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Rare Earth Metal

The sports world, television, and the Internet will be even more abuzz today as Derek Jeter steps off the field at the new Yankee Stadium one last time. There will be plenty of articles, segments, and tweets lauding Jeter’s style, jeering at his sometimes subpar on field performance, or waxing nostalgic about his immortal moves like “The Dive” and “The Flip” and “Mr November.” Instead, therefore, I’ll explore another, more subtle angle: Derek Jeter as the master class example in celebrity image construction and management.

If asked to describe Jeter with single words, I’d say the following: consistent; understated; loyal; durable; reserved; private; thoughtful; discreet; political; under control; cool under pressure; prepared; and a leader by example.

Playing in the klieg lights of New York City amplified Jeter’s athletic talents, perhaps beyond what should have been. This is a common knock dished out by Jeter haters, but playing in a high-pressure environment adds a degree of difficulty most people cannot truly understand. He then fell into a dynasty, a legendary head coach, world titles, and money. He was made by the time he was 25.

Relatively speaking, based on how Jeter measures success, it was all downhill after that fateful Game 7 loss to Arizona in 2001. His team made it to the playoffs and a few World Series (winning once in 2009), but despite all his efforts, the magic of 1996-2001 was never to be replicated, despite his day in and day out attempts to do so.

Anyone who truly understands baseball and followed this timeline already knows how frustrating the ownership tussles and the media pressure could have made Jeter feel. I’ve never seen him lose his cool, his optimism, his competitiveness, or his focus. Sure, one can argue he’s well paid and a city playboy, but he already had fame and wealth by 2001 — he was driven by something deeper: baseball immortality. The end of his career was marked by personal records and achievements, but over a 13-year period, he only got to truly celebrate with his team once.

During this time, as well, Jeter became a celebrity, a star endorsement, and some might say corporate spokesperson. It’s easy to snicker at, and surely baseball misses gritty, pure player characters like Pete Rose and Ricky Henderson. Jeter became so polished, he represented his team worldwide (a multibillion dollar corporation), endorsed the most premium consumer products (Nike, Gatorade, etc), and somehow managed to mostly stay out of the world of Page Six tabloids.

And that’s mostly what I’ll remember about Jeter. The purely selfless plays, the extreme situational awareness, the high pressure performance, and his ability to be an authentic public face in a time when it’s hard to find in people just one quality, let alone the many that Jeter embodies. On top of this, his self-discipline to keep his private life private and off the press is remarkable. Imagine how many people stalked him, or tried to dig dirt, or tried to plant stories. He never let it get there. He understood that he represented an organization that is bigger than him, and that an investment in layers of security and discretion would both pay off and ask as insurance in a career that saw the creation of social media and the explosion of mobile devices.

It’s the end of an era, but I am not worried because I know I will see Jeter again soon. He’s too ambitious to just a live a normal life. He has tasted success but it is not yet time to smell the roses. Tonight will be his last game as a player, but he stopped being a great player a few years ago. No matter, he earned the right to go out on his terms, and in the process, became something more interesting, a person who could own a baseball franchise, who could become part of the Yankee brass, who could run for elected office, who could finally get married and have kids. Whatever way it goes, one thing is for certain — like everything he has done before, it will undoubtedly be done with one of today’s rarest earth metals: class.

The Bitcoin Crunch

Remember “The Series A Crunch”? Well, I think an offshoot of this will manifest itself across what feels like almost 500 Bitcoin related companies. I, myself – I am a Bitcoin believer and Bitcoin junkie. Yet, despite that optimism, I am continuously floored by just how many Bitcoin startups are out there. I don’t know who is funding them or how they’re making money to survive the typical cycles needed to make Series A investing, which I’ve recently heard defined as “when pros invest and set the terms.” (As a disclaimer, please note I’ve invested in 7-8 early-stage Bitcoin-related startups. I am a long-term believer.)

So, based on that, I’ll try to briefly summarize my thinking: A year ago, some of the world’s best investors placed their bets on a small handful of Bitcoin startups. Many of these companies centered their offering around payment and exchange of Bitcoin. A few months ago in 2014, there was more talk of storage of Bitcoin. And most recently, in the summer of 2014, there’s more talk about companies offering more robust access to the block chain itself, or building out chain-powered apps around ideas such as derivatives and other types of smart contracts.

Reflecting over the last 20 months, I am shocked by the number of Bitcoin startups I’ve seen. It may be more than photo-sharing apps now. Most of them, of course, sadly have no traction whatsoever. Many of them are tended to by people who haven’t been toiling away with the protocol for years. They are solutions chasing a problem. Given the landscape, here’s my view on what will happen to Bitcoin startups moving forward.:

  1. There was an arms race to acquire early Bitcoin accounts and wallets, and a small handful of companies dominate that space. It’s unlikely someone can just enter the space now (though there is a caveat) and do anything meaningful.
  2. The successful Bitcoin teams I’ve found had at least one founder who grew up hacking around with crytocurrency and the Bitcoin protocol. There are many folks entering the Bitcoin space in a “fast friendly” way and those people are likely to lack the proper context of what the technology can really do in order to build something innovative.
  3. Companies which get good seed funding generally consist of stellar teams, are working on consumer adoption issues (like building a mobile app), are building more merchant tools to get suppliers interested in Bitcoin, and are leveraging the Bitcoin platform to bring developers and larger companies into the mix.

