage funds in their portfolio, 45% of failed to return 100% of capital, while another 34% returned less than half. Mama Mia!
- Funds with loss rates near the lower or upper bands of their peer group tend to underperform because they take too little or too much risk.
- So a loss ratio of 35%-70% may signal a healthy balance between risk and reward.

For context, even the great USV had a “names” loss ratio of about 40% in their first fund, which was reported to have an incredible TVPI of 14X.

So if you are over optimizing for investing in cockroach and zombie startups that never die, you can pat yourself in the back, because nobody else will.

Bite #6

Investment Memos are Broken

Well, at least mine is.
I published my startup assessment template a long time ago and I have to admit, as a decision making tool for live deals, it’s broken. Deals are usually debated via email, chat and verbally in partnership meetings, and memos can’t keep up.

So we’ve revamped our format.

Memo 2.0

At LionBird we’ve set up a homemade system for investment scoring that is light enough to be done prior to decision making, takes inputs from the whole team and covers the most salient points of investment.

LionBird Scoring Template

This version is geared towards the fundamentals of early-stage, pre-traction investing with a focus on: the team, market, strategy, and “intangibles”. We find this helps us to contextualize opportunity cost and to focus on the fundamentals of an opportunity, rather than who else is investing or what kind of valuation we’re getting.

Making investment scoring useful but practical is always a challenge, and we’ll continue to tweak this going forward.

Bite #7

Upping your Reference Game

What is the goal of founder reference checks?

Beyond validating what a founder has or has not done and checking if they are psychos, IMO reference checks should focus on:
- What are the founder’s weaknesses?
- Did they really stand out in the past?
- Is this someone I can work well with?

Here is how to hone in on these three points in an impactful way.

Three Smart Reference Questions

#1: Uncovering a Founder’s weakness
From Scott Cook:
— Cook asks, “Among all of the people you’ve seen in this position, on a zero to ten scale, where would this person rank?” They go, “Seven.” Cook says, “Why isn’t this person a nine or a ten?” And then you’ll finally start learning about what this person really thinks.

From Trifecta Capital:
— What type of team members complement Jane’s weaknesses? (sometimes reference checks are hesitant to share any weaknesses, this illicits a response)

#2: How much does this person really stand out?
Two direct but good questions:
— What makes you believe this person is extraordinary?
— And what’s the most impressive or impactful thing that Jane did for the company?

#3: What is it like to work with this founder?
Questions from Tom Tunguz:
— How is the referenced persuaded or convinced? What kinds of motivation does he/she respond best to?
— Given it’s likely we’ll work with Sue, what advice would you have for us on how to best work with her?

Bite #8

Startup Turnarounds

At LionBird, we’ve recently been approached by a few startups that have raised too many round extensions and need a reset. When they get to us, we see a compelling team (there’s a reason others invested so much), a logical story of “why now” which builds on current assets and a bargain valuation being offered.

But if you don’t have a well thought out rationale for what’s not working, you can lose a lot of money in these deals.

Learning from the “turnaround pros”

Whether you’re thinking about investing in a turnaround case from within your own portfolio or someone else’s, it’s useful to examine the strategy of Tech RX, termed “the Silicon Valley Fixer uppers”.

What strikes me is that they structure their involvement similar to private equity firms in terms of exit scenarios, governance and ownership targets:
Exit case: They first check whether the top talent has stuck around and whether they have the right attitude. They then examine financials in detail. Lastly, they assess the landscape of potential buyers. If there are no logical buyers in sight, Tech-Rx won’t step in.

— Control: from VentureBeat- “The firm’s №1 rule is that the current team must give control to Tech-RX and its partners — whatever Hogan says, do it. For the duration of the “turnaround,” the firm retains executive management and financial control.”

— Financial: Tech-Rx invests between $500,000 and $5 million into companies, taking 50 percent of the common stock, offering 20 percent to any new management it brings in, and leaving 30 percent for existing shareholders and founders.

So the next time you are tempted to restructure a startup, it’s worth considering whether you are well structured yourself to do so. Most VCs aren’t.

