Tag - vc

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Why the Micro-VC Surge Will Drive Innovation Across the US
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The Economics Underlying Chatbot Mania
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The Middleman Strikes Back
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The Real Reason Bitcoin Startups Are Struggling to Fundraise
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Breaking The Mold With David Hornik

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.

The Economics Underlying Chatbot Mania

Over the last several weeks, we’ve reached peak AI/Bot mania. Most of the conversation has centered around Chatbots and the potential emergence of a new platform/distribution layer. If you’ve been mostly ignoring the press, some good reads are:

Tl;dr – the major takeaways are as follows: given that consumers don’t really download apps anymore, brands & retailers have a new access point to end consumers, sitting on top of existing messaging platforms and leveraging chatbots to ensure mass scale. The truth is that the chatbot platform conversation is really just an extension of the one we had about a year ago during the emergence of Magic/Operator and SMS as the new platform, which we discussed in Are We Already Rebundling Mobile. An important extension given that such bots have been democratized and can now be spun up not just by tech companies, but by traditional retailers (on their own or within Messenger) or even by individuals such as you and me.

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All @TayTweets joking aside, the more intriguing aspect this time around is that Artifical Intelligence and Machine Learning have improved by leaps and bounds. A few articles that reflect this point are: Why AlphaGo Is Really Such a Big Deal, The Current State of Machine Intelligence, Can Machine Learning Predict a Hit or Miss on Estimated Earnings, and The Humans Hiding Behind the Chatbots

But again, the vast vast majority of analysis has focused on bots living within the worlds we frequent (messaging & SMS) and the platform implications. SO – I wanted to spend a few paragraphs to quantify and explore the effects of these advancements from a unit economic or business perspective. The big ones are twofold in my mind: (1) Properly executed AI can transform certain human capital marketplaces from operating as take-rate businesses and transition them into high gross margin software businesses. (2) Chatbots in their current function as customer service agents can make a material impact on contribution margin & overall EBITDA if they can successfully remove the customer service expense line.

20% Take Rate —-> 90% Gross Margins?!?!?

First, some context. About four months ago, writing in “The Middleman Strikes Back” I suggested:

“It’s clear why a hybrid AI/machine learning model is the holy grail for several verticals – replicating [a high] level of personalized service while minimizing overhead labor costs and maintaining extraordinary software level gross margins.”

But in fact, I was wrong. Dennis Mortenson, founder of X.ai in “The Humans Behind the Chatbots” believes that the hybrid in “hybrid AI /ML” should be minimized even further…to zero:

“The two scheduling e-mail bot companies have divergent plans for expansion. Clara, which is slowly letting people off its waitlist and said it currently serves hundreds of companies, charges $199 per month per user. X.ai, on the other hand, plans to move from limited beta to a public release later this year and wants to charge about $9 per month. Dennis Mortensen, its founder, wrote in an e-mail that “only a machine-powered agent can take on the 10 billion formal meetings that U.S. knowledge workers schedule every year.” Mortensen said the service will start asking e-mail senders to clarify when the computer can’t interpret an message—“Did you mean Monday, April 4?”—instead of having an employee read it and infer. “We want to give the job away for free, or for $9, which you can only do if it’s software,” he said.”

Executing on Dennis’ vision, by removing human labor in the middle, you have effectively transformed a take-rate marketplace into a high margin software business, while managing to provide a similar product. Here are examples of some of the service/agent businesses* that could see their economics transform towards 80-90% gross margins when fully leveraging AI:

The Unit Economics Underpinning the AI

Additionally, the company’s variable costs (ie the cost to provide each incremental production or engagement) will transition from significant (paying humans) to immaterial (software cloud hosting fees) enabling a much lower cost of servicing demand, should these companies choose to lower prices. Doing so could expand the audience for such products tremendously.

While I was initially a big skeptic of X.ai, the combination of a product that increasingly works with minimal human intervention and a product priced to undercut the market tremendously at $9/mo is a proof that this transition from human marketplace to pure software is already underway.

Further, there’s even an even bigger opportunity in play. If Matt Turck’s suggested “data network effects” take hold many of these service marketplaces – few of which are operating in actual winner take all markets – could be replaced by a software layer, leveraging data network effects so strong that those markets actually become winner take all.

$$$ Massive Value Creation in Public Markets

Again, this is mostly a theoretical exercise, but let’s imagine for a moment the value creation consequences of fully automated chatbots successfully managing 100% of a company’s customer service interactions.