The risks associated with these developments (or predictions!) are three-fold:

First, there are some great investors who do not conceive of Bitcoin as anything beyond a currency, or ones that do not believe the environment will be welcoming to these companies (for legal or regulatory concerns). This has constricted the number of larger venture capital firms that can invest in the category (for now), which means Bitcoin startups who graduate to the level of institutional investor may either find a smaller market for their equity and/or some of them may be conflicted out of participating given the eventual consolidation of talent and product ideas that will undoubtedly occur as the ecosystem matures.

Second, all of this means many of the startups which purport to be Bitcoin-related won’t meant the thresholds required to graduate to the level of real institutional venture capital. This is what I refer to as “The Bitcoin Crunch.”

Third, I think this is all healthy and natural, and starts to separate the winning solutions from the mediocre. I’m a believer in Bitcoin both as a unit of exchange as well as a platform for people to build all sorts of new applications, including ones that never use bitcoins themselves. It will take time, though. I do believe something will tip all of this over at some point — it could be an entrepreneur who cracks the code on tying Bitcoin to consumers’ mobile phones, or the group of developers that partner with a company like Amazon or Google to build the next generation of distributed computing architecture on top of the protocol. I have no idea what it will be and when it will happen, but I do believe it will.

The Birth Of Floodgate: Text Of My Discussion With Mike Maples

I sat down with Maples earlier this year. Below is a transcript of the talk. It’s sometimes easy to underestimate just how entrepreneurial an investor can be. When you read the stories below, you’ll see. There are many valuable investing nuggets in here, worth a very careful read…

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@semil: We are in the Studio today with Mike Maples, managing partner at Floodgate. Mike, welcome to the Studio.

Maples: Thanks for having me.

@semil: Years ago you were in Austin. You founded motive and went public. You were looking for the next thing to do. I think it would be really interesting to tell us how you came to the Valley and started Floodgate. Most people know you and think “Oh yeah! Mike started Floodgate,” but there is actually kind of a winding path to get there.

Maples: Yeah and I guess I got intrigued by two things at the same time. First of all, I just got intrigued by what at the time was being called Web 2.0. I was watching all these things happen. Blogs, user generated content, podcasting, broadcasting — all these things. I was just like, “I’m sitting here on the sidelines. I have got to get up to Silicon Valley.” Then I got intrigued by the Venture Business and I had no idea that you didn’t just apply for a job in the venture business, so I naively thought, “Well, I’ll just immigrate to Silicon Valley, and I’ll just….”

@semil: Because you founded this company and it went public and….

Maples: Yeah and I thought it’s like any other job. You just…you say, “Here are my qualifications and hire me.” That’s not how it really works. I’d never made an angel investment in my career. I’d never done a consumer startup. My profile as an investor was not very encouraging it turns out in hindsight.

@semil: You moved to Silicon Valley. What were the first things you tried to do, or what did you work on?

Maples: I was lucky enough that two venture firms gave me some time to spend inside their firms — Foundation Capital and August Capital. I think a lot of the insight for the micro-fund I had while I was there at those two places. I saw a plethora of entrepreneurs who wanted to raise just a million dollars. If you have a five hundred million dollar fund, you just can’t make the math work investing a million dollars. I thought, “What if you had a twenty five million dollar fund”? Then, if you made twenty 5x you return the fund on a million dollar investment. That’s where the seeds of the Micro-fund were born. That’s when I started getting intrigued by the idea and the fortunate thing is — being insight the two firms — I had enough data points to have some conviction that I was onto something.

@semil: You originally came here and thought that, “Hey, I want to be a Venture capitalist” Let’s say on Sand Hill Road.

Maples: Right.

@semil: Basically, you were told, “No” twice.

Maples: Yeah, I did not distinguish myself well enough inside of those two firms to be offered a partner role. I never really looked at it that way. I looked at it like I was thankful that they gave me the time.

@semil: Of course, of course.

Maples: They were awesome to me at the time.

@semil: Right. That also planted the seed for, as you were saying — no pun intended — to see a gap in the market, right?

Maples: Right.

@semil: Tell us a little bit about how you started forming Floodgate, or what became Floodgate.

Maples: Couple things were happening at the same time. First of all, I had no track record as an investor. I just decided the only way anybody is ever going to think I’m an investor is if I invest. I started investing my own money — $50,000 a quarter. I said, “I’m going to do this for 12 quarters and I’m going to either hit some winners, or I’m going to declare it a strikeout, failed experiment.” My first investment ever was Odeo — Evan Williams. I was begging him to let me in, because he had no reason to accept money from a washed-up enterprise software guy from Austin, Texas. He took some of my money.

@semil: Why do you think he took some of your money?