Bite #9

The famous book I hadn’t heard of

Ever heard of Carlota Perez’s book “Technological Revolutions and Financial Capital”? Well, Fred Wilson attributes her work as foundational to his investment thesis, and Marc Andreeson says she wrote the single best book to understanding how the software industry works. So I set out to understand why this book gets recommended so often and what practical lessons I can take away as a VC.

Having recently finished reading it…I’d be surprised if others have actually read every page in the book. It’s very academic.
Luckily for you, I’ll share my key takeaways below.

Book Bite*

A question that’s been on my mind for a while now is whether this vintage’s returns will be harmed by larger funds raised and rising valuations.

Well, according to Carlota Perez’s book which studied past cycles, new technology is adopted on an S-curve. The last phase of the S is where technology reaches widespread use and the real money gets made in aiding that diffusion. This was true of the industrial revolution, the age of steam and railways, the age of oil, cars and mass production, and, if it’s true of the current ICT revolution than the best investment opportunities are still ahead of us.

Once you have this in mind, the reasoning behind the predictions and behavior of many other leading VCs becomes much clearer. For example, read recent investment theses put out by Battery (start at slide 12), 8VC, USV and the smart folks at LionBird :) and you’ll see they all have the same core belief: that the best opportunities lie in broadening access to digital smarts.
Let’s hope we’re right.
— —

Bite #10

The Numbers Game

While it feels odd to admit, startup fundraising (even for those that end up being top performers) is oftentimes a numbers game, where the right warm intros can be of enormous help to founders. So in cases when founders need to pitch 50+ investors to find the right match, it’s no surprise that they often turn to their current investors for relevant intros.

Besides the usual networking, what can we do to meaningfully impact the amount of qualified warm intros we provide to our founders?

Downstream Database

Like most VCs, our best referrals to startups come from our existing portfolio founders, who happen to be “pay it forward” type people in general. So we decided to tap into this to amplify our own ability to be a good source of referrals to more downstream VCs.

To see the email we sent to our top portfolio founders that helped us add another 50+ names to our downstream investor intro database, click below:

Click Here

The email has been the start of a wonderful resource for activating our portfolio founders networks in the service of others.

Bite #12

The value of value add

A lot of VCs won’t invest in companies where they believe they won’t be able to add operational value. This strikes me as an ok filter when applied at a high level to portfolio construction, but can be silly as rationale to dismiss an individual deal.

If you are thinking of investing in an opportunity that looks promising but that you can’t add much value to beyond being a good financial partner, here are three filters that may help you decide whether to do the deal:

  • Can I do effective due diligence on the opportunity?
  • Does this deal fit my portfolio construction strategy?
  • Why do they want us in this deal (ie why am I so lucky)?

#3 is often the trickiest as we all want to believe we have a contrarian view or that the founder values us personally. More likely, you’re just a sucker :)

If you can’t DD an opportunity, have no good answer to “why me?” or feel you’ve done too many deals outside your core strategy, those are legitimate reasons not to do a deal. But if you won’t invest because you view yourself as a “hands-on” VC, you may be missing the bigger picture. After all, hands-on isn’t even what most founders are looking for.

Bite #13

Can you smell a rocket ship?

We all know that pro rata rights are valuable for doubling down on startup winners. But in practice, knowing when to follow-on in portfolio companies and how much to follow with is hard.

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So what are some good ways to think about reserve allocations?

When to double down

Early stage VCs tend to overestimate their information advantage in follow-on rounds, leading to over exposure to pro rata opportunities. Mike Maples argues that we should instead treat follow-on investments like public market investors:
I say that follow-on investing is more like index investing than stock picking. When you pick, you have an infinite range of companies to choose from. But all follow-on investing involves you being allowed to invest from a fixed pool of companies.

So when you’re in that mode, you’re always asking: is my wisdom overtly greater than the wisdom of the crowds? Index investing kind of assumes this is not the case, unless you know something that you’re sure you know. The problem that I think most people have is that they believe they know more than the rest of the market because they are on the board or they know the founders better. But I give the market a lot of credit for being able to select what the good series A candidates are.

