In my post recently titled Does VC Fund Differentiation Matter? several people commented on some variation of “people” as the key to everything.
I don’t view people as differentiation. I view them as the price of admission. Amy just walked by, read this over my shoulder, and said: “I don’t know what that means.” Hopefully, by the end of this post, it’ll be clearer …
Yesterday I talked to several VCs or entrepreneurs considering becoming a VC. I didn’t know any of them – these were random intros from different people that I knew. I didn’t have an agenda for each call. I was just curious and felt like meeting a few new people yesterday.
In each call, the person gave me their background and what they were exploring. Then they asked me a few questions. These questions were different versions of “what is your investment strategy” and “how do you decide what to fund?”
I went through my usual riff on this, which I should probably just put up on Youtube so I can point people at it rather than spend five minutes saying it over and over again. While I was doing this, a background process in my mind linked me back to the post I wrote on VC Fund Differentiation (or lack thereof). If you’ve heard this riff before, the next bit will be redundant to you.
We have a set of filters. For an early stage investment, we only invest in our themes. We only invest in the US. We don’t have to be the first money in a company, but if the company has raised more than $5m, it’s too late for us. Our goal with this filter is to say no to almost everything within 60 seconds.
Assuming something passes through this filter, we then focus on three things.
</riff>Ok – riff over.
Underlying item two and three is obviously the people. But it’s a characteristic of the people. It’s a characteristic that, at least for us, that has worked over a long period of investing.
When I was a kid, my dad used to say to me “people are the price of admission.” He meant that if I was interested in getting involved in something, I should evaluate the people first.
If we did this before applying our filter, we’d never get anything done because we’d spend too little time looking at too many things. But, by applying the filter first, we can put most of our energy into evaluating the people involved and whether they want us to be involved.
I’ve met and emailed with many pre-seed and seed GPs in the past year. Over sushi last night with two of them, who are also long-time friends, one of them asked me “Brad, how do you think we are differentiated?” This generated a rant from me that went something like this.
There are over 500 seed funds in the market right now. Maybe there’s a thousand. Many of them are angels raising a VC fund. Others are entrepreneurs / operators raising a VC fund. A few are existing VCs who are starting a new firm. I don’t even know what differentiation means anymore as it all blurs together. The operators say we know how to run businesses and help the CEOs that way. The angels say look at the deals we’ve done and the networks we have. Everyone describes the expertise they have around whatever the current hot new technologies are. Regional funds are trendy again. Differentiation is bullshit at this point – the only thing that matters is strategy and returns. And many of these funds / GPs have no realized returns, so all that really matters is strategy.
It wasn’t an angry rant, but it resulted in 15 seconds of awkward silence as we each reached for a piece of sushi.
There are words that get overused to the point of not meaning anything. Differentiation is one of them. It’s now part of a cliche, as in “how are you differentiated?” I no longer care about this. I expect you can create a set of slides or a story about your differentiation, but if I dig in and try to understand what you mean, I expect I’ll feel pretty hollow at the end of it.
I suggested to my friends that we talk about the fund strategy. I know what they are investing in (stage, types of companies) and I know what they do (seed, one or two checks, no board seat but available to the founders for anything at any time, not concerned about ball control on the deal), but this is just the surface strategy.
I realized they were looking at me funny, not because they didn’t understand, but because I probably had some wasabi on my chin. So I went on another rant.
Your fund size is X. How many investments are you going to make? Over what time period? At what pace? How are you going to decide what not to invest in? How are you going to respond to the range of paths a seed deal goes down? Are you going to do your pro-rata or are you one check and done? Are you going to try to have any impact on the VCs who lead the next round? How do you want downstream VCs to think about you, or do you even care? At what point do you flip from being a buyer of equity to a seller of equity? If I give you $1, are you going to invest $0.85, $1 (meaning you recycle), or $1.10 (meaning you recycle 110%)? Are you going to only invest from the fund, or are you going to create SPVs on deals in later stages?
