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1
Looking Out Towards 2017
2
Why the Micro-VC Surge Will Drive Innovation Across the US
3
Trump’s Rust Belt and the Hoofbeats of Technology
4
The First Time Founder Discount
5
How Slack and Facebook Are Making Access to Information Less Democratic

Looking Out Towards 2017

2016 was a good but challenging year for me. It was a year in which I watched family members battle serious health issues, a year where I allowed myself to become distracted and reactive at home and at work, and one where my professional insecurities often got the better of me. But, like most challenges, they make us stronger and I’m extremely confident heading into 2017.

Numerous investors have announced their predictions for 2017, notably Fred Wilson, Sam Gerstenzang, Rob Go, Glenn Solomon, among others. I’m not smart enough to play that game, but I did want to use my blog to both formalize for myself, and publicize to others, my focus in 2017.

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2017 Operations

The biggest mistakes I made in 2016 were not taking enough time for myself and allowing myself to become deeply reactive. There is no worse curse in venture than to be a reactive player; it is fundamentally impossible to be extraordinary if your days are prescribed by others.

Deeper, not taking enough time for oneself is a function of being overly reactive. When you allow your schedule to be determined by others, you are in effect conceding that your own thoughts, imagination, brainstorming, headspace are secondary. I don’t believe this to be true.

My 2017 is going to look different than 2016. I believe I am at the point in my career where I can de-prioritize my fears of missing great deals and instead focus on finding the right ones. To that end, I am going to take many fewer inbound meetings in 2017 and instead build a strong pipeline of outbound ones. I am going to chase relationships that I am passionate about, rather than the ones that are convenient or obvious.

I am going to spend less time on e-mail and more time learning, discussing and engaging. One thing I’ve done poorly in my venture career is not go deep enough into the weeds with entrepreneurs. As a writer, I am extremely enamored with stories and storytelling. The benefit of this is that it enables me to quickly parse out big, category defining ideas and hone in on them. The detriment is that I frequently focus too heavily on the vision and ignore the implausibilities and difficulties underlying the story.

2017 Investment Thoughts (not Theses)

Before getting into specifics, I think that 2017 is the year that many investors realize they need to begin learning new industries. Pure play mobile has hit crescendo and SaaS is so mature that we’re now funding SaaS to manage SaaS. In late 2012/early 2013 I decided I would learn everything I could about bitcoin. I mostly didn’t take a meeting for six weeks, but emerged from my cave slightly bearded, had taught myself to mine Bitcoin (and many alts), knew all the big personalities on Bitcointalk and became well written on the industry.

In 2017, I expect to do that again, hopefully twice, if I get my way in genomics and urbanization.

Here are some other areas I have opinions on:

  • Fintech: Over the past several years I’ve spent my energy becoming well versed in many disciplines of consumer internet from e-commerce to retail to marketplaces to bitcoin. For 2016 I put my mind to getting smart on the fintech sector – both consumer and enterprise facing – and we made two related investments over the course of the year: M1Finance and Sunbit.

I had de-prioritized fintech opportunities in 2015, believing that we were a relative late mover to the market and that many of the early winners from Lending Club to Avant to Wealthfront had strong platforms and balance sheets from which to move horizontally away from their core products into adjacent markets. Then, in early 2016 LendingClub experienced a fall from grace, it’s CEO stepped down, and the entire sector hunkered down into crisis mode. I love, love markets in chaos. The chaos reignited my interest in fintech – I was convinced there would be extraordinary opportunities overlooked as investors felt over-exposed. But what I learned in 2016 was that fintech, broadly, remains one of the largest disruptive opportunities of my generation, and I plan to hunt actively for winners in 2017.

  • E-Commerce: As a consumer, I love e-commerce. I love Amazon Prime. I love discovering new millennial brands from Everlane to Allbirds. And yet, over the course of 2016, albeit it kicking and screaming, I was forced to concede that – as one of my business school Professors taught me – “the internet… is a crappy place to have a store.”

The struggle with that statement is that the internet, in many cases, is actually a phenomenal place to acquire and retain customers. But many of the other capex costs can be prohibitive.

In 2017 I am likely to take a material step back from traditional commerce and d2c brand related opportunities while keeping an eye out for the rare few that are fundamentally recasting cost structures and/or reducing consumer friction by a factor of 10.