What I found is that, had I gone all-in every time a tier-1 investment firm followed, we would have lost money as much as not. But if we had done that and invested when we knew something explicitly, our follow-on investing skill would have gone up dramatically.

It follows that if you stick to these principles you may be left with less companies to double down on. Well, Floodgate reserved only 30% of its first fund for follow-ons, then 50% of its next one. Assuming your reserve allocation ratio doesn’t impact your reputation, perhaps it’s worth being more selective with follow-ons?

Bite #14

Reverse Pyramids

Can we effectively separate the work of VCs into discrete tasks and delegate to junior personnel?

Well, Noam Wasserman has been thinking about this since 2002, when he compared the pyramid organizational structure of other expertise driven firms (law, accounting, investment banking) to that of VC. In his dissertation, he followed a sample of 317 firms and measured how investment team structure is correlated with investment returns in VC.

The Results

What Noam proved -

  • In Early Stage VC: firms with a higher ratio of senior investment partners to junior outperform those with the reverse
  • In Later Stage VC: firms with a higher ratio of junior investment staff to senior outperform those with the reverse

Makes sense. When analyzing later stage companies, GPs can carve out more discrete objective tasks related to historical analysis without losing richness of primary source. Early stage is more subjective and details are lost when delegating responsibility.

One catch: in Noam’s study, the amount of structural leverage was measured as the ratio of junior investment personnel to senior investment personnel. What about the trend towards hiring “value add” or “platform” oriented personnel?

I’d assume if hiring “value add” staff enables your firm to provide founders with a meaningful advantage that they can’t get in the open market, this can make sense (note: reducing vendor procurement friction is not enough of an advantage). The danger of course is that if you have all these staff on hand I’d have to imagine there is a pressure to use them.

Bite #16

Need for Speed

Ideally as a VC you are engaging with founders you want to back in a value-add way well before they begin raising money. But sometimes it’s unavoidable: speed of decision making becomes a factor in winning a deal that you want.

On the other hand, as VCs managing other people’s capital, making quick investment decisions without doing proper due diligence is reckless. So how can you speed up internal decision making processes?

All Hands on Deck

If you are in position to be one of the top choices of an entrepreneur but don’t have long to build conviction, how can you speed up your internal processes?

Prepare for this scenario ahead of time. For example, from Frontline:
If a Partner thinks a great deal is about to be missed they are able to get all the other Partners to cancel anything non-compulsory in their calendar over the next week to get the due diligence, calls, meetings, investment committee etc. done within 5–7 days.

Whatever you want to call your version of this policy (at LionBird we call it a “code red” alert), it helps to be able to pull this card when needed. But I’d add to the above that you also need to use this process to build the founder’s conviction in you as a partner, otherwise you’re just running fast towards an empty finish line.

Bite #17

Misses > Losses

There is an old saying in VC:

“I don’t worry about the investments I passed on, I have enough to worry about with the companies I did invest in.”

That is exactly the wrong approach to VC where investment misses can cost you far more than losses.

So how can we productively revisit our bad decisions?

Investment Post-Mortem

When enterprise startups lose a deal, they hold a sales post-mortem. In VC where the biggest misses cost far more than in any other industry, we should hold ourselves similarly accountable.

To do so, add one slide to your weekly meeting deck which includes the following points for discussion:

  • Company name
  • Value lost
  • Why: what was our blind spot?
  • Context: how much time did we spend on the deal? What other deals were in our pipeline at the time?
  • Improvement: what can we improve in our investment process for next time?

Of course, if you are a reasonably sized fund all you need for good returns are a few good deals so you shouldn’t obsess over those you missed. But that doesn’t mean you shouldn’t learn from them.

Bite #18

On Fragmented Markets

Technology markets have in the past had winner takes all most (or at least most) dynamics. But many of the traditionally offline industries that startups are applying technology to today are fragmented for structural reasons.