I paused to eat another piece of sushi. We then had a healthy conversation that extended the strategy into ways they worked with CEOs and founders, how they wanted these founders to talk about them to other founders and VCs, and how they thought of themselves in the context of the other 500 seed funds floating around.
As I walked back to my car after saying goodnight to my friends, I felt unsatisfied with my answer to the question of “how are we differentiated?” I thought if I slept on it, my subconscious might do something magical and help me out. But as I sit here in the light of a new day, I’m still feeling the same way I did last night about the complete lack of differentiation among the landscape of seed funds. And, as a result, the relative unimportance of differentiation when compared to other things.
There’s a long-standing cliche concerning SaaS companies that once you get to $10m in ARR you are unkillable. As Jason Lemkin says in his post from early 2013:
Inevitability in SaaS comes around $10m in ARR, plus or minus. Once you hit this point, you have a brand, you have a fully baked team, you have a robust product, and you have a self-generating stream of new leads and new business. Will you get from $10m ARR to $100M ARR? I don’t know. Is an IPO in your future? Not sure. But once you hit $10m in ARR or so, you cannot be killed by anything. That’s the power of compounding SaaS revenue. And actually, as we’ll get to, $10m in ARR — this is when it really gets fun.
I’ve struggled with this concept and how to translate it into action in my world. While the phrase “you cannot be killed by anything” is evocative, your actual value can be killed, as there are many problems getting from this stage (whatever we are going to call it) to the next level.
I don’t like to think in ARR when I’m working with SaaS companies. I’ve always found MRR easier to process, especially when thinking about derivative measures, like growth rate and churn, that are so important to pay attention to on a monthly basis. And, instead of ARR thresholds ($10m ARR, $25m ARR, $50m ARR, $100m ARR), I like to use MRR thresholds, which I talked about extensively in a post from 2015 titled The Illusion of Product/Market Fit for SaaS Companies. The MRR thresholds I focus on are $1, $10k, $100k, $500k, and $1m. And $1m MRR is the particular moment that is analogous to the $10m ARR inevitability.
If you can blast through the $500k MRR mark and march to $1m MRR, you’ve found product/market fit. You are now at the magical point some people call “Initial Scale.” Cool – you’ve got a business.
If you believe the cliche, you are now unkillable. I’d suggest that instead, you are now in an entirely different zone as a company, where you will be evaluated on a different set of characteristics and will face different struggles. If you want a hint, read Fred Wilson’s recent post titled Team and Strategy.
If you are a CEO, the real work of scaling a company begins about now. The question you’ll be facing will have a lot less to do with product (and the product strategy), and a lot more to do with – well – strategy!
You can start exploring questions like: Are you the market leader? Who are your competitors? What are you doing to build a moat around your business? If this sounds like Competitive Strategy, instead of Strategy, it is, but it’s a critical starting point. If you don’t want to read Porter’s classic book (or read it again if you read it a long time ago), try a Wikipedia shortcut on Competitive Advantage.
You can shift to more specific questions around a category like sales such as: Are you making progress on lowering churn? Have you moved from monthly to annual deals? Are you trying to get three-year deals done? What is the composition and health of your channel?
These are all things that you likely ignored, or didn’t even think of when you were in the $100k to $500k MRR zone. Well – maybe you thought about churn, especially if it spiked up to a point as to undermine your growth rate and cause another cliche – the leaky bucket – to appear in all of your board discussions. But did you shift from monthly to annual deals so that you could lower your long-term capital needs significantly? If you did – great job!
We have many companies in our portfolio in the $1m MRR to $2m MRR zone. It’s fun, but challenging in a different way than the up to $1m MRR zone is. And, once you blast through $2m MRR, all the things you focus on as a CEO change again.
I’ve been thinking about what “truth” means lately. With almost no effort I can find contradictory articles, thoughts, perspectives, statements, and opinions on almost everything being discussed today. I’m sure our election cycle is amplifying this, but I see this in a bunch of stuff I’m reading about tech as well.