Maples: I think we just had a good chemistry. I think he knew that I was a real entrepreneur and hadn’t just played one on TV.He knew I was passionate about podcasting and I’d spent a lot of time really understanding his business.We got into that one. That didn’t work out, right? Odeo goes out of business and Evan gives the money back to all the investors. Nine months into Silicon Valley, I’m like, “I can’t get a job in the venture business. I’ve made one investmennt. It seemed to be going sideways.” I was feeling kind of like a loser. Then I met Kevin Rose at Digg, and it was the same thing. I said,” Kevin, if you don’t let me invest in Digg, I just have to warn you. I’m going to go on a hunger strike in your apartment.”

@semil: [laughs]

Maples: Which, I guess was an unusual tactic, at the time.

@semil: Yes. [laughs]

Maples: I invested in Digg. If it weren’t for Evan and Kevin, I’m not sure that I would’ve gotten enough momentum to ever really raise money, or ever — I’m not sure I would’ve ever gotten into first gear.

@semil: Kind of like you were saying earlier, it’s those entrepreneurs and founders really, who create opportunities for people like you and who are starting those companies.

Maples: Yeah, it’s funny there’s a lot of talk about how, “Well, the entrepreneur succeeded because their own gumption,” but also those early venture guys that believed in them and backed them. We were almost started in the reverse way. We — the entrepreneurs, and their generosity, and their belief that we could make a difference and a contribution — gave us the chance to get some runway and a running start. We’ve never forgotten that. Ann and I, when we think about how we practice the business, we’re always like, “We have to remember, that the entrepreneurs had our back when the chips were down.”

@semil: Right. In another story you mentioned — that kind of ties into that right? I think it’d be great for the audience to share just a little bit about your investment in Chegg, or the guys who started Chegg. I don’t know if it was called that before. You’re saying you knew them for about 18 months and they were about to turn off the lights. They came to you with an idea. Right? Really no one at that point would probably invest in them. Looking back on that, share a little bit about the narrative, but also what you learned from…

Maples: I met Aayush and Osman when they were relocated to California from the mid-west. This Chegg had started this Chegg post at Iowa State University. The original idea was we were going to be the Craigslist for college and college was is the ultimate local market. We tried that for about 18 months and we had moderate success. Then Facebook decides they’re going to do classifieds. We’re like, “OK, we’ve got like sixty days of cash left. If Facebook succeeds, we’re out of business. If they fail, we’re out of business, so we’re sure as heck are not going to raise money on this idea. We had been batting around this idea of textbook rentals a little while — for about six months, but we decided we couldn’t afford to do it because we’d have to buy books. Osman and Aayush are like, “Well, what we need is just 90 days to try it and all we want is a chance to try the fall semester.” They started this thing it was originally called, “Textbook Flix,” which clearly wasn’t going to fly as a long-term name, but we just wanted to try to see if it would work. We tried this Textbook Flix thing and we didn’t even have a warehouse. We would — whenever someone would rent a book, we’d ship it from Amazon. These students would be calling us and they’d say, “What’s up with this book from Amazon?” We’d say, “Oh, just ship it back to Chegg.”

@semil: [laughs]

Maples: “It’s no problem, just a clerical error. Sorry.”

@semil: Before you made this decision to back these guys on this 90 day — all hands on experience, how closely were you working with them up until that point? I know you had spent 18 months with them.

Maples: Back in those days it was pretty close, because Chegg was my first investment in my first fund. One might say I had a pretty good run at beginners luck because Odeo had turned into Twitter. Digg sort of went sideways, but Digg was a great investment to be part of.

@semil: Great group of people.

Maples: Great group of guys. I met the ngmoco guys because of Kevin Rose introducing me to Neil Young, and Bob Stevenson. It was a great project to be involved with. Then Chegg had the biggest early near-death experience. I was fresh off of just starring the jaws of defeat in the face myself, in terms of fundraising and being a VC. It’s only over when you decide to quit, so…

@semil: Then do you think that in today’s climate — that was a number of years ago — that people would make that kind of investment or would they now shut it down and start something new, or do you see that kind of stuff happening, or hearing about it?

Maples: I don’t know. I guess all I can say is that people ask me, “What is the most fun thing about the venture business?” Obviously, Twitter taking off like it did has been huge fun. Or when ngmoco set a world land speed record to a $400 million exit. The most satisfying ones are the ones where we were staring death right in the eyes. It seemed like there was no way out. You had to MacGyver some miracle just out of the ashes and you had no time left. Those are the ones where you say, “Man, if we hadn’t all gone in all together there would be no Chegg to discuss.” I’d say those are the most satisfying. The ones where the chips were down, it looked like there was no way out, and somehow we just MacGyvered a miracle.

@semil: I think that’s a good area to transition into like, how did you start Floodgate? You’re investing your personal money into Odeo, Chegg, and then how did you decide to actually go and ask other people for money and institutionalize this idea you had at foundation in August?

Maples: Yes, at first I thought that no respectable people would ever invest in me, other than folks who I’ve known from the past. There were some guys down in Texas who had believed that I could make some waves up here. I raised about — it was an unconventional fund. I would raise $5 million a year. Basically, I was like, “You guys can back out at anytime and I might decide I’m a crummy investor at anytime.” We did two $5 million tranches. By the end of the second tranche, it was clear things were working. We were in Chegg. We were in Demandforce. We were in reputation.com. Sendori was about to have an exit. Weebly was doing really well. Fund I was an epic fund for the ages.

