Persistence in Venture Capital Returns (Research + Thoughts)

Interesting NBER working paper on persistence in venture capital returns over time

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3226837

From the abstract:

We use investment-level data to study performance persistence in venture capital (VC). Consistent with prior studies, we find that each additional IPO among a VC firm’s first ten investments predicts as much as an 8% higher IPO rate on its subsequent investments, though this effect erodes with time. In exploring its sources, we document several additional facts: successful outcomes stem in large part from investing in the right places at the right times; VC firms do not persist in their ability to choose the right places and times to invest; but early success does lead to investing in later rounds and in larger syndicates. This pattern of results seems most consistent with the idea that initial success improves access to deal flow. That preferential access raises the quality of subsequent investments, perpetuating performance differences in initial investments.

It is interesting to read their analysis with the context of an earlier paper titled “Is a VC Partnership Greater than the Sum of its Partners?”

https://www.nber.org/papers/w19120

From the abstract:

This paper investigates whether individual venture capitalists have repeatable investment skill and to what extent their skill is impacted by the VC firm where they work. We examine a unique dataset that tracks the performance of individual venture capitalists’ investments across time and as they move between firms. We find evidence of skill and exit style differences even among venture partners investing at the same VC firm at the same time. Furthermore, our estimates suggest the partner’s human capital is two to five times more important than the VC firm’s organizational capital in explaining performance.

If you agree with the conclusion of the second paper (which is that VC returns are driven by individual partners not firms) – the first paper’s conclusions make sense – there is a short-term advantage to a firm by having a particular manager as part of the firm – but when that individual partner leaves – the skill + value leaves with them.

In general, I think this is true of traditional venture capital – but I think two sets of activities that are more natural to emerging firms may start to change this for them

1.

Focus on Firm Brand versus Partner Brand

Many traditional venture capital firms have had a focus on individual partners and their performance versus the firm’s performance.

This could lead to better deal flow for the individual (as well as better access to cheaper capital to downstream capital for his or her investment portfolio) – but the performance of a particular portfolio company is attributed to an individual versus the broader team or firm brand.

Examples of how this manifests is inclusion of investments by partner on a firm’s website or the annual enthusiasm around the Midas List.  (There are definitely counter examples to this – one example being Benchmark Capital)

In the emerging groups, such as Y-Combinator and Indie Bio – I think this is one of the most powerful parts of their model. Companies are highly associated with the investment firm – not an individual partner – and the downstream effect is that the firm gets to keep the “equity” value of its investments versus attribution being given to an individual partner

For YC – this is how they showcase their best performing portfolio companies (which includes only batch information – no information on who worked with any specific team)

https://www.ycombinator.com/topcompanies/

Similarly – Indie Bio (as an example of a vertical within SOSV) has done an amazing job positioning itself as the first call for the best scientists who want to become entrepreneurs and building a system that can screen thousands of companies to end up with 14 or 15 per batch

Having invested in a small fund by SOSV to invest in every company in Batch 2 and Batch 3 – we have been fortunate to have a close relationship with their team and have been able to watch watch how their brand has driven amazing top of the funnel demand (thousands of applications per batch) while the number of companies they select has remained the same (and has increased the quality of each batch over time)

For both YC + Indie Bio – they have built firm brands that will last beyond their individual team members and portfolio company outcomes will have a positive effect on sourcing of future opportunities and will enable existing + future portfolio companies to access more + cheaper capital

2.

Network Effects

The ability to cross pollinate learnings from within a portfolio is powerful – but requires a culture of trust (and probably non-attribution of individual partner performance) to work

For True – we saw this in our consumer hardware portfolio – where our early investment in Fitbit led to a number of other consumer hardware investments.

Initially, we were one of the few seed investors in the space – but as the market matured – the ability to access other Founders or teams who had scaled or faced similar challenges was a powerful tool in being able to win investments with the best new companies.

