Spray and Pray (and Pounce)
“Nobody panics when things go according to plan, even if the plan is horrifying…Introduce a little anarchy, you upset the established order and everything becomes chaos.” – The Joker, The Dark Knight
Entrepreneurs are the souls who see and build the future. The investors who invest in those entrepreneurs early are the financiers who, we would like to think, have a glimpse into the future, as well, but also at a rare angle where they have both access to the entrepreneurs and money to create a legal bond with the new entity.
From afar, it may be tempting to assume the investors also see the future and, therefore, are able to “pick” from thousands of startups which ones have the characteristics of a successful company. When investing in startups today, every investor deep down believes she or he is a “picker,” someone who, despite all the noise and copycat companies, can sort through the mess and find the right entrepreneur, the right market, the right startup company to invest in.
As an investor, being perceived as a good “picker” logically confers many advantages. Future entrepreneurs may seek you out early if you’re considered a good picker, because they receive the branding validation from having been selected by the picker. Limited partners (LPs), the endowments, families, and others who invest in these investment funds, obviously want to invest in funds which they and the market believe to be good pickers.
Beyond this, with social media, there is pressure to appear “smart,” to signal that you are both able to see the future and also have access to those builders should the signal appear sooner. While much of the “good picker” rule may hold for larger, institutional venture firms, the market tends to want to apply those same rules to the very early stages of investment. As Benchmark and Lowercase were able to pick and gain their LPs exposure to Twitter, Uber, Instagram, and Snapchat (wow!), surely other seed funds which employ a rifle-shot strategy will have the same deal flow and picking ability, right?
The opposite of rifle-shot here is known as “spray and pray.” It is not a term with a good connotation. First, it can potentially objectify founders of those companies as small options for the fund manager, but mostly a “spray and pray” reputation for an investor could mean other potential co-investors and/or investors who would follow downstream may be less likely to view involvement as a positive signal. Furthermore, traditional and sophisticated LPs may not want to back an investor who sprays investments and then prays some will work out. Anyone can do that, right?
Let’s look at some of the newer, more recognizable entrants into the VC space over the last decade. By listing these firms, I do not want to label their strategies for them, as I don’t know how they work internally, so I’m just an outside observer (and fan) looking in. First Round Capital has a larger portfolio by number than many other seed funds. They’ve also invested in a robust platform, have judiciously increased their fund size but kept it under control, and they were able to gain direct exposure to the big mega-hit company of the last decade. AngelList is its own platform, offering new products like Syndicates and Pro Rata funds to the market — they too gained exposure to the last decade’s mega-hit, which also benefited any outsider who participated in that particular syndicate. Y Combinator now accepts over 200 startups per year into its famed accelerator, and have hit countless numbers of huge companies with more on the way. YC also smartly built products for top of the funnel (Fellows) and the bottom of the funnel (Continuity) to make sure they’re able to invest the most in the clear winners.
All of this became clearer to me after (1) spending the past few months with hundreds of LPs of all shapes and sizes; (2) recalling that a16z spent time heavily investing at seed (to build a network) when they started the firm; and (3) a report from The Wall Street Journal which covered the famous “scout” program of Sequoia Capital, widely considered to be the most successful venture firm in the world. Sequoia is not just the main fund — they smartly have an integrated financial organization which gives them the flexibility to have a hedge fund, a growth fund, a fund of funds, and also invest in programs like “scouts” and a little known accelerator called YC.
We want to believe the best investors are the best pickers. Hell, I think I’m a good picker, but then I also realize every other investor believes the same. The truth is, looking back on seed decisions over the last few years, I had very little idea how big some of these companies could be at the time. It would be a bold-faced lie for me to say I did. If you ask one hundred seed investors the same question, they’d likely say the same. “We are pickers.”
However, the last decade has shown the most visible new entrants are more about smartly creating an index from which to choose the winners. The funnel has changed. Seed is different than Series A. The Series A rounds are hard because the VC has only a few bullets per fund and one rifle. Picking well at seed is hard to rifle-shot because those investors are working with significantly less time and data before making a decision.
So, is it just “spray and pray?” No, that is too easy. It’s about branding for deal flow, about securing the perimeter for coverage, about staying close to your companies and helping out, and having the financial access, right, and flexibility to follow along into subsequent rounds as the best companies emerge. That’s the truth, but the crowd at large, including founders, the investors themselves, and the folks who invest in these seed vehicles don’t want to hear this is how it works. We all want to think, as The Joker states above, that everyone has a plan for their early-stage strategy. But, then, when you look at how different and successful funds like First Round, Y Combinator, and AngelList have been, and you dig deeper into their funnels and strategies for catching and harvesting winners, and you see larger, Top Tier funds like Sequoia employing a wholly different investment strategy for seed-stage companies, it makes me think we’ve all spent too much time judging seed as if it were like VC. At seed, maybe spraying is good, and believe me, both seed investors and VCs do plenty of praying.