  • Crypto: This is arguably fintech, but in my opinion, the next generation of distributed applications – although tokenized – are often only tangentially related to anything financial. I continue to believe that distributed applications, most commonly “altcoins” represent an extraordinary opportunity. And while investing in crypto tokens is not something we have license to do at Chicago Ventures, it’s an area where I plan to spend much of my personal free attention and time (and would gladly meet any entrepreneurs building next gen distributed apps).
  • Reimagination of Cities: I spent much of 2015/2016 focused on the future of the home, reflected both in my piece Furnageddon – about how the furniture we live on is changing – and in our investment in Havenly. But as I dived deeper into urban living, meeting with several companies re-conceptualizing the types of spaces we live in, I began recognizing that technology is fundamentally changing the ways we act in our urban areas as well as their associated suburbs.

I saw a nice interview in Techcrunch with Niko Bonatsos at General Catalyst who had a similar observation, in Investing in the future of urbanization. The 2016 election reminded us that the country is a very diverse place, often with misunderstood needs and incentives. It will be a large focus of mine going into 2017.

In 2016, we invested in Predata believing that geo-political instability was increasingly impacting the bottom of lines of many large institutions, from traditional corporates to finance houses. From my vantage point, I believe that consumers also want to increasing manage the perceived risks in their lives. One example of this from 2016 is a company called Point that allows consumers to hedge their investment in their homes by pulling 10% of the value out for liquidity, with no monthly payments. One of my professors Toby Moskowitz once said to me in business school, that “buying insurance is a poor financial decision, but we all purchase it because it’s fantastic from a covariance perspective.” I’ve long felt that should yield some interesting technology driven opportunities.

  • Betting Markets: Many of you know that my background is in the poker industry, initially as a professional and later as an operator. Online poker is probably a $5-10B market, but is contracting slightly year over year. Similarly, daily fantasy sports started 2016 as an exceptionally hot space, but it turns out it wasn’t a fundamentally great business model (see my article: “Game Over: Why Daily Fantasy Has Already Been Won.”)

 Although DFS is unlikely to become the $100B industry that was predicted, betting markets are still amongst the most exciting markets to observe once they become liquid. Heck, the equity futures market is effectively the world’s largest betting market. I continue to believe eSports has an intriguing market in p2p betting and made an investment in multi-table gaming tournaments via Gunslinger.

Some other angles on p2p betting networks such as Quantopian/Quantiacs really excite me as does Numerai. There are also a lot of other areas of illiquidity that make really intriguing liquid markets – from owned assets to information. If you’re building anything in this area, I would love to chat.

I hope that’s helpful and wish everyone a happy and successful 2017. Thanks for reading.

Why the Micro-VC Surge Will Drive Innovation Across the US

The following was co-authored by Ezra Galston of Chicago Ventures(@ezramogee) and Samir Kaji (@samirkaji) of First Republic Bank.

Over the last several years much has been made of the opportunity, or perceived lack thereof in technology centers outside of the Bay Area and NYC. From Steve Case’s Rise of The Rest Tour, to Google for Entrepreneurs, to Brad Feld’s Building an Entrepreneurial Ecosystem , the discussion has consistently been overwhelmingly positive.

It’s easy to understand the stance as who wouldn’t want to support entrepreneurship, irrespective of geography? However, it’s hard to discern whether these opinions were borne out of a utopian desire or a sincere belief of true financial viability in markets outside of NYC and the Bay Area.

In Fred Wilson’s widely discussed (and debated) piece “Second and Third Tier Markets and Beyond,” he suggested that the opportunity outside of the Bay Area was significant, citing the successes of USV in New York, Upfront Ventures in LA and Foundry Group in Boulder:

“The truth is you can build a startup in almost any city in the US today. But it is harder. Harder to build the team. Harder to get customers. Harder to get attention. And harder to raise capital. Which is a huge opportunity for VCs who are willing to get on planes or cars and get to these places.

There is a supremacism that exists in the first and second tiers of the startup world. I find it annoying and always have. So waking up in a place like Nashville feels really good to me. It is a reminder that entrepreneurs exist everywhere and that is a wonderful thing.”

In an effort to move past anecdotes however, we wanted to explore one of the components that helps drive and catalyze early entrepreneurial activity in any localized geography — the availability of early stage funding.

Simply put, non-core US tech hubs are reliant on local early stage capital to subsist since seed stage fund sizes often make remote investing impractical (by contrast growth stage investors who manage large funds and have significant resources can easily invest in breakout companies outside their region).

With the hypothesis that quality local seed capital is needed to foster a strong entrepreneurial ecosystem, our analysis is centered on whether the MicroVC surge, has provided (or may provide) a material impact to these “2nd and 3rd” tier US geographies.

Fortunately, there’s good news for entrepreneurs everywhere. Of all of the Micro-VC funds raised since 2010 (this number includes firms currently raising funds), over 40% of Micro-VC’s formed were based outside of the country’s largest tech centers of SF, LA, NYC and Boston, a number we found quite surprising.