Here are a handful of examples of some companies you might be familiar with showing their current enterprise value, approximately how much they spend on human capital customer service and the effective sensitivity in their valuation if they could maintain their current level of customer service via no-cost** chatbots:

The Unit Economics Underpinning the AI2

It’s not clear to me this is the optimal way to assess the economic value of chatbots – I kind of doubt anyone knows yet – but what is clear is that the effect to profitability would be tremendous. Massive. And that’s just by automating customer support alone.

Importantly, and intentionally, this exercise ignores the real, global cost of losing so many service level jobs from the economy. I’m not qualified to assess that cost nor its effect. There are many opinions in the market for what an AI economy might look like; Roy Bahat at Bloomberg Beta recently offered an intriguing one to The Twenty Minute VC – a futuristic marketplace actually placing a premium on any human manufactured products or human assisted services because of its rarity. There are others as well. Much discussion around AI is conjecture, but its economic effects are a very serious business.

* Certain of these companies do not publicize take-rate or offer non take-rate subscription models. In these cases, gross margins have been assessed from public interviews, or estimated based on reported hourly worker wages and expected throughput.

** This assumption is implausible as there would still be some associated costs related to the software itself and managing/customizing the software on a daily basis.

Special thanks to Dan Abelon for his feedback on this piece.

The Middleman Strikes Back

The following article was originally published on TechCrunch on December 30, 2015

One of the great promises of the internet – a democratic, transparent, open network that would dis-intermediate entrenched industries, remove fee-taking middlemen, and thereby lower the costs of goods – has seemingly been realized. The OTAs such as Priceline and Expedia mostly killed travel agents, Prosper and Avant are fast disrupting bank loan officers, and the car salesman has been diminished in favor of eBay, Autotrader or Craigslist.

And yet, just as surely as we thought they were gone for good, the middlemen have come surging back to life. Only this time rebranded as our best friends: the personal concierge.

Case in point, personal shoppers were once a luxury – a sign of elite class and prestige. No longer: hundreds of thousands of consumers are now communicating with personal stylists (or data-driven human/Artificial Intelligence hybrids) via next gen fashion platforms such as TrunkClub and Stitchfix – two platforms with demonstrative value (Trunk Club was acquired more than a year ago for $450M and few experts would reject Stitch Fix’s $300M recent valuation).

And while fashion is an obvious use case, the concierge economy is thriving –spanning verticals from wellness to design, with a whole host of broad based horizontal concierge services also trying to impress their worth.

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ET TU, AMAZON?

The logical question is: why? Why, given all the advantages of a fricitionless, democratic playing field, are concierges suddenly surging back to popularity?

I see three likely explanations –

Amazon: If you sell practically any physical good online, Amazon, the internet’s most powerful retailer, is a perpetual threat. With their distribution, leverage, and logistics expertise they have the wherewithal to undercut on price, process and deliver product faster than practically any startup – not to mention, operate at a loss if necessary.

So where is Amazon exposed? On a services level.

Amazon’s operating margins – already tight at 1.3% – don’t allow for much room to train and mobilize a large human concierge force. Which means that building a human-focused, relationship-driven personalization platform actually provides for a tangible differentiator against Amazon – one of the few ways to effectively compete against the giant. And – perhaps more importantly – one of the few ways to build defensibility in a commerce segment traditionally dependent on “brand” as its only de facto moat.

One further point: Amazon is a predominantly a destination for directed search – either on a specific product or specific category basis. But as purchasing increasingly shifts to mobile, it turns out that it continues to be difficult to search, discover and catalogue individual items. Concierges – especially when leveraged via a mobile interaction point – reduce that friction and enable a new purchasing behavior.

Too Many SKUs: We exist in a world of overwhelm. That overwhelm via multi-tasking is affecting how we learn and think, and the overwhelm via optionality and availability of information is also affecting how we process, “shatter[ing] focus,” and deferring decision making as long as possible.

That problem of information overload was initially solved via curation, the mid-point on the spectrum in reduction of cognitive noise:

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But based on the hyper-growth of concierge facilitated platforms, it appears that curation doesn’t go far enough for the emerging set of millennial buyers – that they demand even more assistance and personalization than before.

