1
Dude, no one will ever buy that online. AKA how incumbents get pwned in tech.
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“I’m only looking for billion dollar outcomes.” Why that’s absurd & why it’s not :-/
3
No Thanks, Forbes. The ACTUAL Hottest Chicago Startups
4
A Pre-Seed Primer (if by Primer u mean Rant)
5
The Fallacy of “Smart People”

Dude, no one will ever buy that online. AKA how incumbents get pwned in tech.

I’m blessed to work at Chicago Ventures with some extraordinary people who are continually pushing me to evaluate whether I’m too accepting of the status quo, challenging me to re-imagine the future, and, ultimately, the types of investments we make.

Most recently my colleague Pat Ryan Jr. pointed me to a recent Fred Wilson blog, Don’t Automate, Obliterate, and the corresponding Harvard Business Review article. Tl;dr? Cliff notes are that it’s far more valuable to re-imagine an industry from the ground up rather than trying to build an efficiency focused, automated piece of software on top of it. Two examples: Instead of building call routing and dispatch software for the taxicab industry, re-imagine the taxi industry as P2P ride sharing, a la Uber. Or, instead of building document management software for the legal industry, fundamentally re-consider what the legal world might look like under a crowd-sourced model, for example UpCounsel.

The whole discussion reminded me of a conversation I had with a well known VC about three years ago in NYC. In it, he reminded me that in the early days of e-commerce, shoes were considered an untouchable category – “who would ever buy shoes online? You need to try to them on!” And they remained elusive until Zappos came along and offered a seemingly implausible value prop: what if we were to ship you unlimited shoes for free? Let you keep them for a year to try them out? And then let you return them for free? We all know how that story turned on.

Similarly, he noted at the time, furniture – sofas, mattresses, tables, etc – were one of those categories that hadn’t been cracked by e-commerce. The unit economics made delivery expensive. And, like shoes, consumers wanted to try them on. Is it comfortable? Do the colors match up with room palette? What if, he proposed at the time, a furniture company offered the following value prop: We’ll show up at your home, for free, with ten different sofas of varying feels and colors, let you try them all out for free, and then just keep the one you want and send all the rest back for free?

Compelling. But entirely impractical, if not outright impossible. Right?

Enter Casper.

If you’re not aware of Casper, they’re a web-only millennial focused mattress company promising free delivery within 90 minutes in NYC, a 100-day try out policy, and free-returns (for any reason) if you’re unhappy. Oh, and they’re a fraction of the cost of traditional Serta, Stearns&Foster, Tempurpedic mattresses. Oh, and they come with a 10-year warranty. Oh, and the reviews are off the charts. Oh, and it goes on and on.

Casper actually was an impossibility. Until very recently. Its success is a combination of the availability of low cost on-demand delivery (powered by Zipments no less! [Disclosure: Chicago Ventures is an investor in Zipments]), reduced costs via vertical integration, and innovative customer acquisition channels. Most importantly, Casper is evolving into a lifestyle brand.

Casper exists because its founders elected to challenge incumbent assumptions about what a mattress felt like, how it could be purchased and what it would cost. While their new assumptions were, even recently, implausible, they are now entirely actual.

It is similar to a refrain that famed angel investor Gil Penchina likes to use: “What has fundamentally changed about the world today that enables your business to succeed when all previous attempts have failed?”

As an investor, I am continually scouring the ecosystem for founders who are challenging incumbent assumptions and looking to reimagine industries. Just like it was once considered impossible to disrupt the floral wire services because of their mass marketing spend, David, Farbod & Gregg at Bloomnation challenged that belief by asserting that florists themselves, if empowered with proper tools, could side-step these incumbent middlemen. And they are winning. And florists love them.

Trying to accomplish the impossible can be dangerous – hell, often delusional. But if you’re challenging incumbents because you’ve noticed a shift in the axioms they depend on for success, I’d love to chat.