In total, those Micro-VC funds raised outside of the four core tech centers since 2010 represent $6.7B in investable capital, the vast majority of which have driven significant investment dollars in their geographies.

More important to note is that the opportunity in these secondary ecosystems is unequivocally noteworthy. Using M&A activity as an evaluation metric, these ecosystems, despite a relative dearth of funding, have performed quite well:

In each year dating back to 2010, the percentage of Micro-VC funds raised outside of SF, LA, NYC and Boston materially lags the volume of M&A activity, on % basis, in those same areas. This suggest that Micro-VC funds located in secondary markets face less competition — and proportionally more opportunity — for strong financial outcomes by betting on that delta. Now, it’s true that these opportunities are a bit geographically dispersed, however it’s clear that certain cities (Seattle, Boulder, Austin, Salt Lake, Chicago) have made great strides in developing great entrepreneurial talent.

This dislocation in M&A proportionality is of course amplified by the concentration of funds in the Bay Area and NYC. Because coastal deals are more competitive due to an oversupply of capital, they boast higher entry prices (valuations) than do deals in secondary or third tier markets — and the effect on a returns basis may also be material. Case in point: according to Angelist, the mean valuation for deals in Silicon Valley since 2010 is $5.1M. That compares to $4.5M in Chicago, $4M in Indianapolis, and $3.7M in Detroit — offering Midwest investors anywhere from a 10–30% discount at entry.

There are other ways of interpreting the data. One could argue that Bay Area deals deserve to be higher priced due to a premium in the quality of founding teams. Or that the pure volume of M&A in the Bay Area and Boston de-risk the level of returns variance for any particular fund. Those arguments may be with merit but are also balanced by data released by Pitchbook that show cities such as Chicago, Seattle and Washington D.C effectively comparable on a multiple of returns basis:

It is nearly indisputable that large technology companies are being built and enormous value is being created outside of the coastal venture markets: examples include Grubhub, Groupon, Domo, Qualtrics, ExactTarget and HomeAway. But these markets will require more patience for company maturity, a willingness by fund Limited Partners to accept greater short-term volatility, and conviction that key talent will stay in non-core markets due to a desire of staying local and the avoidance of the high cost of living present in the major US tech centers.

While the rhetoric around non-core markets has been historically positive, it appears that the early stage capital surge through Micro-VC funds may be a major factor in these areas actualizing on their potential.

Extra special thanks to Peter Christman for his tireless work in helping to analyze, aggregate and process the data underlying this article.

Trump’s Rust Belt and the Hoofbeats of Technology

I am permitting myself one political/policy related post on this blog. I can’t help it. I am child of the beltway: my father served in the Clinton White House and I spent my early years on the floor of the West Wing doing 3rd grade homework. This piece takes no sides. It merely offers observations based on my perch in the Midwest.

President-elect Donald Trump’s historic path to victory was driven by a wave of discontent amongst the Rust Belt’s working class – and specifically by unexpected victories in Ohio, Pennsylvania, Michigan and Wisconsin. It’s a demographic that has experienced thirty years of economic stagnation – median family net worth in these areas in unchanged since 1996, materially lagging the effects of inflation – and many of its previously stable jobs have moved overseas.

The Rust Belt is an area of the country that I’ve spent much of the past decade focused on. I moved to Illinois from New York City in 2007 to help build a startup technology company. And over the past five years, we, at Chicago Ventures, have raised over $100M to invest in technology startups in the central region. Spanning dozens of investments, the firms we’ve backed now employ several thousand individuals and collectively generate hundreds of millions of dollars in revenue. Our efforts follow a broader trend: in 2016 alone, nearly $1B was raised by venture capital funds with a mandated focus on the Midwest and central regions. In 2015, $2.9B of venture capital dollars were deployed into Midwestern companies, a 50% boost from 2010’s $1.9B tally.

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But these efforts are largely irrelevant to Trump’s disaffected base. The areas that have most benefitted from the growth in the technology sector since 2010 are metropolitan cities such as Chicago – 40,000 new jobs, the Twin Cities with 10,000 new technology jobs, even Columbus and Madison. These cities – by nearly every economic and educational metric – are dislocated from their rural surroundings which offer a dearth of high tech jobs.