@semil: You started very small, right?

Maples: Very small. t was just me, yeah.

@semil: Let’s just walk through the mechanics. How did you start it? How did you go out to raise money? How did you decide on $5 million tranches? How did you go out and source things? Maybe you knew some people, but not a lot.

Maples: Fund one was defined as that which I can raise in 30 days or less. I saw all of these guys out try to raise funds. They would put $25 million on the cover or something like that. They’d be raising and raising and raising. Pretty soon, you get the stink on you because you can’t raise the money. I was like, “I’m just going to tell a bunch of people I’m not sure I know what I’m doing. Invest an amount of money that you’re prepared to lose it all.” Austin Ventures, who had backed Motive and have backed [indecipherable 10:45] before, put a lot of the money in. I guess I’ve been involved with things that had made them money before, so they gave it a risk. I want my fund to be done before people know I’m fundraising. I was subleasing space from Retro Pharma. I couldn’t have a sign on the door, so I used to call it my undisclosed secure location.

@semil: How did you go out…I guess you was sourcing when you were at Foundation in August, but how did you find it going out without a brand? You were just Mike. Did you find that it was just all personal relationships? Did you have to kiss a lot of frogs? What was it like in those days?

Maples: In the early days, I decided this is a people-flow business and not a deal-flow business. I’ve always had this leap of faith that if you just spend all your time with smart awesome people, that the dots will forward connect. The deals will reveal themselves, and somehow you’ll get into some good ones. That’s when I would say, two meetings before lunch and two meetings after lunch every day. I just did that over and over and over again. I just wanted to get in as many reps as I could. At the end of the week I would say, “How many of these people were awesome and smart, and how do I increase and improve my ratio next week and the week after and the week after”? When you’re meeting the smartest people in the given area — at that time it was the consumer Internet — you’ll eventually going to learn a lot yourself, and you’re going to have something that contribute to the conversation. I would keep a set of notes about some themes that I thought were interesting, and I would share them with the entrepreneurs, and see which ones I agreed with or disagreed with. There was no doubt in anybody’s mind that I spoke with that I really cared about the space in a visceral way and I think that helped. I think also, back in those days, there were no other micro-funds other than maybe First Round Capital.

@semil: Actually, I was going to ask you about this next which is, if you time-shift everything — you sold Motive last year, and you moved here now — it’d be really, really different because you were one of the few doing this kind of model. I guess I would ask more reflectively, what would you think — over the last few years — has been the biggest change that you’ve seen across the venture model? Let’s say, from institutional or micro-angel VCs up to the big guys?

Maples: I would say two things. In the micro-space, I would say that it’s gone from being under-supplied to over-supplied. I think part of being a good investor and having a good company is you need to have enough insight when the world believes the opposite of that. Guys like me and Josh Kopelman, when we started micro-funds, people said things like, “Well, people have tried that stuff before. It doesn’t work. You’re going to get creamed. You’re not going to have enough capital. Consumer Internet is all about eyeballs. You weren’t here for the dot com meltdown.” Nobody really cared what we were doing back in those days. Everybody thought we are stupid, wildcat, or a fly-by-night sort of guys. Now, everybody wants to have a fund. Everybody wants to be a seed investor. Everybody wants to have some variation of the early stage. I think it’s been over supplied. Then if you step way back at the macro factors in the venture industry, right now, I see a bipolarization. Right now, people seem to think that seed deals and chasing the next Pinterest with a lot of money and momentum are the hot places to be.

@semil: Let’s unpack this real quick as we have it. One, if there’s an oversupply of seed capital, what are the things you believe could happen as a result of that? Or will that just be “this is the new normal”?

Maples: I just think that it’s kind of the circle of life. Sometimes there’s too much. Sometimes there’s too little.

@semil: You feel like it’s cyclical?

Maples: Totally.

@semil: In terms of this bipolarization side, in terms of a lot of capital in a small number of funds chasing momentum deals, what do you think could happen as a result of all that?

Maples: I think the venture business reminds me a lot of nine-year-olds playing soccer. When you see nine-year-olds play soccer, the soccer ball goes and everybody goes after it. Then it squirts out and everybody goes after it. What I find in the venture business is everybody is always really excited about the topic de jure, whether it’s seed funds, or super angels, or micro this, or what Yuri Milner was doing a couple of years ago with DST, Y Combinator accelerators. What ends up happening is that’s the soccer ball de jure. Somebody, like Paul Graham, deserves all the props in the world for doing a righteous job and having a great model. Now, there’s — I don’t know how many hundreds of accelerators? Most of them are nine-year-old soccer players. What I find is the venture business has a tendency…I would have thought that it was more evenly distributed where people invest, that there’s more contrarians and things like that. But in the end, I think most people follow the soccer ball right where it is. They do the nine-year-old soccer chasing thing. Next year, there will be a new fad de jure that everybody’s chasing.

@semil: Sounds like the perspective you’re sharing, in closing, that’s the perspective that someone would have who hasn’t spent a lot of time here. You’re still relatively new to the valley. You have that perspective.