 

“I’m only looking for billion dollar outcomes.” Why that’s absurd & why it’s not :-/

Mazel tov technology world. Yesterday (March 31st) you minted two new unicorns: Sprinklr & Tanium. The former’s fundraise elicited my favorite tweet of the day:

But in all seriousness, according to the Wall Street Journal, those fundings bring the number of billion dollar companies to eighty.

So why should you, Ms. Aspiring Entrepreneur care?

I hear lots of other VCs say casually or even in direct feedback “I don’t think your company has billion dollar potential.” Personally, I initially thought that benchmark was absurd – even if you accept Peter Thiel’s power law hypothesis that you should only make investments that can return the fund. For a MicroVC such as Chicago Ventures (and there are now more than 200 of us!) investing out of our $40M first fund, if we own 10% of a company that exits for $400M, we return the fund. Own 15% and a sub $300M exit gets us to the promised land. Own even more and you get the idea. Take that you bigtime, arrogant, Midas List VCs…I will darn well invest in $300M companies!

And then we started learning that our mathematics didn’t actually work in practice. The problem is that nearly every company we invest in will require more than our $2-3M of seed capital. As an exercise, let’s assume that Company X, which has the potential to be a healthy $350M company, is growing nicely on a $3M seed round. It wants to tap Series A investors for a $10M round at a $30M pre-money valuation ($40M post). That means Series A investors, under a best case scenario, will see a <9x return on their money.

Series A investors should be thrilled to return 9x their money…right? Not quite. Anecdotally, I’d estimate that most top tier institutional A round investors are still looking for 25-50x upside on their money in an investment. Empirically, let’s return to our exercise. Tier 1 Series A Investor invests $10M at $40Mpost, and voila, Company X kills it and exits for $350M.  Series A investor returns $87.5M which, on a $250M fund, is barely a third of the fund. Oops?

What we’ve proven is that there’s an economic disconnect between Seed investor threshold and Series A investor threshold. If we had more time, we could repeat this exercise for A round to B round, B to C, etc. You’d find the same tension. In fact, if you analyze the above graph, you’ll note that MicroVC funds (sub $50M) have zero minimum returns overlap with Series A funds >$150M. That is what’s powering the disconnect.

So what happens to Company X? Often Company X is actually a really good business – with strong leadership, traction and economics. In those cases, Company X is generally able to tap either lower tier institutional VCs or non-institutional money: corporate (strategic) venture, HNWI, or private family offices. That is OK, conceptually, but it generally doesn’t make CEOs happy and it can be a challenge for us to explain to the investors in our fund as well.

As a friend to entrepreneurs, this setup is frustrating. But it is the reality. If there are any suggestions from the crowd on how to bridge this gap, I’d love to hear how other funds or investors are handling it. One obvious answer: Raise a larger fund so you can support companies through later rounds. As a 3 year old startup ourselves, we don’t quite have the track record to do that yet – but it’s certainly something we’re thinking about.

I broke my rule again and wrote about VC. Oh well :(

Till next time,

Ezra

No Thanks, Forbes. The ACTUAL Hottest Chicago Startups

Look, I’m a huge fan of Forbes. I read Term Sheet religiously. I have friends who work there as journalists. And I think their April 2015 issue feature articles about Benchmark Capital and Chris Sacca are two of the most intriguing VC profiles I’ve read in a while. Flat out they are killing it.

But their take on Chicago’s “Hottest Startups” can at best be described as, well, laughable?

 

 

And from ChicagoInno’s Will & Jim:

While they certainly got some things right, the inclusion of two public companies, Grubhub & Groupon is obviously a miss. It’s not 1999 where you could IPO off a biz plan and some wireframes (I once put $2k into eFax when I was a teen, oops!!). Those companies are 9 years old now. That’s not a startup. And the inclusion of GoHealth? It’s a hell of a biz, but it was founded in 2001. I was 16. 14 year old companies are not startups. I think what much of the media often conflates is the difference between “startup” and “tech company.” Protein Bar is much more of a startup than GoHealth…

So with all that said, here’s my list of Chicago’s Eight Hottest Actual Startups (in no particular order):