So how can you tell if a startup is in a category that can support multiple winners?

Michael Porter

For those with a high tolerance for academic dry reading, check out Michael Porter’s book “Competitive Strategy”.

There is a chapter on fragmented markets (= market share of the top 8 firms <50%) which itself is worth the price of the book. While a prerequisite to fragmentation is low overall barriers to entry, the book lists 10 additional causes of fragmented markets (mostly related to lack of economies of scale). Importantly, it only takes one of these for an industry to be fragmented.

Click Here For List

Once you’ve identified the structural reasons for fragmentation in an industry, the book goes on to discuss ways to overcome it (also in the list). So the next time someone tells you “This is going to be a huge market with room for lots of players”, try to dig deeper on the why.

Bite #19

Unbundling VC

Since 2010 we’ve been hearing that the VC offering to startups (capital, advice and governance) would be unbundled.

The idea is that founders should be able to get advice from the people they want, to get money from the cheapest source and to leave the control provisions typical of VC-led rounds behind. However, almost a decade later, the business of investing in startups hasn’t fundamentally evolved.

Why might this be the case?

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It all starts with the LPs- as Ravikant says:
“In the case of VC, money came with control — because the amounts being disbursed were large enough, it made sense that they needed to be actively managed. And because it was actively managed, you cared about how well it was managed, thus the advice.”

Until it’s proven with returns that LPs can successfully deploy capital at scale with unbundled GPs or their own direct to startup offerings, the bundle is likely to hold.

But I’m not convinced this is sub-optimal for early stage founders. If it were, the ones with the most fundraising options would operate differently, but this study found that they use their leverage to push back on terms while maintaining the advice and capital bundle:
“…repeat entrepreneurs receive more favorable terms for vesting, board structure, liquidation rights, and the tranching of capital, but did not receive greater equity ownership percentages.”

So why not raise at higher valuations from *dumb* money and then add advisors who earn equity?

From Elad Gil, it boils down to time scarcity:
“Why spend a lot of time searching for both capital & advice when you can save time by getting both through one investor?”

& skin in the game:
“…the one thing that an experienced VC partner can *uniquely* provide you is someone who has a strong incentive (because they own a lot of your company), and a very different perspective and experience base. That’s the old-fashioned “Investor as a Partner” model.”

Let’s see if this decade can change the equation that makes the bundle so strong.

Bite #20

On winning deals

Some deals are so clearly compelling that you have to compete with others to win them. How can you do so without resorting to selling on price/speed?

From Fred Destin’s experience leading Deliveroo’s Series B when they had 7 other term sheets on the table:
So you don’t win it on price actually, you win it by looking the founder in the eye and saying “I believe in your mission, I’m actually in love with your business, I’m on your side” and meaning it, you’re going to have to feel it. And then being a partner along the journey and making the person on the other side feel that that’s true.

Makes sense. Regardless of stage or geography, Founders rank personal relationship and chemistry as the single most important decision-making factor for choosing who to partner with. Everyone appreciates true believers, and even the less cool introverts among us can demonstrate this in our investment process.

Bite #22

Deal Attribution

Pat Grady @ Sequioa says working as a team has been their secret to longevity over time.

But when you go to raise a VC fund, LPs ask who sourced each deal and who sat on the board. Midas list and other media outlets further celebrate the individual over the team. And in terms of operations, having “deal leads” improves efficiency and accountability of deal management.

How can VC partnerships work as effective teams when the incentives are stacked against them?

Assuming one of your values is that you invest as a team, here are three ways to align incentives, culture and processes accordingly-

Load Balancing
From Brad Feld @ Foundry Group:
“In about 90% of the companies we are investors in, two of us are actively involved. In about 50%, three of us are actively involved. But in 100% of the cases, we all know what is going on.”

From Pat Grady @ Sequioa (paraphrasing, 11:20 min in):
“In one fell swoop we changed all the names in the (CRM) database from individuals to the singular name “Team Sequioa”. And the point is that every prospect we’re talking with and every company with whom we’re in business today doesn’t belong to an individual, they are associated with Team Sequioa and it should always be a team effort in pursuing those things.”