As someone who views independent critical thinking as extremely important, this dynamic is perplexing to me. A few months ago I wrote a post about TruthRank vs. PageRank. It started me down a path where I began separating types of truth. Specifically, I’ve begun referring to “your truth” vs. “the truth.”
When I say “your truth” I’m not referring to opinions. I’m referring to your deeply held beliefs. Your truth is the set of ideas that forms the basis of your view of the world. It requires a huge act of will and introspection for you to change your truth.
To understand this better, I’d like to use a classic example from tech – that of Steve Ballmer’s view of the iPhone, and subsequently his approach to the mobile business.
Let’s set the stage with a classic interview with Ballmer at the time the iPhone is announced in 2007.
Now, let’s look at Ballmer’s reflections about this in 2014.
As part of this arc, Ballmer’s big solve was to move Microsoft from a software only company to software+services and then software+devices. For many years, Microsoft was disdainful of Apple’s tightly coupled hardware+software business. In a final thrust of reactionary behavior, Microsoft bought Nokia in 2014 for $7.2 billion and then wrote off $7.6 billion a little over a year later.
Ballmer had “his truth.” It was stronger than an opinion. It shaped his entire view of the world. He held on to it for seven years (or probably longer).
And, at least in the case of mobile, it was completely wrong. It was not “the truth.”
I see this in all aspects of the world. It’s noisiest in politics right now, but it’s prevalent through all aspects of society. I’m running into it constantly in business and technology – both at a macro level (about the industry) and a micro level (within a company).
In the same way it’s different than an opinion (which can be wrong and/or invalidated over time), it’s different than strategy. I’ve always felt that a strategy was the framework for executing your truth. Strategies evolve and opinions change but your truth doesn’t.
And herein lies the problem. I’m seeing people hold onto their truth for much too long. They hold on too tightly. They turn an opinion into their truth. They extrapolate their truth from a small number of data points. The generalize one experience to create their truth. They react emotionally to something that they disagree with and anchor on their truth. They justify their behavior by holding onto their truth.
In many of these situations, individual critical thinking goes out the window. The internal biasing behavior of your truth dominates. You stop being able to listen to other perspectives, to process them, to think about them, and to evolve your opinion. Instead of deeply held beliefs, you end up with a shallow and self-justifying perspective that you hold on to endlessly rather than think hard about what is actually going on.
I embrace the idea of seeking the truth. I love the construct of deeply held beliefs as a framework for it. I challenge everyone to think harder about what the truth actually is, rather than just hold on to your truth to justify your perspective. Remember, the truth is out there.
I had a great interaction with a friend several months ago. The question he asked was:
“How do you beat Michael Jordan at sports?”
I thought about it for a second. I knew Michael Jordan was a good golfer and I don’t play golf. I figured he was in better shape than me and could beat me on a track. There is no way I could ever beat him at basketball. And baseball – well this video kind of says it all.
So I eventually said “I don’t know.” My friend said:
“Take him surfing.”
What he meant, of course, was play a totally different game. Now, I’m not a surfer, but let’s presume neither is Michael Jordan (although he’s so physically talented that a dangerous assumption.) But let’s assume it’s true. When we are both on a surfboard we are each beginners. Assuming he doesn’t already surf, he’s probably not inclined to get on a surfboard. So I can have a huge head start on him if I start surfing now and practicing every day. After a few years, if he eventually decides to try to surf, I’ll likely beat him at a sport.
I’ve been a long time believer in Jack Welch’s famous thesis that if you aren’t #1 or #2 in a market, you should get out of it. Interestingly, for those who don’t realize it, he challenged his own thinking about this in his final shareholder letter at CEO of GE.
When I reflect on our investing approach, we have a very strong focus on helping the companies we invest in become the #1 or #2 player in their market. When we find ourselves in an investment where we aren’t #1 or #2 in a market, we try to follow the meta-point of all of this, which is to change the game and have a different point of view.