  1. Raise.com - Is the fastest growing marketplace for buying/selling unused giftcards. What makes Raise.com special is their mobile focus, enabling consumers to purchase a discounted gift card, on-demand, at a Point of Sale kiosk, to immediately save money on a purchase (above and beyond regular coupons). In the past 24 months, Raise.com has raised $81M in VC funding and now boasts 125 employees.
  2. AvantCredit – The fastest growing full-stack digital lender of consumer loans, Avant was started by Enova Financial (CashnetUSA) founder Al Goldstein. With over $500M in equity and another $500M in debt raised over the past 24 months, the company is now valued above $1 billion.
  3. UpTake.io - Super secretive Uptake was founded less than 18 months ago but has made a significant mark on the Chicago scene, hiring over 100 employees in six months and consuming the bulk of Brad Keywell’s time. Fortune has the only deep scoop to date, revealing among other things that they have a deep partnership with Caterpillar.
  4. Shiftgig - The early leader in people marketplaces for temp or hourly workers, Shiftgig had a tremendous 2014 growing 10x year over year, while its member base eclipsed the 1M verified profiles mark. With a recent $10M announced Series A and over 100 Chicago based employees, the company expects to keep growing into 2015. **Chicago Ventures is an investor in Shiftgig.
  5. Civis Analytics – Founded by former Obama for America techie Dan Wagner and funded by Google Chairman Eric Schmidt, Civis is “building a data driven world.” Although mostly secretive about both their clients and products, they acknowledge working with Boeing, Discovery and the American Red Cross are known to build deep analytics platforms to service both enterprises and non-profits to better understand their customers, strategy and spending.
  6. Signal - Founded in 2009 with well heeled technologists Mike Sands, Mark Kiven and Eric Lunt at the helm, Signal (fka BrightTag) has raised over $50M in VC financing while scaling past 150 employees. Its suite of products enabled brands and agencies to track the offline to online conversion path of customers as well as glean advanced analytics from digital tag management. It may not be sexy but its consistent with strong institutional and corporate investors.
  7. Keeper Security – Despite being entirely under the radar, Keeper is consistently amongst the top grossing apps on iOS month after month for its password manager and digital vault. Having now eclipsed 50 employees (according to LinkedIn), Keeper looks to become the next great bootstrapped Chicago story.
  8. Kapow Events - Barely three years old and already the leading platform for curated corporate events booking, Kapow has made big moves including adding Grubhub co-founder Mike Evans to its board (according to LinkedIn). Despite having started 2014 active only in Chicago, Kapow now services 8 cities with Houston, Philly & DC also listed as Coming Soon. **Chicago Ventures is an investor in Shiftgig.

Close Calls: Mu Sigma (11 years old), kCura (15 years old…sorry half my age is not a startup), ContextMedia (9 years old), TrunkClub (acquired, although still effectively a startup), Sprout Social, SingleHop (9 years old).

Have a suggestion for what I missed? Post it in the comments and I’ll make some changes if people think I’m wrong.

Till next time,

Ezra

 

A Pre-Seed Primer (if by Primer u mean Rant)

In general, I’ve been hesitant to write about VC industry dynamics and instead much prefer to opine on companies, industries, or behavior shifts. I think this is because (a) I simply don’t know how much I can add to the conversation…very few people write about VC nuances well (Semil Shah is one obvious exception). And (b) I find most VC “tips” or whatever to be the lowest common denominator of content. I mean who hasn’t seen infinite articles on how to form a pitch deck or how to find an angel investor. Probably a bit mean spirited but it doesn’t interest me.

But I felt it was worthwhile to make an exception and offer some thoughts on the emergence of pre-seed investing as its vitally important for entrepreneurs to understand.

What is Pre-Seed?

