Monthly Archives: April 2012

Investment Thesis Analysis: Invest in Awesome Technical Teams

Semil Shah (@semil) tweeted a response to my tweet about my post, Working on New Investment Theses:
@bznotes @dshen what if one’s thesis is to simply find the most exceptional technical founding teams?
I thought I’d run this through some of the process described in that post and in my older post Predicting the Future: Research and Thesis Development. I will use YCombinator as an example, since they are the most visible supporters of this thesis (see disclaimer at end of post).
First, some from “Predicting the Future..”:
1. Look at your own personal interests and areas of expertise.
Currently, the most vocal of proponents of this strategy is Ycombinator, who recently announced that they were going to accept founder teams that have no idea. Ycombinator has always looked for hacker credibility in its applicants, accepting only the cream of the crop from top schools all over the world. The Ycombinator group is also composed of hackers as well. Given their experience from a multitude of Ycombinator classes, they have seen that often times all it takes is hyper intelligence plus entrepreneurial traits that can yield a tremendous winner in a startup.
So it would be natural for them to take this leap.
2. What else is unique about you?
a. Do you have a flow of proprietary deals from some source(s)?
Of course YC does. Their brand attracts the best of the best of the best to apply each class.
b. Can you influence outcomes based on your experience, contacts, expertise, etc.?
YC now has amazing support from the community from other businesses, investors and their startup network. They also get amazing press coverage for whatever they do. They are universally respected for everything they say. If you are a startup that has gone through YC, it gives you a badge of honor that you can’t get anywhere else. Investors travel great distances to view Demo Day and then pick the best of the best to invest in, no matter what the valuation. These factors give their startups an advantage in the marketplace over those who are not YC alums.
c. Where are you based?
YC was in Boston, then became bi-coastal, then decided to relocate permanently to the Bay area. Being in “entrepreneurism central” helps them in all their operations, and allows them to optimize them without worrying about missing startup resources in other locales.
d. Now, we move into lots of data…
YC has been doing this for 7 years now. There experience in doing this for so many years, through so many classes of startups has led them here.
Moving on to my latest post, here are some analyses from Working on New Investment Theses:
1. Is there a place where it makes sense for us to play? Do we have or have not expertise in that area?
Yes because YC is made of hackers and hackers is what they know best.
2. What about valuations?
This is one of the strongest advantages of YC – they give a low amount of money for a disproportionately large part of the startup. In the early days, this was appropriate for the risk – each YC startup used to start their project from nothing when their class began. Over the years, this has changed dramatically. Many startups coming to YC have been in operation for over a year and often with significant revenue. Still YC invests relatively low amounts of money and gets a big chunk of the company even at this stage; startups come to YC for the advantages of being associated with YC and are happy to pay that price for the value they receive.
The valuation that YC receives is one of its biggest strengths in getting outsized returns for capital deployed and thus makes sense at the riskiest stage of a startup.
3. What do others think?
YC has always had its bit of controversy. Other investors both applaud and ridicule this style of investing. In many ways, YC walks the world very much as an individual and does not march to any other tune. They hold to their convictions and also adapt quickly and nimbly when things need to change. So investing in founding teams with no idea has its detractors but if anyone can make it work, YC can with all their experience.
And as I mentioned in my post, we have discovered in our own portfolio that not following the herd has resulted in the startups doing the best.
4. What does the world need to look like in order for this area to start taking off?
To me, this goes along with my statement:
By socializing the opportunity to both investors and entrepreneurs, is it possible to literally bring the future to life by our own actions?
The credibility that YC has in the industry means that if they take a stand on something, many will simply follow or believe it to be true because YC said so and they trust their analyses. Therefore, even as that post from YC said they were simply trying this and didn’t know if it would work, many now have taken this to be truth.
