Reflecting On The First 100 Investments
As I begin Haystack III, I wanted to write down and share the reflections I’ve had on seed investing to date. However, please note (1) I’m still learning; (2) I’ll make new mistakes; and (3) these reflections are for me, and not generally applicable to others — there are 101 ways to invest effectively and different things work for different people. And, ultimately, (4) it is a privilege for me to be even just a small investor, and it’s a privilege I take seriously, and am grateful for all the investors in my fund and founders I’ve gotten to work with — they have all taken a chance on me, and that is a very humbling set of circumstances to keep in mind.
With that, here’s what I’ve been reflecting on with 100 investments now in the portfolio, three years in. I don’t have a technology or investment background, so I wanted to invest in a lot of companies quickly as a way to speed up my learning, but I know in the back of my mind, there are no shortcuts and will be more learnings in the years to come. [I want to dig into some my stats (as I’ve shared on Twitter before), but I’ll do this in another post, as here I want to focus more on what I’m taking away as I move into Fund III.] Finally, I’ve had a tough time organizing my reflections in specific categories, so this may ramble a bit. Apologies in advance.
1/ Out Of Market, Out Of Mind
I made a small handful of “out of market” seed investments, some in LA, one in Canada, a few in NYC, one in Boston, and one in Europe. While I’ve been active with them, it is hard to keep in touch and requires a lot of extra work and communication. For Fund III, I’ve elected to keep my focus to invest locally in the Bay Area. I’m sure it will be tested over the course of this fund, and lo and behold, I met an entrepreneur with operations in Israel and parts of West Africa that I would love to work with, but I am not sure about the geographic divide. At the Series A level, I can see how a VC firm would invest out of market, but at the seed stage, I believe the financing risk is too high generally. I sense some people will take offense to this stance, and I hope local seed markets flow to other geographies. I know I’ll miss out on great opportunities, but for this fund, I’m OK with it, which brings me to the next section…
2/ I Can’t See Everything, And That’s OK
At the seed stage, there’s just no way to see every good opportunity. Company creation is so pervasive, I am not sure how wide one’s coverage at seed could be. By adopting more process constraints (like focusing on local investments, etc.), I’m implicitly saying it will OK to not see a company in another market or in a hot category, etc. It’s OK.
3/ Existential Risk Rules The Day
“Only the paranoid survive.” Or, any similar phrase will do the trick. Seed-stage companies biggest risk isn’t competition or a large company — it’s surviving, and often that comes down to securing future financing venture capital. Every seed stage company, whether they admit or not, strives to “reach Series A,” but we know most don’t make it, so we have an explosion of bridge rounds, or second seed rounds, or seed extensions…whatever you want to call them. While a select few companies will have VCs chasing them or boast insane metrics, the rest have to really fight it out, and it often requires a level of risk, sacrifice, and paranoia among the team to get the deal done, which brings me to the next section….
4/ Founder-Market Fit And Startup-Founder Fit
I have learned that I like to find some connection between what a founder is working on today and what they’ve experienced in the past. It could be a loose connection, but I strive to understand what those connections are and how deep they may be. It could be how they’ve been trained, or where they’ve spent their careers, or it could be personal like where or how they grew up. Additionally, I try to evaluate through conversation and reference checks the level of dedication one has to startup life — Do they have the willingness to take real risks, even if it’s reputational risk? Are they willing to sacrifice in pursuit of their goals? Do they exude a mix of confidence about their abilities and competitiveness to fend off all the copycats that will emerge in today’s startup culture, alongside a healthy paranoia that drives them to understand the next round of financing will be an uphill battle? Speaking of uphill battles…
5/ The Seed Round Doesn’t Really Count Anymore
Receiving an offer to invest early in the life of a company generally doesn’t mean much. Yes, it’s very hard to raise money, but there are so many seed stage financings every day, why announce them or view it as some kind of validation? It is not. Securing a seed round means a team has convinced others to believe in their potential. That is something to be proud of as the recipient, yes, but perhaps more of an internal high-five to one’s self versus broadcasting it to the world. I think what really matters are: Do friends and former colleagues want to work at your new company? Do customers find you and bring business your way? Does your product or service change the behavior of your users or customers in meaningful ways? Do any or all of these exist in your company to the point where a professional investor fights to invest in your company, to join your board, and to work with you on a long-term project? Those are the things that count in the long-term.
6/ What Does “Value-Add” Mean At The Seed Stage?