The question that operators and investors should be asking is not whether consumers are connecting with digital assistants, but if – and at what point – we actually acquire too many concierges, thereby repeating the cycle of cognitive overwhelm, and forcing the next iteration of the operator/customer relationship.

Customer Acquisition: One of the curiosities of the concierge resurgence is that it may have opened the door for the next generation of customer acquisition.

The middlemen – when incentivized via a pay for performance model – actually become de facto customer acquisition agents for the company, serving as outbound salespeople. Trunk Club was one of the innovators of this model and our portfolio company, LGS has leveraged it as well with great success.

It replicates much of the power/incentives of a Multi-level-marketing model without the pyramid-like upfront capital commitments and obligations. MLM is a powerful model (Herbalife is one example of many), but social selling can generate abusive aggressiveness, poor customer relationships, and low return purchase rates. Because the concierge model is instead formulated as an expert/amateur relationship, there is an understood value in paying for guidance and reduce price sensitivity.

A concierge-turned-salesperson model isn’t a customer acquisition fit for all verticals, and it also can’t be as well leveraged by hybrid AI assistants, but it does solve some of the scalability concerns that most consumer businesses experience once traditional digital channels (FB, Google) begin underperforming.

THE DEATH OF THE COMMUNITY

Until recently, there was a strong hypothesis that a thriving, active community would unlock an unprecedented ability to facilitate native transactions. Andresseen-Horowitz General Partner Chris Dixon, when announcing his investment in Soylent, noted:

He said he was interested in companies that appear to be focused on selling X but are really online communities that happen to make money selling X. This helps explain why many investors are confused by the sustained success of these companies. One example he cited was GoPro. Many investors decided not to invest in GoPro because they saw it as a camera company, and camera companies generally get quickly commoditized. However, investors who properly understood GoPro saw it primarily as a highly engaged community of sports enthusiasts, something that is very hard for competitors to replicate.

And yet, at least on a macro scale, the presumed value is very much in doubt.

Last month, it was reported that native buy ads on Pinterest during the holiday season did not meet expectations:

The company began inserting Buyable Pins into its iPhone app in late June, and just added the feature to its Android app in early November. The company says more than 10,000 merchants have joined the program, including big retailers and brands like Macy’s, Nordstrom, Neiman Marcus, Cole Haan and Tory Burch, but at least one of these big partners is seeing fewer than 10 purchases a day on Pinterest, according to a person with direct knowledge of the sales figures. This source and another also said that Pinterest insiders have privately admitted to being disappointed with early sales numbers.

According to the same report, results are similarly disappointing at Twitter and Facebook. One time startup darling, community leveraged shopping portal Polyvore was acquired by Yahoo in 2015 for $200M – a healthy price to be sure, but certainly lower than once hoped. Even GoPro, noted by Dixon as a community outlier, has lost nearly 75% of its enterprise value in the public markets over the past 12 months. True, it trades at a premium to commodity manufacturers, but it appears its community purchasing may not be as strong as once imagined.

Nevertheless, transactional communities with more vertical specificity (such as Soylent) do outperform bare bones e-commerce. And is it clearly the very early innings in Pinterest and Twitter’s efforts to sell product directly through its platform. But don’t be surprised to see the larger horizontal community players continue to struggle, and ultimately acquire companies in the concierge space in order to boost their conversions, order sizes, and frequency.

THE ECONOMICS

The upside of human driven assistant/concierge services is that in most scenarios, they add value to an end user experience. The downside is that they add material costs to a company’s P&L.

Take for example any of the listed wellness apps (Rise, Talkspace, Big Health, etc) which, if it operated on a purely software basis would boast 80-90% gross margins. But a human focused component affects that in one of two ways:

  1. Either the company employs (W2’s) any number of wellness professionals who are expected to interface with a given quota of customers. Although that model enables the wellness app to maintain their gross margins, it cuts deeply into their contribution margins because of the additional labor expense.
  2. The other option is to view the wellness professionals more like marketplace suppliers, and connect them to customers on a 1:1 basis, while paying them a percentage of every transaction, say 70%. Though this does have the effect of removing the wellness professional costs from the G&A line, it also changes the nature of the business – from a 90% margin software business to towards a marketplace model with a 30% take-rate.