Maples: Yeah, and I think that the key to being a good investor is not to chase the latest thing, but to be your best self and to have conviction that you have something to offer in your space. When you spin your wheels, that’s when you get away from that.

@semil: All right. Mike, thanks for coming in and sharing all those stories. It’s great to have you.

Maples: Thanks for having me. It’s great to see you.

Decoding PG’s Latest “Startup Investing Trends” Essay

Over the weekend, YC co-founder Paul Graham penned this very important essay on his observation on investing trends. It is a very important post. I’m not one to fawn over PG’s recent posts and tweets, but if you’re at all interested in investing in and around startups, it is critical to understand this piece and read it over and over again. I’ve reproduced PG’s essay below (it should be read, not summarized) and have inserted my commentary in bold text within. If you find this interesting and/or disagree with something, please leave a comment.

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[Full text of Paul Graham's latest essay, "Startup Investing Trends" reproduced here ]

Y Combinator has now funded 564 startups including the current batch, which has 53. The total valuation of the 287 that have valuations (either by raising an equity round, getting acquired, or dying) is about $11.7 billion, and the 511 prior to the current batch have collectively raised about $1.7 billion. As usual those numbers are dominated by a few big winners. The top 10 startups account for 8.6 of that 11.7 billion. But there is a peloton of younger startups behind them. There are about 40 more that have a shot at being really big.

Things got a little out of hand last summer when we had 84 companies in the batch, so we tightened up our filter to decrease the batch size. Several journalists have tried to interpret that as evidence for some macro story they were telling, but the reason had nothing to do with any external trend. The reason was that we discovered we were using an n² algorithm, and we needed to buy time to fix it. Fortunately we’ve come up with several techniques for sharding YC, and the problem now seems to be fixed. With a new more scaleable model and only 53 companies, the current batch feels like a walk in the park. I’d guess we can grow another 2 or 3x before hitting the next bottleneck. [The common comment here is “YC can’t scale,” and then “when they tried to, it was bloated.” While that seems logical based on recent events, I would bet YC specifically will scale, mostly because knowledge within the organization is continuously collected and decentralized. Second, there are so many great, loyal, successful alumni of YC who could assume more leadership capabilities or physically expand the franchise -- it’s not hard to imagine a YC based in NYC, and in fact, I expect that to happen eventually.]

One consequence of funding such a large number of startups is that we see trends early. And since fundraising is one of the main things we help startups with, we’re in a good position to notice trends in investing. [YC is in the BEST position, not just a good position, to notice these trends.]

I’m going to take a shot at describing where these trends are leading. Let’s start with the most basic question: will the future be better or worse than the past? Will investors, in the aggregate, make more money or less?  think more. There are multiple forces at work, some of which will decrease returns, and some of which will increase them. I can’t predict for sure which forces will prevail, but I’ll describe them and you can decide for yourself.

There are two big forces driving change in startup funding: it’s becoming cheaper to start a startup, and startups are becoming a more normal thing to do.

When I graduated from college in 1986, there were essentially two options: get a job or go to grad school. Now there’s a third: start your own company. That’s a big change. In principle it was possible to start your own company in 1986 too, but it didn’t seem like a real possibility. It seemed possible to start a consulting company, or a niche product company, but it didn’t seem possible to start a company that would become big.

That kind of change, from 2 paths to 3, is the sort of big social shift that only happens once every few generations. I think we’re still at the beginning of this one. It’s hard to predict how big a deal it will be. As big a deal as the Industrial Revolution? Maybe. Probably not. But it will be a big enough deal that it takes almost everyone by surprise, because those big social shifts always do.

 One thing we can say for sure is that there will be a lot more startups. The monolithic, hierarchical companies of the mid 20th century are being replaced by networks of smaller companies. This process is not just something happening now in Silicon Valley. It started decades ago, and it’s happening as far afield as the car industry. It has a long way to run. [This is important to understand because one could divide LPs and GPs into two groups -- those who believe our economy is going through a cyclical change, and those who believe we are witnessing a structural change. The distinction is important, and I’ve written more about it here. PG’s argument, which I agree with, is that startups are the new normal and will continue to increase in number.]

The other big driver of change is that startups are becoming cheaper to start. And in fact the two forces are related: the decreasing cost of starting a startup is one of the reasons startups are becoming a more normal thing to do.

The fact that startups need less money means founders will increasingly have the upper hand over investors. You still need just as much of their energy and imagination, but they don’t need as much of your money. Because founders have the upper hand, they’ll retain an increasingly large share of the stock in, and control of, their companies. Which means investors will get less stock and less control. [Relatively speaking, this is absolutely true. The question is, “How much?” I’ll offer an idea below.]

Does that mean investors will make less money? Not necessarily, because there will be more good startups. The total amount of desirable startup stock available to investors will probably increase, because the number of desirable startups will probably grow faster than the percentage they sell to investors shrinks.

There’s a rule of thumb in the VC business that there are about 15 companies a year that will be really successful. Although a lot of investors unconsciously treat this number as if it were some sort of cosmological constant, I’m certain it isn’t. There are probably limits on the rate at which technology can develop, but that’s not the limiting factor now. If it were, each successful startup would be founded the month it became possible, and that is not the case. Right now the limiting factor on the number of big hits is the number of sufficiently good founders starting companies, and that number can and will increase. There are still a lot of people who’d make great founders who never end up starting a company. You can see that from how randomly some of the most successful startups got started. So many of the biggest startups almost didn’t happen that there must be a lot of equally good startups that actually didn’t happen.