The trend was first written about by Manu Kumar at K9 Ventures in April 2014. In it, he noted:

Seed is not the first round of financing any more. In fact after noticing this trend last year, I have transitioned to calling most of my initial investments “pre-seed” rounds, where the company raises close to $500K, before raising a full seed round. The Seed round is larger — closer to and sometimes upwards of $2M. The Series A is now the fourth round of funding for a company — the first is usually friends and family, or an incubator (~$50K), then pre-seed (~$500K), then seed (~$2M), then Series A (~$6M-$15M).

And the trend is building. Last month, Notation Capital raised an $8M seed fund, noting amongst other observations that “There are so few real VCs willing to invest in pre-growth. They all want to invest in the growth chart.” And yesterday, Charles Hudson, a Partner at SoftTechVC (one of the original MicroVCs) left his post to form his own pre-seed fund, citing a desire to get his hands dirtier at even earlier stage with entrepreneurs.

The Pre-Seed Evolution

This is really the only relevant part of this post (the rest is just my formalized fluff to make myself look smart): High level – the venture landscape has changed and “early stage” or “seed” or “microVC firms” are not going to be the proper source of funding for most entrepreneurs.

This is Chicago Ventures’ evolution as a fund. Chicago Ventures was born in December 2011 (let’s call it 2012) amidst the boom in MicroVC funds, of which there are now more than 200. Many of these funds will fail, but others are building strong networks, brands, and track records. I’d like to think we’re on the right trajectory in those areas, but as you’ll note, the consequence of our success was that as we did our job well, we moved further upstream in the investment stack.

We’re not the only ones. I’d imagine many iterative MicroVCs have experienced similar shifts. A deepening risk aversion is a natural consequence of the current ecosystem dynamics: incrementally more startups, increasingly verticalized target markets, and growing non-institutional early stage capital. Venture Capital is a game of missing information and the current setup provides even very early stage investors with a greater information advantage than ever before: and for us, there’s simply no option but to take it. (Remember, that we have a fiduciary duty to our investors as well). The even better news for MicroVCs is that with a few exceptions, the market is so oversaturated with startups, that even by waiting an additional 9-18 months, our entry valuation (albeit often higher) is still low enough to make fund economics work.

What this means is that many of the outlets that used to provide $250k checks to early stage entrepreneurs no longer exist.

Entrepreneurs need a new option: a firm whose model is based on high variance investments in exchange for increased ownership and lower valuations. These are  the new Super Angels. Funds such as K9 Ventures, Boldstart, Ludlow, and Brooklyn Bridge Ventures are great examples of quality firms filling this gap. Their models are predicated on having the conviction to place bets before larger investors step in.

In my opinion, entrepreneurs reading this at the 2-6 employee stage, with a product only a couple of months old or still in MVP mode, should be approaching these firms first and avoid wasting time with traditional seed VCs. The pre-seed firms are working hard to build strong upstream syndicate networks and if they believe a larger institution could be an appropriate partner, will make the recommendation accordingly.

#Chicagoness

If you’re not from Chitown, you can skip this section. High level – I maintain the highly controversial and unpopular opinion that Chicago has degraded over the past three years from a pre-seed funding perspective. And it is a real crying shame.

That seems like an insane proposition given the explosion in the Chicago tech scene, 1871’s hyper-growth, incubators such as MATTER, and the proliferation of local seed funds: Chicago Ventures, Lightbank, Hyde Park Venture Partners, JUMP Capital, and MATH.

But again, it’s all in how you define “seed.” If you’re a company in market with traction, a relevant team, 18 months of metrics and looking to fundraise $1-3M to step on the gas, Chicago is strong as hell. But if you’re earlier, there’s a gaping hole.

3 years ago, Chicago’s 45 most active angels merged together into a single entity, Firestarter Fund which often serves as a follow-on fund for $750k-2M rounds. The intentions were beyond noble but it had the effect of pushing most of those angels’ money upstream into larger financings. Other angels merged into Corazon Capital – a group I personally believe is phenomenally value additive, hands on, a dream investor – but again, a lot (though not all) of that money is being deployed further upstream.