I’m a very small investor on the cap table. The biggest area seed stage companies ask for help with is, unfortunately, one area I can’t really help much on: Recruiting. Now, I have certainly sent a few ex-colleagues to startups in my portfolio and try to do more when I can, but as a percentage it’s pretty small. I’ve also helped “close” many candidates who are looking to join portfolio companies, which is definitely more effective for me. After a while, one kind of glosses over the standard requests like “Hey, if you know any good iOS engineers, send ‘em our way — we are hiring!” I didn’t want to turn into a recruiter (though I think it’s a very valuable skill), and I believe the talent fragmentation in today’s SF/Valley startup scene is so pronounced that being effective at this may be a waste of effort. Instead, I choose to focus on mitigating the risk in Point #3 above, and from that lens, everything flows.
7/ Being Helpful Via Push Versus Pull
With a larger portfolio and being so early, I initially decided to be available and approachable when someone needed any kind of help or just someone to talk to. To encourage this to happen more casually, I set a calendar alert to BCC email all the founders together on the 1st of the month with a short note to tell them what I was up to, to share where I was speaking, to share generalized opportunities I came across, and to add my phone number. From those more casual emails, conversations would emerge. And as those conversations progressed, I would start to ask about burn rate and runway, and if I gathered that the founder was potentially underestimating how much runway they really had, I would offer to work together on it. Many took me up on this offer. Some didn’t. There will be a higher number of things that don’t work at seed, so I focus on (1) trying to pick well prior to selecting an investment and (2) being in a position to help if it’s welcomed, but then not pushing beyond that. It is not my company.
8/ Investing Pre-Product Or Pre-Launch
Unless I know the founders previously on a personal level or it is someone who has successfully started companies in the past, there are way too many good investment opportunities on my desk for me to consider investing in someone’s concept or dream. In fact, I’m shocked how many people waste time trying to pitch someone about their concept when there are live products in the wild for investors to play with and test. It does feel a bit like people view this very early stage investing as a newfield area to go after, but to me it looks more like grant funding — now, there’s nothing wrong with grants, assuming those grants are made on some type of asymmetric information and/or prior evidence of application of talent.
9/ Leading Rounds Versus Catalyzing Rounds
Being a small investor, I cannot lead a round by investing the most money. However, on occasion, I have been one of the earliest investor in a seed round and then worked to catalyze the round by sharing it with a network of investors who enjoy co-investing with me from time to time. In these cases, so long as the founder is OK with it, I can have a bit more influence on the overall terms (what I think the clearing price will be) before sharing it with the wider network. This has been very successful to date — for both investors and founders I work with. Keeping in line with my views on the threat of existential risk, I focus on catalyzing rounds to make sure they get done versus trying to lead them with the small, inexperienced checkbook I wield. And, as seed rounds are never really closed and therefore this is rarely true urgency around closing a seed round, it is entirely manufactured without real teeth as founders may need bridge capital later on in the company’s life.
10/ The Good And Bad With Party Rounds
I have no clue, statistically speaking, if party rounds impact the trajectory of a company. It is intuitive to think that they do, given that more investors with a smaller share won’t care as much about the company, but then you can see some companies on AngelList which have over a 100 direct investors (not through a Syndicate), and it makes you wonder. Clearly for a founder, managing more lines on the cap table can be a pain, but ultimately, if every seed stage company faces existential risk, and if there are too many investors such that no one has meaningful enough ownership to care for and fight for the company in hard times, that composition may impact how the company fares. Philosophy aside, most rounds I see are split between having 1-2 leads with a few individuals and pure party rounds where the founder just scraps to get it done. For now, I’ve decided to focus on making the sure the round can close if I have conviction versus trying to make sure there’s a lead, though some cases definitely require a lead.
11/ Seed Investors Not Updated Often
I struggled with this initially, because one assumes people will update you. But, most don’t. I’ve learned to accept it for now, and if someone contacts me later for help, I may ask them for more context and an update in order to properly help. Some of the best-performing companies rarely or ever sent an update, despite the investor feeling he/she may want one.
12/ Conflict In Seed
Big VC firms can’t really invest in more than one company in a category, but some get away with it. Incubators and accelerators definitely can, and they take advantage of it. At seed, things are so early and people change course often, a seed investor with a larger portfolio can sometimes fall into a conflict. This has happened to me. On some occasions, there is a direct conflict and I don’t engage; sometimes it’s possible, so I try to ask current founders if it’s OK for me to talk to another company; and the tricky part is that sometimes I don’t see it at all, only to find later that a founder views a company as competitive. Things are so uncertain at the seed stage, I just try to be as honest as possible, but I am going to make mistakes here and have, though I’m not sure what I can do about it given how the market is evolving. At the end of the day, everyone is in conflict with everyone else.