Some of this we did in formal events – but the goal was to get out of the way and normalize cross company collaboration within the portfolio – initially at the Founder level, but over time – we’ve seen it within functional senior leadership groups (ie in marketing, product, or engineering)

These are some of the events we hosted to start the conversation in specific markets – but we’ve seen this flywheel work in other markets including CPG, Computational Biology, Open Source Software, Insurance, Cryptocurrencies, and more.

https://trueventures.com/true-atoms/

https://trueventures.com/true-healthcare/

https://trueventures.com/true-infrastructure-summit-2015-wrap-up/

 

As a specific example of how this can work in the portfolio, the initial Ring Video Doorbell used the same Wifi Chip as the Fitbit Aria scale.

During our investment process with Ring, the Fitbit team shared what they had learned about the wifi chip + helped work with the Ring team to use those learnings to help them best place the chip in the device.

This knowledge sharing helped our firm win the investment and then ultimately drove better performance of the company (and the on going relationship between the companies ultimately helped as technical learnings could flow back + forth between their groups)

First Round Capital + other firms have other programs that look to drive similar coordination – and I think the firms that do this well – will be stronger and ultimately have more predictable outsized returns over time.

New Investment Checklist (2017)

Below is my current working pre-new investment checklist.

Most of these questions are answered early through conversations with the Founder or others at the company – so this is mainly a final reminder of what qualities I’ve found to be important in potential investments over my time at True (either through others or learning directly the hard way)

Would love any feedback on any potential new qualities to add (or questions about attributes on the list that you’d disagree with)

New Investment Check List

Founder Questions:

1. Who is the main protagonist Founder that you’re backing?

a. Are there any potential trust issues?
b. Would you want to work with this person for the next 12+ years?
c. How do they treat other individuals? (Lawyers, employees, etc)
d. Do they have the ability to be a long-term leader for the company?

2. What do they understand about the market that other don’t?

a. What experience led to that unique insight?
b. Why would others think they’re wrong?

3. Do they have the ability to recruit great talent?

a. Who are their co-Founders and how is equity split?
b. Who are early advisors and why are they excited?
c. Can they identity the people they will hire for their first 10 roles?

Business Questions:

1. Does the company’s mission matter?

a. Will you be proud to talk about this investment?
b. Can it inspire employees, future investors, etc

2. What is the company’s long-term sustainable competitive advantage?

a. Network effects are ideal
b. Are there features that increase customer lock-in or switching costs?
c. Is this a company that could exist for 100+ years?

3. Are you swimming with the tide long-term?

a. What are the major macro market forces in your favor?

4. Why is this possible now?

a. Why would have previous attempts failed?
b. Either technology or capital efficiency story
c. Why would others say this business won’t work now?

5. Is there significant innovation around product?

a. 10x better than alternative products
b. Are there any alternatives that could be indirect competitors?

6. How often do customers interact with the product?

a. Ideally more than once per day

7. What is the quality of the company’s future revenue?

a. Visibility or predictability of revenue matter
b. Recurring or Re-occuring revenue is ideal
c. Arbitrage doesn’t usually lead to long-term enterprise value
d. Any customer concentration issues?
e. Any partner dependencies?

8. Is there a path to $100m in Annual Revenue? $1 Billion in Annual Revenue?

a. At scale, what is the customer + margin profile of the business?
b. What is the profile + challenges of similar businesses at scale?

9. Is there significant innovation around early go-to market strategy?

a. Organic marketing is best
b. Are there channels to effectively reach your target customers at scale?

10. How much equity capital is required to scale the business?

a. Are there alternatives financing sources if more capital intensive?
b. Can you make money as a seed investor?

Most Important Question:

1. If you could only make one investment this year, would this be it?

Crypto Asset Analysis + Seed Investments

Presentation from our Annual Team Offsite at Stinson Beach in July 2017 included below.

This shares some of our internal discussions on how we’re starting to think about evaluating new types of crypto projects + assets.

As an active investor in startups built around open source software, we’re increasingly excited about new + interesting business models to support community activity and have been participating in the cryptocurrency space since WordPress.com started accepting Bitcoin in November 2012.