When I go through our portfolio, there are a bunch of companies that are clearly #1 or #2 in their market. These are very satisfying to be an investor in and their paths are clear.
Then there are some that aren’t #1 or #2, or are in very crowded markets where it’s hard to figure out what #1 or #2 is. And there are some that are in unformed markets, or their ultimate product and strategy is not clearly defined, so it’s hard to put them clearly in a market segment. This is the blessing and curse of being an early stage investor.
Then there are some who should simply go surfing. We try to tell them that when we realize it and in some cases they’ve gotten very good at surfing. When this happens, it’s especially satisfying.
Yesterday we closed our fifth fund, Foundry Venture Capital 2016, L.P. As with all four of our other funds, it’s a $225 million fund.
In 2007 we raised our first fund – Foundry Venture Capital 2007. We subsequently raised a $225 million fund in 2010, another one in 2013, and a late stage fund in 2013. Our 2013 fund was originally raised in 2012, but we didn’t start investing it until 2013 so we renamed it 2013.
Except for our late stage fund, each of our funds has 30 investments (+/- 2) in it. Each is $225 million. Each is roughly invested 1/3rd into companies in Colorado, 1/3rd into companies in the bay area, and 1/3rd into companies in the rest of the US (Boston, NY, Seattle, LA, Portland, Austin, Minneapolis, Washington D.C., Burlington, and Phoenix.)
Our investment strategy has been unchanged since we raised our first fund in 2007. We are thematic investors, an approach we pioneered with a few other firms that today is trendy (and often mislabeled). We invest $5 million to $15 million in a company over its lifetime. We are early stage investors – if you’ve raised more than $3 million you are too late for us. We only invest in the US, but will invest anywhere in the US. We are syndication agnostic – we’ll invest with other VCs or invest by ourselves.
Our late stage fund gave us flexibility to invest more money in our later stage companies. We aren’t a growth investor, but rather interested in investing more money in our winners. This fund has already seen two big exits – Gnip and Fitbit.
We view our jobs as taking a box full of money that our investors give us and giving them back a bigger box full of more money over time. It’s pretty straightforward. We try to do this our own special way while having a lot of fun doing it. We have a small number of investors (around 20) who we appreciate deeply for supporting us in our journey.
And we couldn’t do any of this without the founders we get to work with. We appreciate them more than anything. Well, other than Jason’s musical abilities. For example:
There has been a cliche going around the last decade or so that goes “hope is not a strategy.” It inspired a book titled Hope Is Not a Strategy: The 6 Keys to Winning the Complex Sale and is repeated often by VCs in boardrooms when they are confronted with companies that are flailing, especially when trying to reach their revenue goals. I’ve been guilty of saying it a few times although it always left a funny taste in my mouth and I didn’t know why until this morning when I read a great essay (unpublished at this point) by Dov Seidman, the the Founder and CEO of LRN. In it Dov has a great punch line.
“No doubt you’ve heard the old business cliché that hope is not a strategy. During the recent presidential election one candidate in fact said this very thing in an attack ad against the other. It’s an expression usually used to belittle someone and to exhort them to deliver a linear plan. And while they are right that hope is technically not a strategy, inspirational leaders understand one final thing: that without hope there is no strategy. “
He is so absolutely correct.
I’m an optimistic, hopeful person. I think things will turn out ok. I don’t deny reality and I live by the words of John Galt when he said “It’s not that I don’t suffer, it’s that I know the unimportance of suffering.” I suffer plenty, I have plenty of things fail, and I’m sure I disappoint a lot of people. But I never give up hope, never give up trying to do better, and never give up learning from my mistakes.