NOTE: Even before YC made this move, there are funds that have shouted the “founders first” mantra. However, I would contend that even though they say this, upon further examination of their startups, they still are picking even if one of their criteria is a rockstar founder team.
Calling out one point which is examining Specific Industry Trends from “Predicting the Future…”:
Many things have happened since YC started back in 2005:
i. Development tools became more readily available and it became easier and easier to build high technology startups over time. Amazon’s EC2 and AWS then made it so much easier to setup a server and backend and you didn’t have to worry about that at early stage to test your concept.
ii. Educational materials got better. Credit Eric Ries and Steve Blank for creating startup manuals and methodologies like the Lean Startup and The Startup Owner’s Manual.
iii. The economy went into the crapper. With interest rates near zero and volatility in the stock market going crazy, the only place that seemed to be making money was in startup investing. This meant that the marketplace filled up with eager investors, both large and small, searching for returns in the most riskiest asset class of all.
iv. With so many jobless, and hatred for big corporations at an all time high, and the few outsized returns generated by internet startups of today’s internet boom, young people flock to startups and are encouraged to be entrepreneurs. Incubators flourish to help, universities all offer entrepreneurism programs and classes.
v. Celebrity status of both investors and entrepreneurs also drives subtly the urge to become either. Who doesn’t want to be famous?
vi. The internet marketplace for startups becomes exponentially filled up with early stage startups. It’s so easy to build one now, and there are tons of resources to help people start something. New investors coming to the market help fuel their creation and existence for at least a short amount of time, unless they become successful. Competition becomes ridiculous for most ideas and for each idea, you find many competitors.
vii. Consumers (and the beleaguered IT guy at a big company) are deluged by pokes, flirts, offers, friend requests, requests to join and play – our limited slices of attention are getting deluged by more and more of these interruptions and we can’t keep up. Viral loops stop working. Growth gets harder and harder to get.
Given that the world looks like this for internet only startups, I find that there are still the class of investors who believe in this world which i call “true believers.” These are the people who still think they can find the next Instagram or Facebook even in today’s crowded world.
My contention is this – if you still believe that the internet is place to invest in, and you are a “true believer” and want to find the next Groupon or Zynga, then you have NO CHOICE BUT TO DO WHAT YC DOES – gather all the smart, talented people you can find and then invest in as many as you can, spending as little as possible to get as much % ownership of the company as you can. You have no idea if an idea will work because of market conditions; but there will be some that will even if you don’t know which ones. But betting widely means you’ll increase the odds that you’ll find the next Groupon/Zynga and you need to reduce the chance that you missed one. Rumors say that YC has proven that even with their failure rate, they have gone positive in their return relative to capital that they have deployed.
All investment theses are highly situational – nothing works forever, and something that didn’t work before can work again if market conditions change. Or can work for one person but totally impossible for another. And by the way, luck can confound the best of strategies.
As you think through some investment thesis you’re thinking about investing against, can you muster up as many advantages as YC has, in investing in awesome technical teams without ideas? If you can’t, you might want to think twice about investing against SOMEONE ELSE’S thesis…(yes you do get points for original thinking and for having the guts and conviction to bet against the crowd! Extra points for literally forcing the (your) future into being through your own efforts…)
As I talked about in my latest thesis post, it’s all about swaying the odds in your favor. Unfortunately, they are still odds and no matter what you may still roll snake eyes and lose your shirt. Oh, and that other investor who started investing on a thesis you painstakingly built just become an investing genius because he found the startup that gave him 100X return and you passed on it…
DISCLAIMER: This post was written without any discussion with any YC member but only from outside observations as a friend to YC who has studied their growth and ascendance in the entrepreneurial and incubator community. I may be totally wrong in their thinking. If someone from YC reads this and tells me so, I will be happy to edit this post. But readers, please do take this analysis with this in mind.