As a firm focused on pre-seed and seed investing, we believe there will continue to be opportunities for venture capital firms to invest the initial startup capital into new crypto projects (as part of an initial equity financing or as part of an agreement in exchange for future protocol tokens.)

We’re interested in potential opportunities in:

  • Decentralized applications (ie projects like FunFair for Decentralized Gaming)
  • Enabling infrastructure (ie projects like 0x (Decentralized for Trading Tokens) or zCash (Blockchain + technology focused on privacy + selective transparency)

In particular, in potential crypto investments we’re looking for:

  1. Applications that truly need to be distributed (“Need to be built on a blockchain”)
  2. Solid technical team (with expertise across Internet infrastructure and crypto)
  3. Utilization Token tied to business model
  4. Potential for Strong Network Effects

If you think you’d be a fit with our portfolio based on the above information, please reach out – it’d be great to learn more.

True Science Investments

Presentation from our Annual Team Offsite at Stinson Beach in July 2017 included below.

This shares some of the lessons from our investments involving life sciences (starting with Ginger.io in 2011 + Moleculo in 2012) as well as some of the evaluation criteria we think about for potential future opportunities.

As a firm, our focus is leading the first institutional round (usually pre-seed or seed) with investments of $500k to $3m. We often invest with angels and love research work coming out of universities or other labs.

For companies based in core science or research – we like to see:

  1. Great science with large potential impact
    1. Therapeutic applications in healthcare
    2. Other non-healthcare applications with high margin potential
  2. Founder is a leader in the space
    1. Ability to develop cornerstone IP + reputation in the space
    2. Multi discipline teams; cross discipline individual expertise
  3. Path to efficacy (or similar metric) on less than $10m of paid in capital
  4. Market size + Product + New Type of Regulatory Risk
  5. Platform opportunity with large market potential
    1. Ability to build defensible data moat is key
    2. More data makes technology better; increases enterprise value

If you think you’d be a fit with our portfolio based on the above information, please reach out – it’d be great to learn more.

Markets and People (or Thoughts on Venture Investing)

I’ve been thinking about this passage from an article about Sequoia’s Michael Moritz recently:

“Moritz waxed philosophical by comparing venture capital investing to bird spotting. “I rarely think about big themes. The business is like bird spotting. I don’t try to pick out the flock. Each one is different and I try to find an interestingly complected bird in a flock rather than try to make an observation about an entire flock.” For that reason, while other firms may avoid companies because they perceive a certain investment sector as being overplayed or already mature, Moritz said Sequoia is “careful not to redline neighborhoods”.

Continuing with the ornithological analogy, Moritz pointed to Cisco and said, “There’s a lot to be said for investing in the ugly duckling.” When Don Valentine led Sequoia Capital’s investment in Cisco, many others had passed on the husband and wife founding team of Len Bosack and Sandy Lerner.

At its core, venture investing is a job that can be broken down into people (execution) and markets.

Continue reading Markets and People (or Thoughts on Venture Investing)

The Challenge of Real World Interactions (Or Why Consumer Hardware Startups are Hard)

After CES, I wrote a post discussing what we look for when evaluating investments in consumer hardware products.

Since then, I’ve been involved in a series of conversations with investors, Founders, and partners of consumer hardware companies – both small, medium, and at scale.

As an increasing number of factors have brought down costs of starting these companies, there has been a growing meme around the how “easy” building a consumer hardware businesses has become – which any Founder of a scaling consumer hardware company would tell you in simply untrue. (You can see our opinion on it here and here.)

Continue reading The Challenge of Real World Interactions (Or Why Consumer Hardware Startups are Hard)

Working with Atoms: 5 Lessons for Building a Hardware Startup

In 2011, I attended my first Consumer Electronics Show in Las Vegas. While there were a handful of startups scattered throughout the main expo floor, including True-backed Valencell and Makerbot, the majority of companies in attendance were the traditional consumer electronics manufacturers that have ruled the shelves of Best Buy for the past few decades.