We are coming to the end of a calendar year that has had a lot of crazy, bizarre, hostile, and negative stuff in it, especially in the past two months. I measure my years by my birthday, so my new year started on 12/1 when I booted up v47 of me. I was in pretty rough shape physically and emotionally because of the preceding few months but I was on the mend and optimistic. Other than struggling through a nasty cold (which is clearly linked to a completely trashed immune system from a pile of antibiotics and the past few months of system stress) I’ve had a great few weeks with Amy, some friends, and very little travel.
As I look forward to the next year, I have a clear strategy – both for my work, my personal life, and my health. A bunch of friends have said mildly cynical things like “you say that every year” or “I just read the annual ‘Brad broke himself” blog post” – mostly in an effort to be supportive, but clearly with the view that no matter what I try differently each year, the outcome will be the same and I’ll melt down somewhere in October or November.
Part of the beauty of an annual cycle is the opportunity to try again. To revisit your existing strategy or to create a new strategy. To shift your mindset from “this is inevitable” to “having hope for a different outcome.” Now – if you only have hope, but no strategy, you won’t make any progress. But if you have a strategy, but no hope, you are dooming yourself to failure before you begin.
So take advantage of this time of year. Do whatever you need to do to hit reset. Purge your brain of all the angry, negative, cynical, defeatist crap. Accept that context in which we are living. Then, create a new strategy for yourself – for work, for yourself personally, for your relationship, for whatever, and inject a good dose of hope into the mix.
Do something new. And be extraordinary at it. Remember Yoda – do or do not, there is not try.
Yesterday I sent emails out passing on participating in two seed rounds for companies I really like. They had lots of investors trying to invest and each company was competitive with two other seed stage companies we’ve seen in the past 30 days. All are exciting, all are working on something that we like, and all of them are at the starting line with different strengths and weaknesses.
So far this year the number of high quality seed investments we are seeing in themes that are relevant to us is overwhelming. This is an awesome situation – for us and for entrepreneurs – and something I’m extremely excited about. But it forces us to think about our strategy, especially at the seed stage, and make sure we are comfortable with it. We are, but it occurred to me that it’d be worth putting it out there both so it’s known how we are thinking about seed investing and to get feedback on how we are approaching it.
First, some background. We’ve made a conscious decision as a firm never to grow – either number of partners or size of fund – so we are limited to the number of new investments we can make a year based on our approach. This translates into about a dozen new investments a year plus or minus a few.
Our strategy is “early stage” – so we are comfortable with seed investments, first round investments, and what might in the past have been called Series B investments if the company hasn’t raised much money to date (less than $3m). We summarize this as saying to entrepreneurs that if you’ve raised less than $3m so far, we are a target for you; if not, we aren’t. We are willing to invest as little as $375k as our first investment (e.g. Next Big Sound) or $15m as our first investment (e.g. SEOMoz).
We only invest in companies in our themes and only invest in US-based companies so we can say no in 60 seconds to 99% of the companies we see. Our goal isn’t to invest in all of the great companies; it’s to invest in around a dozen great companies a year. We are geographically agnostic – anywhere in the US – about 33% of our investments are in Colorado, about 33% are in California, and the rest are spread around the US. We are syndication agnostic – happy to invest alone and equally happy to invest with firms we like to work with. And we are very patient – we’ll lead our own follow-on rounds (at markups if warranted), are willing to invest up to $10m in a company before we declare “the moment of truth” as we’ve seen many companies break out in year three or year four of their life, and play for many years with the goal of building meaningful companies.
Finally, we believe strongly in active engagement as a seed investor. It’s not natural to us to make a bunch of passive seed investments or to toss $100k directly into a company without engaging with the company at the seed stage. We don’t have a seed program, nor do we expect to – if we invest, we are in for the long term.
So – what do we do?