From Doug Leone @ Sequioa:
“The investment partners don’t get fancy offices. Instead all the investors occupy an open space together with standing desks. And language is very important…we call everybody “partner.” If we hire a young investor and I’m one of the older people, I’ll introduce him or her as a “partner.”

— —

It is possible to foster an environment where you perform better as a group than as a random collection of individuals. But it does require losing a few points of efficiency to gain a few points of culture.

Bite #23

Lets all agree to agree

There was a blog post by Bijan @ Spark Capital that presented consensus driven investing in VC as almost unconventional:

“I have heard some venture capitalists at other firms recall that their best investments…only happened because someone slammed the table and forced the decision…for what it’s worth the best investments at Spark have been times where our entire team was over the moon about the founder, product & mission.”

How common is group based vs independent decision making in VC?

It turns out that both in the early and late stages, group decision making is by far more common than independent.

Implementation comes in many flavors. For some entertaining reads on how others implement decision making, click below:

Click Here for Case Studies

This includes-

  • Benchmark’s ballots system
  • Bloomberg Beta’s “Anyone can say yes” policy
  • FloodGate’s “pound the table” framework
  • Founders Fund’s “snowball” system
  • …& more

At LionBird, we’re conviction-based investors. This means we don’t do an investment without a passionate deal champion, and we also don’t invest if someone has especially strong conviction against a deal. We created a process involving company scoring and debate to support this healthy tension. To each their own! ¯\_(ツ)_/¯

Bite #24

Follow-on Frameworks

While initial investment decision styles come in different flavors, follow-on assessments can be managed more systematically.

How can you implement processes that take into account the time you’ve spent with companies post-investment to improve your reserves allocations?

While we operate in a world of imperfect information, here is a very practical article on how to build a process for reserve decision making. Like any forecasting exercise done in the face of uncertainty, the process is more valuable than the end results.

Alternatively, if you are in the camp that believes early stage VCs tend to overestimate their information advantage in follow-on rounds, go up to Bite #13 for a different framework from Mike Maples. His theory is that you should only follow-on in cases that a top tier firm is investing or when you know something explicitly that the market does not.

In reality, both methodologies can work together. Having your own view doesn’t mean you aren’t open to re-evaluating as you get feedback from downstream investors. At LionBird we assign Buy-Hold-Sell scores according to different valuation targets internally, but then when we get fundraising feedback we incorporate the quality of the follow-on investor into our deliberations.

Frequently adjusting targets/scores for companies according to the latest updates they receive can be tough at scale. But because we’re a small team with <20 active companies in the portfolio, we go over all the company updates each weekly meeting making coordination less of an issue.

Bite #25

The upcoming recession

Ray Dalio’s brief blog post “The World Has Gone Mad And The System Is Broken” is the most thoughtful take I’ve seen on why we are due for a market correction soon.

If his analysis is accurate, what can we as investors in startups do to prepare?

Bill Gurley on Recession

The VC business sucks. At least according to Howard Marks, who told Bill Gurley:

“Well, your business sucks. You can’t avoid cyclicality. I have a strategy for when I think yields are going to expand, and when they’re going to contract. I always have a game to play, because you’re going to always have boom-bust cycles.

In contrast, the VC business is low barriers to entry, high barriers to exit. So, as markets start to boom, the amount of capital that comes into the category is immense. But when the market breaks, the capital that doesn’t have a mechanism to go away quickly, because it’s already been committed to 10-year+ windows.”

So does this mean we should pack our bags and head home?

Not quite. Bill Gurley goes on to mention:

“The vast majority of the average returns over a multi-decade window are right at the end of the cycle. And so, if you get conservative and pull back and miss- like there were venture firms in 96, who said “this is way too overheated, we’re pulling back” And they missed 97, 98, 99. So, there’s this saying: “the best way to protect against the downside, is to enjoy every last bit of the upside”.”