The flip side is that there is more private Chicago money looking to enter the venture class: real estate professionals, banking, HFT, etc. But this money overwhelmingly does not have experience in helping build or manage early stage startups. Worse, because they are largely not price sensitive, they will inflate entry valuations to the point of being unpalatable for institutional seed VCs once the company hits an early growth curve. This forces those companies to continue tapping non-institutional money ad nauseum.

There may be relief in sight: local pre-seed institutions are emerging. JumpStart Ventures founded by ContextMedia execs Rishi & Shradha have made nearly 20 early stage investments over the past year. Wintrust recently announced a pre-seed equity fund. But there remains a massive hole for local startups at a critical juncture – where they need $250-500k to add a couple team members and experiment in market.

My Feelings

Earlier this week at an event I hosted, a founder who’d just closed her pre-seed round remarked to me how taxing the entire process was. Rolling closes over many months, lots of small checks, etc. She was relieved but visibly exhausted.

That in itself doesn’t bother me. Entrepreneurship isn’t easy – difficulty is simply the reality. One of the variables a firm like Chicago Ventures optimizes for is to spot the survivors: the hunters, the killers – founders with thick skin who can push through rough patches with positivity. What does bother me is that the founder mentioned has effectively no outlets for empathy or professional support. Despite raising capital, she is still largely on her own.

Empathetic support and experience are the roles pre-seed funds can fill. It isn’t charity – these firms should be appropriately compensated for their risk and infrastructure. But it’s hard to build healthy, balanced entrepreneurs and startups if there aren’t healthy, balanced institutions supporting them.

Till next time,

Ezra

The Fallacy of “Smart People”

Yesterday’s primary Twitterati discussion centered around Henry Blodget’s thought provoking piece DEAR SILICON VALLEY, Here’s Your Wakeup Call. In it, he bemoans the lack of responsible, diligent analysis amongst some of today’s leading VCs, and their unbridled, unchecked optimism.

Some were quick to malign Blodget for his representation of all Silicon Valley through the lens of a single (or a couple of investors). But I actually tend to agree with Blodget’s unspoken, yet underlying point: that as the tech world has had a strong ten year run on the backs of a white hot NASDAQ, the new generation of tech VCs have achieved something of a cult, unbounded status (at least amongst my peers).

What do I mean by this? On a couple of recent occasions, take Jet.com’s recent $140M raise pre-product as an example, I’ve responded to the question of “what do you think of that?” with one of my go-to responses: “It feels off to me, but there are a lot of smart people around the table, so I must be missing something.”

But this is a fallacy. Smart people do dumb things. Especially when driven by ego, fear, exhaustion or pressure. All realities of the current venture climate. I don’t think outsiders recognize how competitive the current state of the venture world is. No one, absolutely no one, not even demi-gods like Marc Andreessen are exempt from the strain.

As an aside, if you looked up my bio on paper, I’d probably make the (reasonably) “smart person” category. I went to NYU undergrad, and fortuitously managed to pull down an MBA from The University of Chicago. But even within the context of good choices, I’ve made extremely poor micro-decisions. Two examples:

1. Good Choice: Getting nearly six figures into the middle of the pot way back in 2007 holding two pair versus a naked flash draw.

Bad Micro-Decision: Not asking to run it twice to hedge variance.

Result: Bye bye college tuition. (Bad side of variance)

2. Good Choice: Asking a girl at the bar, now wife, on a date.

Bad Micro-Decision: Playing with fire for years, not fully committing, leaving optionality open.

Result: She waited – now happily married. (Good side of variance)

I suspect that the overwhelming majority of the tech investors, entrepreneurs, and evangelists that I, my peers, the press, etc, look up to are actually quite brilliant.

But it doesn’t prevent them from making poor micro-decisions, even within the context (or guise) of good choices.

I will continue to spend time working to understand the rationale behind any given investment or choice when “smart people” are involved. Yet, confusingly, within flawed reasoning there may exist many pieces of correct and insightful logic. That’s always the mystery.

So thanks to Henry Blodget for reminding me to more diligent, even when otherwise smart people are involved.

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