After missing CES in 2013 and 2014, I arrived this year expecting to see a similar mix of companies. However, I was thoroughly blown away to see the entire Sands Expo Hall filled with small, emerging consumer electronics businesses—hundreds (if not thousands) of new companies across a variety of brand new categories, including smart homes, digital health and “maker” products. And this didn’t even include the drones and other new technology areas in the main expo hall.

CES2

For a market that was dead before 2008, connected devices are back in a big way and are seeing more innovation (and funding) than ever.

At True, we’ve been fortunate to invest in more than 15 new startups selling physical products, including 3D Robotics, Makerbot and Ring. We even hosted an event last year called “True Atoms,” bringing together the best Founders and executives from across the lean hardware ecosystem to share best practices and learn from one another.

And while many trends, including decreased component costs, increased access to smaller-run manufacturing and the growth of cellphones, have made it easier than ever to launch a connected-device company, the challenges of scaling remain incredibly complex.

We previously wrote a blog post talking about hardware companies as “the double black diamond” of startups. One year later, I wanted to share some more thoughts and ideas about what we look for in new opportunities in connected hardware.

Continue reading Working with Atoms: 5 Lessons for Building a Hardware Startup

Sharing Notes on Bitcoin and the Crypto Currency Market

Though we haven’t invested in the space yet, we’ve been actively tracking Bitcoin (and the broader crypto currency market) since late 2012 when Automattic (on WordPress.com) became one of the first large merchants to accept bitcoin and kicked off an internal discussion on the technology.

Below I’ve included our first market landscape document (which was written in the beginning of 2013) and an update written earlier this year (2014)

If you’re interested in the space, would love any feedback on our thesis below or to chat about what you’re working on.

Continue reading Sharing Notes on Bitcoin and the Crypto Currency Market

Fundraising Tips: Power of Story and Context

On Tuesday, the True team spent the afternoon at the World’s Largest Office Hours, part of the National Venture Capital Association’s VentureScape annual conference. The goal of these office hours was to bring hundreds of venture capitalists and entrepreneurs together in one room for an afternoon of networking, mentoring and idea exchange. As a member of the NVCA and supporters of innovation and entrepreneurship in general, we were extremely happy to participate.

Our team had a series of six meetings with Founders of companies who were seeking our feedback and advice on their business and pitch. As we worked through each session, we began to see a pattern emerging. Specifically, within the first minute of sitting down, the Founder would launch directly into describing the product or show a demo of the product.

In each case, we would slow the Founder down and ask a series of questions designed to provide background and context to the broader story.

Continue reading Fundraising Tips: Power of Story and Context

Themes to Watch in 2014

Written for Eric Jackson’s Predictions Post for Forbes, some themes to watch in 2014:

The Rise of Citizen Science

Humans have long participated in scientific research, but Moore’s Law and Open Source Communities have given individuals inexpensive access to powerful research tools for the first time.  Similar to other industries, when the cost of experimentation approaches zero, you spur individual creativity and open up whole new areas of opportunity.  Early success stories include Foldit, Galaxy Zoo, Phylo, and Zooniverse but companies like OpenROV and 3D Robotics or projects like HiveBio in Seattle show what could be possible in the short-term.

Commercial Open Source Grows Up

Open Source Software has come a far way from its roots with Richard Stallman and the Free Software Movement in 1983.  Individuals have long understood the technical merits and starting with the Open Sourcing of Netscape’s Browser in 1998, corporations have been opening up to the strategic and business value of Open Source too.  Over the past decade, we’ve watched more and more individuals build sustainable businesses around open source projects – early examples include Automattic, SugarCRM, Cloudera, Mulesoft, and Puppet Labs – and next year we’ll start to see more of them maturing into large independent enterprises.

Human DNA as Code

This is the opportunity created by a software-first approach to solving problems in human biology and patient care driven by the explosion of available medical data (through EMRs) and molecular data (through the rapidly declining costs of full genome sequencing and other tests.)  The market is lipe for rethinking as data finally comes online in a readable and maluable format.  Companies to watch include Moleculo, Counsyl, Ginger.io, and Practice Fusion.