Given those two options, it’s clear why a hybrid AI/Machine Learning model is the holy grail for several verticals – replicating the level of personalized service while minimizing overhead labor costs and maintaining extraordinary software level gross margins.

That said, it is still unclear if hybrid AI assistants can provide an end-user experience powerful enough to materially affect purchasing, conversion, and frequency.

For the time being, within the fully human powered services, the winning business models will be ones that can hire relatively inexpensive, untrained people, who can then be empowered via software or leveraged workflows to deliver a meaningfully improved end-user experience. This has the added benefit of yielding greater supply/expert-side scalability in that the pool of potential concierges is far larger (if performance does not require deep inherent expertise) and the level of consistency, even across expertise levels, will be more stable.

Startups trying to wedge into the market using a high level of service need to be highly cognizant of, and focused on, controlling costs. Especially as the investor market continues transitioning away from high cash burn models, obsessive attention on how to deliver a high quality experience, deepening long-term scalability, and leveraging lower-cost labor will yield many compelling outcomes.

Special thanks to Rebecca Kaden, James Conlon, and Peter Christman for their assistance on this article.

[For disclosure, Chicago Ventures is an investor in LGS, Mac&Mia, Rise Science, Retrofit, and Havenly.]

The Real Reason Bitcoin Startups Are Struggling to Fundraise

If you’ve read my blog over the years, you know I’ve written extensively on bitcoin in the WSJ, re/code, and Coindesk. And yet, a couple of years after my initial interest in the bitcoin sector, neither myself nor my firm Chicago Ventures is yet to make an investment into a bitcoin tech startup. And that in spite of my taking a large personal stake into bitcoin itself, and many “altcoins” such as Ethereum, Maidsafe and Factom.

Let me be clear: I am an unequivocal bitcoin bull. I believe that bitcoin may well represent the greatest transfer of wealth in my generation. I also believe that bitcoin itself, as the fuel underlying the blockchain, is exceedingly vital – as very clearly outlined by my friend Nick Tomaino in The Blockchain is Important and so is Bitcoin.

For the past 12-18 months I have intentionally passed on nearly every early stage bitcoin related business because of what I believe to be a systemic funding gap that is not easily reconcilable. Simply put: given the macro level of consumer adoption within bitcoin (below) it is exceedingly difficult for most new entrants to reach a level of traction compelling enough to warrant follow on capital. And because the majority of these businesses are not generating substantial revenue, availability of continuation capital is a pre-requisite to any current funding round.

So where is consumer adoption of bitcoin? One of the better breakdowns I’ve seen is by Tim Swanson on his blog Of Numbers – where he chops the data multiple ways and finds at best 2x year/year growth: A Brief History of Bitcoin “Wallet” Growth (whereas most VC-backed consumer companies are shooting for 5-10x+ Y/Y growth).

bitcoingap1

EARLY STAGE CONCERNS

My hesitation towards investing in the sector comes from the following analysis (the data behind my analysis, as well as copied graphs are via Coindesk). Here’s the data as I’ve assessed it –

bitcoingap2

2015 saw a nearly 50% decline in total bitcoin related VC deals from 99 to 57. Though that reflects a macro-level hesitancy on the sector (or perhaps over-exuberance in the 2014 bull market), that – in and of itself – is not debilitating.

But the two disconcerting trends to most early stage investors are:

  1. Of the 78 newly funded companies in 2014, only 21 raised follow on funding in 2015 (6 of the 27 follow-on rounds in 2015 were for companies who had first been funded in 2013).
  2. Funding is fast consolidating quickly around “platform” investments (as expressed by the graphs below) – which I characterize as either “universal” or “infrastructure” focused. These are the startups least exposed to the short-term volatility of consumer adoption as they touch multiple parts of the ecosystem.

The evidence appears in these two charts:

bitcoingap3

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Universal and Infrastructure related investments now make up nearly 50% of all bitcoin funding, but more importantly, are the buckets into which all of the year’s largest funding rounds fell into: Coinbase, $75M (Universal), 21 Inc, $116M (Universal), Circle, $50M (Universal), and Chain $30M (Infrastructure).

With that in mind, let’s unpack those two points –

(1) With 57 of the 78 funded companies in 2014 not raising publicly disclosed follow on funding round in 2015 that means that there are either (a) a lot of likely zombie bitcoin startups or (b) a large number of non-disclosed bridge/extension rounds.