13/ Seed Is From Venus, Series A Is From Mars
Oftentimes, all of this activity gets lumped into “venture capital.” It is not quite accurate. The lessons I’m trying to learn don’t all apply to Series A, which is much more of a zero sum game where investors have to enforce discipline on the system, where they can’t invest in more than one company in a category. (At seed, there is a bit more room to invest in a category, as I described above.) So, I’m hoping people don’t take this post as a proxy for what large VCs do — it is not. Seed is very different and this post can’t be extrapolated to other stages of investment.
14/ On Relationships With LPs
I wrote a series about posts this past summer on StrictlyVC about my experience in meeting, getting to know, and taking investment from LPs. You can read those here. Ultimately, traditional investors in VC funds like to write bigger checks than small funds can provide room for, and increasingly, many of them are looking to make follow-on or even direct investments in the portfolio companies of their managers. This is especially true at seed, where access to companies proves to be most difficult for larger investors to stomach. I learn more about the market, about LPs, and about myself each time I go out to raise — this time around, there were two surprising things: (1) Some LPs first move in diligence was to verify that I actually had a fund and that the fund held previous investments — I had no idea they would do this, but it makes sense; and (2) that no matter how well you think you can pick them as an investor, people will always question your deal flow and judgment. People will question how repeatable your previous record is, and they’ll want to dig into how you get deal flow, which is likely the same way everyone else gets into the flow of deals. As the manager of a small fund, for better or worse, I’ve chosen to meet as many LPs as I can and go into each conversation assuming what I’m doing is too small for them and to focus on building a relationship with them. I’m hoping that over the long-term, with time, that I can build organic trust with a small group of partners.
15/ Investment Pace Matters
This is a learned skill. When I started, I was bad with this, and it got worse being a one-person shop. I got a LOT of feedback on that, and I listened to it — the main change I made is that I have found someone to manage my back-office accounting who is very strict about setting a pace and sticking to it. For Fund III, to start, I can do two wires per month, and he has to have all the docs in place before initiating the wires — then I go into the account and approve them. It’s still my decision, but that little extra process helps with the pace. At seed, the temptation is to make lots of investments because no one is sure what will happen, but from an institutional LP point of view, LPs definitely look over your track record and try to measure and predict how selective an investor can be. Pace is a big part of that equation. Still, two a month for Fund II is still pretty high, but a slow down for me relative to prior funds.
16/ Deal Flow, The Mother’s Milk
Everyone wants to know “How does one get their deal flow?” It’s all the same, everyone is connected to everyone (for the most part), and if you’re seen as a good actor and valuable in some small way, people often share their deals and/or people make introductions. When there’s lots to choose from at seed, picking the right companies becomes more of a challenge, and those who have picked well may do so out of luck, out of process, or some combination. It’s very hard to say.
17/ The Biggest Mistakes I’ve Made: Weighting Concepts Over Market Timing
The most common mistake I’ve made to date (there will be more!) is being seduced by a concept and weighting that over even little signs of momentum in the company or sector. From afar, it’s easy assume investing like this as “people who invest in the future,” but for it to be effective (e.g. to return investments), the size of the market and the market timing are critical, especially when there are hundreds to choose from at any given time. Now when I’m evaluating an investment, I’ll try to find the overlap in a venn diagram of three circles: (1) Is the market huge and evolving in dynamic ways over the next 3-5 years? (2) Is the product or service being offered in that market compelling and defensible in some way (could be based on tech and/or people)? and (3) Do the founders, either veteran or first-timers, have a combination of skill and willingness to sacrifice to make a run at building a company? If the answer is “yes” to all three, then I dig in more for references and socialize it with my close network to get feedback.
18/ Counterintuitive Advice That Backfired
This is easy. I seeded a company earlier this year that started to pick up traction, much to my surprise. The founders immediately turned around and said they wanted to raise a Big A, but summer was approaching, so I shot back with “raise from big funds in the Fall, it’s hard to get a competitive process going in the summer.” Well, that was definitely the wrong advice I gave them, and I pushed it pretty hard. They completely ignored it, and they got their round done before Labor Day, and given how the market reacted then and thereafter, they were absolutely right. Lesson learned.
19/ Reputation, Not Money, Is The Currency
It’s easy to observe the ecosystem and assume all investors have tons of money. Well, many of them do, and even those that don’t write big checks. It’s a great job, no doubt. But, if everyone has money, and all that money is the same color and has the same worth, what differentiates it? Reputation. Reputation, it turns out, is the only real currency most investors have. In a competitive environment, reputation lets an investor see a deal he/she shouldn’t have, or lets an investor convince a founder to work with him/her, or lets an investor be a little extra persuasive when trying to coach a founder. It’s easy to assume investors are conferred power by virtue of having money, but the money isn’t always there and can go away for the next fund — reputation is the real currency, one that takes years to earn and can be washed away in an instant.