Working on New Investment Theses

Some of us at Launch Capital have been thinking hard about what areas to invest in next. For me these areas have been:
1. Ecommerce
2. Unsexy offline businesses that get the Internet thrown on top
3. Hardware+Software+Internet
But we are always on the look out for the next new areas. Following this post with my conversation with Mark Suster, Predicting the Future: Research and Thesis Development, we looked around the world and found some possible new areas.
With each of these possible areas, we then thought about:
Where is the real oppty? Is it in a single product? is it in the application of the product or service? Is it in the creation of the product? Is it in raw materials that create the product? is it in a business that faciliates product creation? Is it a financing biz that gives them away for free? Or can you make money on some other related way?
Is there a place where it makes sense for us to play? Do we have or have not expertise in that area? Do we care (see my latest blog post about learning new things: The Jack of Neverending Trades)?
What about valuations? Is that area a place where others have not pushed valuations past where we can participate?
What do others think? My managing director and I talked about this yesterday and he recounted that he found that the best investments are where the herd completely ditched them. I concur – many things we will look at will have the world totally against us. I think this is where the biggest opportunity is, which is to find stuff before others do, make the bet, and hope that we’re right. Also we’re going to be wrong – probably a lot. But this is early stage, the next closest thing to slot machine gambling….and we’re trying to find that magic magnetic ring that pulls all the 7s to come up…
Are there like-minded investors? Should we reach out to them and see where there thoughts are? Try socializing the idea quietly at first. Do people think we’re crazy or think that’s the best idea in the world?
What does the world need to look like in order for this area to start taking off? To become mainstream? Is this achievable? Under what conditions is it achievable? How long would we estimate it will take? Are there any big market forces to watch – ie. any big corporations starting to make noise about it? Any futurists, bloggers, or journalists talking about it? Will the US governmentt pass legislation to juice this area (they have definitely juiced others)?
Are there any like minded entrepeneurs? Can we socialize with them? Figure out what they are working on? Use their creativity to seed ours?
Afterwards, we gather all this information and stew on it. Let our subconscious minds mull over it. Think about it in the shower (where i do my best thinking haha!). Let our creative minds pull together all the elements.
After doing all this, do these new areas still make sense from an investment thesis standpoint? If so, then it’s onwards to quietly watch the world and see if investment opportunities come up. Perhaps we can even seed the market by quietly planting ideas. By socializing the opportunity to both investors and entrepreneurs, is it possible to literally bring the future to life by our own actions?
As an early stage investor, I find that this thesis work is really interesting. Given that we need to invest as early as possible into opportunities and trends, we take the most risk from all avenues. This is why I consider thesis development immensely important for us. By thinking about the future and developing visions for it, it is my belief that thesis development can help tip the odds in our favor that we’ll find wildly successful ventures to invest in. Following the herd can also yield good results, but if I take all the possible variables (ie. our fund mathematics, industry trends, valuation trends, competitive trends, etc.) into account, I can only see that developing theses will make us better and smarter investors than the others who do not.
Two other great recent posts to read on thinking about investment theses and the future:
What I’m Obsessed About At Work by Brad Feld
WIRED: How to Spot the Future

The Jack of Neverending Trades

One of my favorite things about being a startup investor is learning about all sorts of new things. The first is about the investing business itself – I can safely say that I’ve only touched the tip of that iceberg for sure. The second thing I learned was much more broad.
Actually the second “thing” is really “things” plural.
As most people know, I invest typically in all things internet. I am fortunate that I worked at Yahoo! where we worked on a pretty broad swath of things, and I’ve had exposure to a multitude of products and services. As head of user experience and design, I oversaw a lot of it and learned a ton about a lot of things, becoming a jack of all trades of sorts. Even then, there were many things we didn’t do. When I started investing, I found my broad exposure very valuable both to me as an investor, and also helpful to entrepreneurs as I could tell them all the good and dumb things we did at Yahoo! in those industries. But then, the internet filled up with the usual stuff.
Now I’m looking at stuff I know little about, or nothing about!
Some things I’ll never get into – personal resonance is still very relevant and important. For others – there could be something there… it would also mean a lot of effort and time in learning about the business, industry, its customers, everything about it I can. Enough to be an expert maybe, certainly enough to be dangerous!
I get extreme joy when I learn about some area I know nothing about. I look stuff up in books and on the internet, I talk to experts, customers, advisors, and others in the industry. I may even visit places where the product is sold, or where the pain point is felt. My team’s research department pulls up every shred of info on a subject and I devour it all.
Then, this is most exciting to me – making a monetary bet in that area in a company and knowing I made the right call if it exits. Unfortunately, the chance of a successful exit is pretty low at early stage but I am still left the knowledgeable I’ve gained which is satisfying and, I’m sure, will prove useful in the future.
There are many in my field who say to never invest in anything you know nothing about. I would say that is true, except that it leaves out the part about going out and learning about that thing that you knew nothing about. It is disheartening to see that many investors stop learning or become lazy and lean on others’ expertise.
To me, becoming a jack of neverending trades is one of the best things about being a startup investor.