It gets worse. A Trump White House might well aim to stem blue collar job losses via anti-trade policies, but it will nevertheless face extraordinarily strong headwinds. Software – which Marc Andresseen presciently noted in 2011 – is undeniably “eating the world.” Just last month, Otto – which Uber acquired for $680M earlier in the year – completed its inaugural autonomous trucking delivery. Trucking, with a mean starting salary of $51,000 according to Indeed, employs 3.5 million drivers across the country and is the most common job in nearly every state Trump carried, according to 2015 Census Bureau data. Progress in artificial intelligence and robotics is already threatening tens of millions of additional service level jobs from customer service to nursing, and is even encroaching on white collar industries such as CPAs, financial advisors, even optometrists. The effect on the Rust Belt could be devastating.

New jobs are likely to be created to service growth in emerging technology industries. But they, like many of the 5.8M jobs already open (and unfilled) according to the Labor Department, are also likely to demand highly skilled professionals and skew towards urban areas.

Still, having invested throughout the central region for the past five years, I do believe there is room for optimism. First, the Midwest is home to many of the premier universities and computer science programs in the country. Michigan’s “No Worker Left Behind” experiment, which lasted three years and culminated in 2010, may provide a key. The act, which opened up all of the State’s universities to low income or laid-off workers, retrained 100,000 individuals over that period. According to a 2013 study of 4,500 of its participants, 55% attributed success in obtaining a new job to the program while 58% said they found it helpful in performing their jobs. Moreover, according to former Michigan Governor Jennifer Granholm, the program offered many of the state’s most displaced workers a second chance at “dignity” – which has been an increasing focus of the post-election discussion.

Second, many Midwestern states offer Angel Investment Tax Credits designed to spur innovation and increase jobs in high growth startups. However, these tax credits often make little distinction between investing in distressed versus non-distressed areas, with the effect that the overwhelming majority of rebates stay in existing technology centers. I have watched firsthand as the majority of these credits have supported businesses that would otherwise still have been funded and provided rebates to institutional investors who were largely agnostic. States must work to re-think these programs to stimulate technology development specifically in distressed areas.

Third, and most importantly, more school districts – especially those in rural areas – should follow Chicago’s lead in making computer science education mandatory. A 2015 Gallup/Google poll found that 90% of parents view computer science education as a good use of school resources and 67% want it to be mandatory. CS education is about more than web development jobs – it will provide improved literacy as the digital age spurs a more technology driven, rather than asset driven, economy. This effort, like the others, has the added bonus of improving the dignity and self-confidence of our valuable working class.

Pundits have defined the election as a referendum on the status quo; but the status quo was already in grave jeopardy. This election, globalization took the blame – but in 2020, it may well be technology and automation.

The First Time Founder Discount

Venture is a cyclical business. But in spite of dire bubble warnings, recent unicorn implosions, and a February 2016 nosedive in public SaaS valuations, the NASDAQ has now been on fire for nearly the past decade. In layman’s term, we’ve been on a (only slightly variable) linear up and to the right curve since 2009.

That is contradistinction to the dot com boom of the late 90s which effectively lasted less than five years, from mid 1995 through NASDAQ’s peak in March 2000 – and, more importantly – was quickly followed by a deep recession which lasted for much of the early 2000s.

The effect of this extended period of abundance is a duration long enough for thousands of entrepreneurs to have raised venture money, struggled, solved, raised more money and exited materially (or failed, and, learned something).

As early stage investors, these founders (repeat founders, serial founders, successful founders, what have you) have become increasingly attractive to invest in because they frequently come with the ability to hire and scale up quickly as well as avoid many of the timely mistakes early in a company’s life that can eat up valuable seed stage dollars. Consider this the venture equivalent of a flight to safety, in an otherwise chaotic, early stage market.

The consequence of this flight to safety is that the early stage valuations of first institutional rounds for repeat founders have ballooned and round sizes have increased accordingly. I took a look at the past 24 months of investment data at Chicago Ventures to break out post-money valuation* and round size dependent on founder profile (n=30):

the-first-time-founder-discount

The highlights are that successful repeat entrepreneurs are raising rounds out of the gate nearly double the size of first time founders ($5.65M versus $2.85M, respectively). Anecdotally, the delta may actually be fundamentally wider as we’ve invested in repeat entrepreneurs far earlier in the go to market cycle (often, even pre-launch) than with first time founders (who typically have significant traction).

The effect of this is that first time founders need to thread often competitive markets on limited resources, and then, even with “traction,” will be blessed with only half the resources of more accomplished peers. This is why I tell entrepreneurs that in spite of press to the contrary, it remains a brutal fundraising market.

If there’s a silver lining, it’s that across both founder profiles, first institutional rounds represent approximately 25% of the fully diluted post-money valuation. Seed/A investors have clear ownership targets and that doesn’t seem to change much based on founder profile.