The only tool we have to deal with a potential recession is time diversification via steady investment pacing. So even if you assume this cycle will end, unless you know exactly when then it doesn’t serve you to sit it out.

Bite #27

How many companies should you invest in?

Historically, the best VCs have achieved superior returns by optimizing for larger hits, not lower loss ratios (see Bite #5).

The math says the best way to ensure you have a hit is to diversify your portfolio, but over simplified models have limited utility in real life. Usually when you scale the number of investments you make the quality of the portfolio goes down.

So what’s the best way to think about how many companies to invest in as a VC?

On constraints and edge in VC

First some basic math-
assuming you have a ~4% chance of 10x+ realized multiple on any investment, you should be investing in >15 companies for a 60% chance of an outlier, >20 companies for an 80% chance and ~24 for a 90% chance (but of course 10x won’t do the single handed job of returning the fund if you have an equal weighted portfolio of 20+ positions).

From that starting point — to determine how many companies you should actually invest in, consider what is your edge and what your constraints are.

For example, in terms of deal flow, if you’re seeing deals that are as good as the ones that you’re doing but you’re saying no to those, you can probably afford to grow your portfolio size.

On the other hand, paraphrased from Peter Thiel:
“Given a big power law distribution, you want to be fairly concentrated. There just aren’t that many businesses that you can have the requisite high degree of conviction about….Founders Fund tries to invest in 7 to 10 companies per fund.”
This was in 2010 and has since changed as they’ve grown AUM and number of partners, but the principle holds: it’s hard to find deals that can return 1.5x+ the value of the fund.

In terms of risk tolerance — the more concentrated your portfolio, the larger the impact of upside and downside scenarios. This is because higher ownership in a smaller number of companies means you have less chances to hit an outlier but if you do, it’s likely you’ll own more of it at the time of exit.

Another way to think about this:
if the almighty was a GP we would expect him/her to invest 100% of his fund in the earliest round of one company. LPs that invest in talented managers push for more concentrated portfolios for this reason, but you need confidence in their skill (or divine luck) to beat industry odds.

Depending on how hands-on you are in working with companies and how involved your selection process is, at some point you’ll hit constraints on time allocation. Tie that to fund size and there are further limits on the number of right sized deals (in terms of capital you can put to work per partner) you can make. This is what makes quality scaling of a VC so hard and is why bigger fund size usually translates to doing bigger deals at later stages.

In the end of the day, portfolio construction thinking should go beyond the typical sector/ stage/ geography conversation towards discussion of a GPs edge and constraints. In these tradeoffs is where we find the opportunities to improve!

Bite #28

When others are fearful…

We all understand logically that we should “…be greedy when others are fearful”.
But in practice human psychology is a b*tch!

How can you to look past the news cycle?

Correlation Ventures released a great study answering a simple question
Q: In retrospect, was the year immediately following the 2001 and 2008 shocks a relatively good or bad time to be investing in the U.S. venture market?

A: Yes! Realized multiples increased significantly immediately following 2001 & 2008 (look at the two bar charts on the right side).

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In the 2nd chart below: look at the slope of the lines following ’01 & ‘08

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What to make of this?

As Adam Fisher @ Bessemer wrote in his must-read blog post-
“Time diversification is a real thing in venture capital, including during periods like this…Three years from now when you look back, you will realize the biggest investment mistakes you made were in the 12 months preceding this crisis, not in the first 12 months following it.”

So give me a call if you want to discuss any of our companies :-)

Bite #32

Saying no

What’s the right way to pass on an investment?

From a recent 20 min VC interview (edited for clarity)-
“It’s just such a complex equation that’s going on in your head that you can’t really articulate, so any time you’re going to try to do that you’re going to fail and it’s going to come off as inauthentic or vague.

And then even if you put a lot of thought into it the founders will often say “well you know you said it wasn’t a big market but it actually is a big market” or “you said this but it’s actually this”.

“Or most people lie and say it’s something else, and then the founder iterates on the feedback…leading the founder off track.