There might be 10x or even 50x more good founders out there. As more of them go ahead and start startups, those 15 big hits a year could easily become 50 or even 100.

What about returns, though? Are we heading for a world in which returns will be pinched by increasingly high valuations? I think the top firms will actually make more money than they have in the past. High returns don’t come from investing at low valuations. They come from investing in the companies that do really well. So if there are more of those to be had each year, the best pickers should have more hits. [I’m not sure I agree with this paragraph entirely. I do believe the top firms will generate even more returns as they grow in size and cut bigger checks at the later stages, but more modest funds can most definitely generate outsized returns by investing earlier, at lower valuations. USV is the obvious example, so look at this back-of-the-envelope estimation I made of one of their best vintages.]

This means there should be more variability in the VC business. The firms that can recognize and attract the best startups will do even better, because there will be more of them to recognize and attract. Whereas the bad firms will get the leftovers, as they do now, and yet pay a higher price for them.

Nor do I think it will be a problem that founders keep control of their companies for longer. The empirical evidence on that is already clear: investors make more money as founders’ bitches than their bosses. Though somewhat humiliating, this is actually good news for investors, because it takes less time to serve founders than to micromanage them. [I guess this style of demonizing will always continue. Ha! From my vantage point, all the great investors and up-and-coming ones never act as “bosses” nor “bitches.” They’re partners. Of course, without founders, investors couldn’t do their work, but if you ask the founders, most of them value having those good investors around the table for a variety of reasons and do not think of them as servants -- they want to leverage them and their networks.]

What about angels? I think there is a lot of opportunity there. It used to suck to be an angel investor. You couldn’t get access to the best deals, unless you got lucky like Andy Bechtolsheim, and when you did invest in a startup, VCs might try to strip you of your stock when they arrived later. Now an angel can go to something like Demo Day or AngelList and have access to the same deals VCs do. And the days when VCs could wash angels out of the cap table are long gone. [I hope this is true. It would be great. My concern is that I know a bunch of very successful but quieter former-angels who have stopped. They’d disagree with PG’s assessment. Specifically, they’d say valuations for individual angels are too high, and since most companies end up in some kind of modest M&A, the path to any return for an angel is even tougher.]

I think one of the biggest unexploited opportunities in startup investing right now is angel-sized investments made quickly. Few investors understand the cost that raising money from them imposes on startups. When the company consists only of the founders, everything grinds to a halt during fundraising, which can easily take 6 weeks. The current high cost of fundraising means there is room for low-cost investors to undercut the rest. And in this context, low-cost means deciding quickly. If there were a reputable investor who invested $100k on good terms and promised to decide yes or no within 24 hours, they’d get access to almost all the best deals, because every good startup would approach them first. It would be up to them to pick, because every bad startup would approach them first too, but at least they’d see everything. Whereas if an investor is notorious for taking a long time to make up their mind or negotiating a lot about valuation, founders will save them for last. And in the case of the most promising startups, which tend to have an easy time raising money, last can easily become never. [This is absolutely true. I have seen it. In fact, there’s a new fund which sort of operates this way, perhaps based on this realization. It’s called Bloomberg BETA and it’s run by Roy Bahat, and my friend James Cham, and a few others. While I think deciding in 24 hours is probably too fast for a variety of reasons, it’s also not rocket science and small checks should be decided on very quickly. The problem in practice is that most smaller investors will still tell founders that they’re “in” so long as they find a lead because they don’t want to wire $100k while the founders grind out three months to collect the remaining $900k, if they can at all.]

Will the number of big hits grow linearly with the total number of new startups? Probably not, for two reasons. One is that the scariness of starting a startup in the old days was a pretty effective filter. Now that the cost of failing is becoming lower, we should expect founders to do it more. That’s not a bad thing. It’s common in technology for an innovation that decreases the cost of failure to increase the number of failures and yet leave you net ahead.

The other reason the number of big hits won’t grow proportionately to the number of startups is that there will start to be an increasing number of idea clashes. Although the finiteness of the number of good ideas is not the reason there are only 15 big hits a year, the number has to be finite, and the more startups there are, the more we’ll see multiple companies doing the same thing at the same time. It will be interesting, in a bad way, if idea clashes become a lot more common.

Mostly because of the increasing number of early failures, the startup business of the future won’t simply be the same shape, scaled up. What used to be an obelisk will become a pyramid. It will be a little wider at the top, but a lot wider at the bottom.

What does that mean for investors? One thing it means is that there will be more opportunities for investors at the earliest stage, because that’s where the volume of our imaginary solid is growing fastest. Imagine the obelisk of investors that corresponds to the obelisk of startups. As it widens out into a pyramid to match the startup pyramid, all the contents are adhering to the top, leaving a vacuum at the bottom.