1. Pass on the cluster: Per the intro to this post, if we see a cluster of seed investments in an area that we like, we are passing on all of them and trying to engage with them with the goal of leading the next round for one of them. Our belief is that we have to earn the right to invest and we want the entrepreneurs to choose us. At the same time, we want to invest in entrepreneurs who want to work with us and view us as a unique resource for them rather than just another check. In almost all cases like this, the seed round is easy to raise right now, which is awesome for the entrepreneur and gives her more choices downstream. We hope to earn our way in as one of these choices, while at the same time getting to know the entrepreneur better over a reasonable period of time. Of course, part of this is keeping the individual entrepreneurs plans confidential so we are very careful not to share any information between companies, although we’ve found several clusters where all of the entrepreneurs know each other and are already friends.
2. Support accelerators – especially TechStars – to create more seed opportunities: We co-founded TechStars and are investors in the program. Last year we helped put together (and invested in) Star Power Partners, which invests $100k in a convertible note in every TechStars company. As a result, we are tiny indirect investors in all of the companies that go through TechStars. Many of these companies raise less than $3m coming out of TechStars – all of them are subsequently in our zone for the next round financing.
3. Support other seed stage VCs: We’ve actively supported (as investors in their funds – individually, not through Foundry Group) many seed stage VCs including Jeff Clavier (SoftTech), David Cohen (Bullet Time), Manu Kumar (K9), Chris Sacca (Lowercase), Dave McClure (500 Startups), Eric Norlin (SK), and David Beisel (NextView). We don’t expect anything for this other than a role as a typical LP, but we view it as increasing the seed ecosystem.
4. Stay firmly focused on our strategy: We’ve seen strategy drift destroy VC returns, create chaos within VC firms, and make a mess of many VC / entrepreneur relationships. We know what we do well and are intent on continuing to do it for a long time.
As I mentioned at the beginning, we’re always thinking hard about how we do things and would love any feedback.
My partners at Foundry Group and I decided not to do something after a month of thoughtful deliberation. The decision is fresh so I’m not going to talk about the specifics, but our conclusion was that while it would be relatively easy to do and potential financially lucrative, it wasn’t consistent with our strategy.
I used it as an example this morning during my run with @reecepacheco about fully engaging with your mentors. While we could have made this decision on our own, we talked to a number of people who we consider our mentors (including several peers, investors of ours, and folks that have been doing what we’ve been doing a lot longer than we have), got their direct feedback, synthesized it, and made a decision. Of course, we had plenty of conflicting data, but it was all additive to our decision. And it was ultimately our responsibility to make the call on what we wanted to do.
During my run this morning, Reece and I also talked about fully engaging in the thing you are currently involved in. Reece and his partners are about half way through the 90 day TechStars NY program. He had lots of great feedback for me on his experience to date, but also had lots of questions about what he was doing and how he was approaching things, especially as he looked forward beyond the end of the program. I reinforced that he’s in the program for another six weeks or so and, rather than worry about what to do post-program, he should stay fully engaged in the experience he’s having now.
These two concepts are linked back to the notion of “Deciding Not To Do Something.” In the case of the decision my partners and I made, by listening to our mentors and being fully engaged in the business we are currently in, we decided not to do something that would have been an unnecessary distraction. Part of being fully engaged is understanding clearly the strategy you are executing. In our case, it’s a long term strategy that we are playing out over 20 years from when we started in 2007.
Sure, we’ll adjust tactics on a continuous basis, but we always measure what we are doing against or core beliefs that are the underpinnings of our strategy. And, while tempted by new and interesting ideas, we use these core beliefs to help us decide when we shouldn’t do something, even if it looks attractive.
We also revisit our strategy on a regular basis. We talk about it quarterly and do a deep review – both looking backwards and forwards – once a year. While we evolve parts of it over time, our clear understanding of what we are trying to accomplish helps us have clarity when presented with a strategic option that we shouldn’t pursue.
I find deciding not to do something to be incredibly liberating intellectually and emotionally. And, when I leave a big new idea on the cutting room floor, I make sure I sweep it into the trash and move on, never questioning the decision.
Reece – thanks for the early morning run, the talk, and the opportunity to talk this stuff through in advance of writing this post. Stay in the moment and keep kicking ass.