Frankly the #1 reason I pass is that I am just not impressed by the founders. How can you say that? How can you tell someone to their face “sorry the reason I didn’t want to invest in you was because of you”…The incentives just aren’t there for a VC to say “Look, you’re just not impressive enough.”

It’s a tricky dilemma, but there may be a solution.

Data based approach

As an industry we’re not great at passing on investments. How can we do better?

Ultimately, what I decided to do was look at the last 100 startups that I met who I ended up rejecting and documenting all the reasons I passed on them. With this, I am able to tell founders that while I can’t tell you in this specific case why I passed on your deal, I can at least provide you with an aggregate view on what I look for as an investor.

At the surface you’d assume it’s almost always an issue with the team, but having done this exercise myself it turns out that ~40% of my nos are to “VC fundable” teams (VC fundable = we would fund them if they were pursuing another idea).

Is this good enough?
To be clear, this is only meant to be sent to founders that you met once or twice. If you send this to someone that you’ve been engaging with for a long time, you’re probably just a jerk.

While I’m not totally sure whether this will be well received by founders, it seems worth the experiment if it allows you to be more transparent with founders while saving yourself time.

Bite #33

On repeat founders

We all know that entrepreneurs who have previously achieved successful exits have an advantage when it comes to their 2nd startup. But despite their higher success rates, there is an imperfectly competitive VC market in which prices do not get bid up to the point where excess returns from investing in serial entrepreneurs are eliminated.

Why? “Exited founders” (which refers to someone that started, ran and sold a tech company) tend to optimize for partner fit rather than purely on valuation or firm brand. From this paper-

If a company is started by an entrepreneur with a track record of success, then the company is no more likely to succeed if it is funded by a top-tier venture capital firm or one in the lower tier. Thus, prior success is a public signal of quality.

In other words, smart founders don’t need their investors to signal that their company is of high quality. They are their own signal. Instead, what is important to them when choosing a partner, besides achieving a fair (not crazy) valuation, is the investor’s reputation among their peers and the ability to trust you as a partner.

In a market where VC is moving from picking to getting picked, deal flow and name recognition are table stakes. More important is being able to achieve the concept of brand equity, meaning “a price premium over your competition that consumers are willing to pay”. In our case, you need to become the best money equity can buy.

Bite #34

Brand in VC

VCs like to say that they make their money through their best bets but they make their name through their worst bets. That isn’t true.

Everyone knows that a firm’s successful investments are their brand. That is why unlike in other asset classes, early success in VC is persistent.

So how should we think about how to allocate our time between struggling investments and the outliers in the portfolio?

For Doug Leone @ Sequoia, there is a simple answer to why he works closely with his struggling investments — it’s about being a badass.

Regarding the fund he was managing during the 2000 bubble (27 min into this podcast, paraphrased):
That was a formative time for the culture of Sequoia. We took the approach…that nobody was going to lose money at Sequoia Capital. And we went to work for 10 years to make sure those funds succeeded.
During those times there was no question what we were going to do. I don’t think we ever even had the conversation. We just had to. It had nothing to do with having to save our careers, our money, none of that. It had to do with being a badass and doing what nobody else would do. That’s what it has to do with. Do the right thing when it’s inconvenient to you.

It’s clear that they not only did a great job recovering investments (taking a fund that was at .3x and bringing it up to close to 2x) but in building an emotional narrative that connects with future partners and defines their values.

It definitely resonates with me. I’ve been amazed over the years at what my partners, former entrepreneurs and relentless optimists, have done to help the slower moving companies in the portfolio pull through. While the concept of “a bridge round to nowhere” has been popularized, I’ve seen very successful outcomes come out of multiple extension rounds and time spent wisely.

At the surface, these efforts are illogical at the individual level. But when taken in the aggregate, supporting your struggling companies should measurably impact your results and your reputation over time by allowing you to keep your dollar loss ratio far below your names loss ratio and by enabling you to build a reference list that is as powerful as good logos in helping you win future deals.


Investing in re-engineering the health status quo

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