That opportunity for investors mostly means an opportunity for new investors, because the degree of risk an existing investor or firm is comfortable taking is one of the hardest things for them to change. Different types of investors are adapted to different degrees of risk, but each has its specific degree of risk deeply imprinted on it, not just in the procedures they follow but in the personalities of the people who work there. [Boy, I could write a whole post just on this. Very, very true. Change in a VC firm on any dimension is hard because VC partnerships combine two of the least-efficient ingredients found on Earth: partnership structures and VCs themselves. I’m partially joking, but partnerships are, in my mind, the tragedy of the commons in corporate life. This is why the top firms mostly have either flat structures or have a top-dog in charge who makes sure the partnership doesn’t devolve into a tragedy. Therefore, changing dynamics inside a firm is really, really hard. Even for the easy, small stuff -- but if you consider an input as big as risk, well, that’s nearly impossible unless the partnership changes in composition drastically.]

I think the biggest danger for VCs, and also the biggest opportunity, is at the series A stage. Or rather, what used to be the series A stage before series As turned into de facto series B rounds.

Right now, VCs often knowingly invest too much money at the series A stage. They do it because they feel they need to get a big chunk of each series A company to compensate for the opportunity cost of the board seat it consumes. Which means when there is a lot of competition for a deal, the number that moves is the valuation (and thus amount invested) rather than the percentage of the company being sold. Which means, especially in the case of more promising startups, that series A investors often make companies take more money than they want.

Some VCs lie and claim the company really needs that much. Others are more candid, and admit their financial models require them to own a certain percentage of each company. But we all know the amounts being raised in series A rounds are not determined by asking what would be best for the companies. They’re determined by VCs starting from the amount of the company they want to own, and the market setting the valuation and thus the amount invested.

Like a lot of bad things, this didn’t happen intentionally. The VC business backed into it as their initial assumptions gradually became obsolete. The traditions and financial models of the VC business were established when founders needed investors more. In those days it was natural for founders to sell VCs a big chunk of their company in the series A round. Now founders would prefer to sell less, and VCs are digging in their heels because they’re not sure if they can make money buying less than 20% of each series A company.

The reason I describe this as a danger is that series A investors are increasingly at odds with the startups they supposedly serve, and that tends to come back to bite you eventually. The reason I describe it as an opportunity is that there is now a lot of potential energy built up, as the market has moved away from VCs’s traditional business model. Which means the first VC to break ranks and start to do series A rounds for as much equity as founders want to sell (and with no “option pool” that comes only from the founders’ shares) stands to reap huge benefits. [Again, this is absolutely right. The market has moved away from VC’s traditional business model around what constitutes required ownership levels. Fred Wilson wrote about this last week, as well. The problem here, in practice, is that only firms as small and modest in size like USV can adapt to these changes. If you are managing $800M or over a billion dollars, those 20% ownership floors are critically important for the investors’ model. Smaller funds, by contrast, are on the hook to return less dollars overall, so they are in a position to do what PG says. The problem, however, is that generally-speaking, founders are still motivated by the size of the round they can pull down, as well as the valuation. This is where deals fall apart in real life: A smaller fund wants to invest in a hot Series A deal, and they want to invest around $5m at a more modest valuation, but a larger firm will literally double the cash in, and then all sorts of irrational behaviors kick in, as well as endorphins. Again, I agree with PG, but haven’t seen this yet, though I hope to. In fact, I view it as a sign of sophistication of a founder to take on more modest valuations in order to maximize their exit options down the road.]

What will happen to the VC business when that happens? Hell if I know. But I bet that particular firm will end up ahead. If one top-tier VC firm started to do series A rounds that started from the amount the company needed to raise and let the percentage acquired vary with the market, instead of the other way around, they’d instantly get almost all the best startups. And that’s where the money is.

You can’t fight market forces forever. Over the last decade we’ve seen the percentage of the company sold in series A rounds creep inexorably downward. 40% used to be common. Now VCs are fighting to hold the line at 20%. But I am daily waiting for the line to collapse. It’s going to happen. You may as well anticipate it, and look bold. [Definitely true. Smaller firms are going down to 13%, even 8-9% for smaller Series A. However, so much of this is inside-baseball. Sometimes founders do want to work with specific investors and will take more dilution in order to. Sometimes they want to reward the firm that made the first offer, even if the terms aren’t “the best.” I’ve seen this happen a few times already this year.]

Who knows, maybe VCs will make more money by doing the right thing. It wouldn’t be the first time that happened. Venture capital is a business where occasional big successes generate hundredfold returns. How much confidence can you really have in financial models for something like that anyway? The big successes only have to get a tiny bit less occasional to compensate for a 2x decrease in the stock sold in series A rounds.

If you want to find new opportunities for investing, look for things founders complain about. Founders are your customers, and the things they complain about are unsatisfied demand. I’ve given two examples of things founders complain about most—investors who take too long to make up their minds, and excessive dilution in series A rounds—so those are good places to look now. But the more general recipe is: do something founders want.