* For rounds raised on convertible notes I have used the cap on the notes as valuation. I recognize this is imperfect. If all notes converted at the cap, this would actually significantly underestimate the valuations of these rounds (as those caps are mostly pre-money caps) but I’m assuming some % of notes will either not convert (company fails) or convert at a discount.

How Slack and Facebook Are Making Access to Information Less Democratic

Earlier this month Jonathan Libov, an Analyst at Union Square Ventures penned a widely circulated piece on the importance of paying attention to “fringe” technology and interests in the corners of the internet. He noted:

Fringiness, if you will, is in many ways vital to the business of venture capital. Sure, there is a large segment of investments that are wholly mainstream from the start and can be found by some combination of being in the right place at the right time and good execution (e.g., Uber). But there is a large segment that capitalizes on the arbitrage of thought, culture and research. Inasmuch as a venture capitalist has developed ideas and conviction about how the world will develop, hanging around the fringe is an opportunity to participate in big opportunities that are priced well because the majority of other investors haven’t caught on yet.”

I agree with Jonathan. But there’s one problem: the fringe, which used to be accessible to anyone with a mouse and keyboard, has, over the past several years become increasingly opaque and inaccessible. So what changed?

First, some history: My earliest memory of the internet’s fringe was in America Online WaReZ chat rooms a subculture where people swapped files, tried to gain administrative accounts. (It was during this period that I taught myself how to code in Visual Basic simply so that I could write hot-key functions to sit on top of AOL). In those days, conversations within the walls of AOL’s interest groups and chat rooms were undeniably private – neither indexed nor aggregated – and nowadays, probably flushed and lost forever.

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But that would quickly change post-AOL, transitioning into a longstanding period of heavy archival. Online communities and interest groups enjoyed a largely public discourse for much of the past 15 years. Usenet newsgroups (and all the amazing content of the alt. and rec. topics) were initially indexed by DejaNews and later made fully searchable by Google. As Usenet was fading, massively searchable online forums powered by UBB.threads and later by the vBulletin platform were wholly indexed by Google and remain archived and accessible to this day.

And the trend continued with Reddit’s rise to popularity. As the world of micro communities and interest groups began to transition away from individual web forums and centralize within Reddit’s walls, they adhered to the ethos of content accessibility. Although their pages have historically ranked poorly on Google, they do, in fact, rank, fully meta-searchable and transparent.

But Reddit’s advantage – massive amounts of centralized content and interests – was also its curse, yielding an often aesthetically messy, abuse ridden experience. Alex Shye, an entrepreneur in the Bay Area, likened Reddit’s architecture and experience to Craigslist – which had been successfully unbundled into vertical specific marketplaces such as Uber, Airbnb, Thumbtack and others – and predicted that Reddit would be similarly unbundled into vertical specific content platforms and communities.

He was right. Sort of. Reddit is being unbundled. But not by vertical specific sites. That honor has been assumed by massively horizontal platforms: Slack and Facebook.

slack-daily-active-users-021216-930x656

Slack, the $3.7 Billion communication platform has expanded from its root as a team based communication tool and now boasts tens of thousands (at least – the number is not publicized) of individual teams/communities. Many of these communities have thriving discussions, but are not fully public – often demanding an application process for entry – nor are they explicitly archived or searchable. How many of the more than 3M Daily Active Users are in interest-based communities is anyone’s guess. But anecdotally, it’s high.

Concurrently, Facebook Groups have been consistently growing in absolute number and engagement for years, now boasting over 1 billion Monthly Active Users. Teddy Citrin at Greycroft Partners recently noted that the launch of Groups’ Discover Flow has for the first time offered transparency into the scope and depth of Groups’ unique memberships. But even so, these Groups are also membership gated and their content remains unindexed by Google and downright unsearchable – unless one is a member.

And there may be one additional macro-trend at play: as messengers, led by WhatsApp, FB Messenger, Line, and Kik continue to incentivize native brand engagement and content/product conversation, that may yield large volumes of incremental content, reviews, comments, and awareness that leave the broader searchable ecosystem.

Admittedly, there has always been discourse existing beyond the internet’s open walls, whether it was cased in e-mail or IRC channels. But excepting e-mail, the conversations have still generally occurred in open mainstream channels. But recently, I have watched my own dependency on Slack and FB Groups increase materially to maintain relevancy of certain interests. [I have also watched more private conversations get revealed on Pastebin – but that is a separate discussion.]

The fringe exists as the “fringe” for a reason – it is by intention intended to sidestep mainstream conversation. But nevertheless, from my vantage point, it’s becoming increasingly opaque. If you are also thinking about this shift in community and information, feel free to shoot me a note, would love to chat.

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