Letting Your Dreams Get the Best of You

If you’re an investor, have you ever gone through this:
You meet an entrepreneur and go over their startup idea. As he’s talking, your mind starts racing ahead and imagining all the wonderful places this startup will grow to be. The entrepreneur continues his demo of the site, faithfully calling out how great his features are, and how the visual design is awesome. But you’re only half listening; your brain is thinking about all the possibilities and how big this is going to get. You voice some of them; the entrepreneur nods and you see his nodding as “Yes I agree with this sage of an investor before me!” He continues onwards with his pitch, noting all the awesome features one by one but you’re still thinking about the $100M opportunity. At the end, he asks for your measly $100K to join him on his journey, him working on his nice product, and you living out your version of his startup along with your awesome vision of where it will go. You sign on the dotted line, transfer the money, and you’re on your way.
As he works on his coding and congratulates himself on his 100th user signup, you start chatting about how he’s going to achieve your ideas and your vision. He nods sometimes, but slowly but surely he starts talking as if he doesn’t have any idea what you’re talking about. He’s got a product to build, dang it! He’s got 100 users who are emailing him and making him think he’s the most awesome guy in the world! He needs to take care of them! You continue to talk about your vision, and he continues to move nowhere near where you’re talking about.
After about a year of this, you realize that the entrepreneur isn’t really listening to you. Instead, he’s been giving you grinfucks; you thought that you were convincing him that there was a better way but in actuality, he’s been thinking that his way was the only way, thank you very much.
In the end, your startup dies a miserable death. The entrepreneur got some awesome lean startup experience, and you (and your buddies too) have wasted $100K. He’s off to raise money on his next big feature for the web, and you’re still not recovered from a year of frustration that someone didn’t listen to your investor awesomeness.
In my early years as an angel investor, I fell into this trap several times. And this trap has many elements to it.
It is sometimes indeed possible that you really do have some investor awesomeness – call it life and work experiences as well as experience in spotting opportunities as an investor in many startups. And sometimes you are probably right in thinking that an entrepreneur should take his startup in some direction or another. The trap you have to watch out for is investing into his startup when you imagine and do not have actual verification that he believes in the vision or direction in the same way you do.
This is not about whether he may be right in the end, or you may be wrong. Or even if the outcome is awesome despite either or both of you being right or wrong. What I’m talking about is thinking you’re investing into a project of a certain nature when it’s actually not – you’re only wishing and imagining it to be something but it wasn’t real.
In many ways, it’s like meeting your perfect significant other, but that perfection is in your mind and you think he/she has the perfect traits for you, but in reality they are someone else and can never be that fantasy significant other for you.
A lot of this is about the fact that it is nearly impossible to transfer your idea to someone else. There can be many reasons for this. You and the other person simply have different viewpoints and experiences. When you say something, they may totally interpret that in a way that you didn’t mean for them to interpret it. Or they may not even know what you’re talking about. If you make a suggestion for a direction, it may be that, given your experiences and skills, you are the only one who can execute that direction and they may not be able to do it at all.
Today I was talking about this very thing with one of my entrepreneurs. Two weeks ago I pushed them on generating a big vision out of what they were working on. We went like this for several days. But they could only come up with something that I considered too likely to produce a small outcome for me to invest in. I sent them an email to that effect and then I went off on vacation.
However, we caught up today after I got back and spoke live about my email. I basically explained to him that I needed to hear that they were on board with some big vision. I had already come up with some possible big vision directions in my mind, but having some experience now I did not imagine them to also have the same visions; I wanted and NEEDED to hear them say it to have confidence that they understood and internalized whatever big vision there was, and were really on board to execute against that, versus what they presented to me two weeks ago. Given my desire for investing in big ideas with world dominating plans, I needed to hear them telling me the plan and not me telling them what the plan was.
To re-emphasize, this is not about who’s right or who’s wrong. It is entirely possible that in my investor awesomeness (in my own mind) that I am totally wrong on whatever vision I am imagining for a startup – and I’ve definitely been wrong many times. It’s all about making sure that you have comfort in whatever you and the entrepreneur can see eye to eye on, or lack thereof, and then making the investment decision based on that reality and not just what’s in your imagination.