“Motiveless Substance”

I came across an incredibly thoughtful tweet today penned by wordsmith @mm:

Few blogs–and people–in Silicon Valley are of more motiveless substance than @benjy. If only he wrote more. http://benjyw.com/ 

Earlier today, on my way up to San Francisco, I read Benjy’s latest blog post which was RT’d into my stream. It is an excellent post. I’d recommend reading it. A few hours later, I came across Morgan’s tweet, which had the descriptor “motiveless substance.” I had to pause and re-read that phrase. It’s kind of an awkward comment. But, then I read it over a few times, and realized, it was perfect. Content-marketing in our world is only growing in popularity, partly because it’s cheap to produce and partly because it works, and it works really well. And, I am a small part of all this noise created we have to suffer with. And, I like to think what I write is of substance, but I’m not sure that’s always the case. And, I’d be lying if I said there wasn’t some motive buried deep inside what I do and continue to do. It is, then, with motive. But, true “motiveless substance” is rare and provides real signal. I hope to read more posts that fit this type of writing, and I hope one day I can write like Benjy.

Having a Presence in SF and NYC

Software and mobile applications can be developed anywhere in the world, especially today. Even hardware, for that matter. And specifically, two locations have created a strong community of technology creators separate from Silicon Valley: New York City and San Francisco. The density of activity has become so intense, investors on the west coast are flying out more often to NYC, are taking cars up to the city, and even opening satellite offices, hiring new colleagues (even at the partner-level), arranging to syndicate deals with preferred investors in new locations, and trying to learn the nuances of each new ecosystem. I believe all of this activity is moving in the right direction and entirely rational, with one caveat: To me, there’s a subtle difference between:

  • (a) “having an office in SF and/or NYC” versus;
  • (b) “having a presence in SF and/or NYC” versus;
  • (c) “being ‘present’ in SF and/or NYC.”

I don’t want to suggest that any one of these three approaches is better than the other, but they shouldn’t be confused with each other or used interchangeably, as they are fundamentally very different and directly effect the type of relationship investors have with not only founders, but also tech bloggers, operators in startups, PR professionals, and folks who are looking to jump from their current gigs into the startup world.

A Powerful Insight from Highlight

Highlight launched in early 2012, generated unsustainable buzz prior to SXSW, and entered a “quiet period” after everyone realized mobile battery performance was too valuable to spend unwisely. As is the case with new mobile products, I road-tested Highlight and subsequently erased it from my iPhone after a month. That’s not to say I didn’t like it. For a v1 product, I thought it was brilliant. Even the ability to “pause” highlight during times was well thought out. After a month away, I reinstalled Highlight and have basically kept it “on” every since, coming up on two months now. My use of it hasn’t been earth-shattering, and the app hasn’t required me to do anything special, and I have met some interesting people on it. And, after this second time around the block, I’m starting to see the bigger idea that Highlight (or other similar apps) could tap into — Push.

Here’s my logic: Back in the day, Google gained leverage by capturing our intent through search. We would hunt and peck for information, and Google delivered it to us. Then, when people with identities (or pseudonyms) came online into various social networks, the act of curation or the power of discovery grew in importance, making sense of the “mess” of information around us and offering “delight.” Today, and in the near future, mobile-specific services that are “always on” and run in the background could provide that next big delivery mechanism, pushing relevant information to us based on the strong API support from the handset makers and mobile operating systems, as well as information based on context, such as location. Today, Highlight periodically tells you when someone who is a second or third order connection via Facebook is around you, but in the future, a service like Highlight could tell you when your friends or colleagues are around, or when you’re nearby a store you love that’s having a sale, and so forth. That is a massive shift from the hunting and pecking we still do on our mobile phones and tablets — and more importantly, it’s a shift I’m looking forward to as a user.

The Organization of the Obvious

This is the initial post on my new blog. I decided to stick with WordPress, but opted to self-host in order to integrate Disqus for comments and customize portions of it in the future. I have two goals for this blog. One, I want to create original content about technology and startups on a daily basis. The posts won’t be long or perfect. They won’t look like what I’ve written on TechCrunch, or on Quora, or on my previous blog. They’ll be entirely different, I hope. Shorter, more direct, and more opinion. My style will be to frame questions that interest me rather than try to write long tomes or explain everything about nothing. And two, that’s where you come in. That’s why I researched all commenting systems and elected to invest in Disqus. My second goal with the blog is to ignite discussion, debate, and disagreement. I will invest the time to moderate. As a reader, you may post comments using identities from Facebook, Google+, Disqus, or Twitter. Finally, I must admit — despite my hopes — that I’m a bit skeptical folks will be interested in commenting given how much content is generated out there today and how fast it flies around. I’ve even caught myself saving items to Pocket and just skimming the headlines, never getting around to reading anything. In that spirit, I’m hoping that the small group of folks who start reading and following this blog actually don’t share it, but instead participate in a discussion, and hopefully one day, a real community. In the future, I’m even hoping to organize aspects of this blog in real life. That sounds like fun to me, but it will take some time to get there. As you poke around, some of the blog is missing or incomplete. It’s a work in progress, and I hope it gets better every week. Thanks for your time, and thanks for reading. First real post will hit tomorrow.

Haywire is written by Semil Shah, and is published under a Creative Commons BY-NC-SA license. Copyright © 2014 Semil Shah.

“I write this not for the many, but for you; each of us is enough of an audience for the other.”— Epicurus