Though bridge rounds are a sub-optimal situation for founders and investors alike, they are a reality and we’ve done our share of them at Chicago Ventures. The problem here is that an extension is fundamentally a “bridge to an outcome” – and in the case of most of these bitcoin startups, neither the market nor macro adoption has converged to the point where a meaningful “outcome” is achievable in 6-18 months.

When investors consider making a new investment in the space, they are increasingly cognizant that bitcoin adoption will not explode overnight and that the funding duration for any consumer-facing company is likely to be 5-10 years before generating material revenue. Given the technical nature of these businesses – and the consequent requirement to staff expert engineers – it’s a very cash intensive proposition to take on and a tough hurdle to overcome.

Nevertheless, of the 30 newly funded startups in 2015, a full two thirds touched payment processing, financial services (transfers) or wallets – the exact categories that are hardest to generate outperformance in the current macro environment.

(2) Over the past two years, much investor commentary has focused on discovering and funding “bitcoin’s killer app.” It is unclear to me whether that was simply a nascent understanding of the ecosystem or intentional misdirection, but it is a misunderstanding. The inherent flaw in that thesis is that it naively assumes that bitcoin is missing a UI, whereas in reality, the blockchain – because it can be leveraged by existing experiences – already has millions of beautiful interfaces to tap into.

Given that, it makes sense that funding is converging around platform plays: those that are either the building blocks of the emerging blockchain ecosystem or those with demonstrable network effects. The struggle for early stage investors wanting to make platform bets is that being a laggard into a space where competitors’ network effects are already strengthening is a recipe for disaster.

Here’s what the funding shift looks like in graphical form as the smart money transitioned towards platform focused opportunities as opposed to discovering a “killer” front-end app.

bitcoingap5

THE NEXT 24 MONTHS

At the time of this writing, bitcoin is once again buzzing: after nearly a year of price decreases and stagnation towards $200, bitcoin has been on a roll, surging past $500 and now holding strong in the mid $400s. In addition, both Wired and Gizmodo believe they’ve uncovered the actual Satoshi Nakamoto, an eccentric, iconoclastic, tax dodging entrepreneur: Australian Dr. Craig Wright, although those who’ve communicated with Satoshi in the past disagree.

It sure does seem likely that 2016 could be another boom year for the broader bitcoin ecosystem.

But the described concerns remain – without a discernable shift in adoption, the vast majority of bitcoin related opportunities, both consumer and b2b blockchain focused, are exceedingly difficult to fund by early stage funds. Consumer, because of largely stagnant adoption, and, b2b, because of the relatively small size of most pilot contracts signed for ledger-focused blockchain-related record keeping. The exceptions, of course, are Barry Silbert’s Digital Currency Group and Dan Morehead’s Pantera Capital, both of whom are committed to expanding the overall bitcoin ecosystem via early stage bets.

Naturally, this equation is also different for larger funds that are opportunistically investing downstream for the right entrepreneur or idea – in that case, they have the pockets to support a company throughout the funding gap. But that is the exception rather than the norm.

My estimation is that smart money at the early stage will largely stay on the sidelines in 2016, waiting to see if new platform opportunities emerge via the 21 Bitcoin Computer, or other decentralized networks, especially as incumbents such as Coinbase, Circle and Chain prove the strength in their networks and multi-faceted applicability.

Breaking The Mold With David Hornik

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There’s an old adage that if you want to get something done, find the busiest person you know to take on the task. David Hornik is the embodiment of that manta.

I first met David a year and a half ago as part of my journey with the Kauffman Fellows. He was so insightful that our group unabashedly asked him to spend an additional two hours answering questions a month later (the only time we did this in our program’s history). He obliged. As a young investor learning and growing in the industry, it’s almost unfathomable to me what David has accomplished – but moreso how much he’s able to give back in spite of the constraints on his time. David’s reputation as a giver – he’s been nicknamed the “Robinhood of VC” – is so prolific that he was profiled for an entire chapter by Adam Grant in his bestseller Give and Take.

His personality shines in our interview. In fact, behind the scenes, I actually tried to end the interview several times – to which David objected, requesting that I push deeper. My sincerest appreciation to David for his time, and I hope all readers (entrepreneurs and VCs) are able to benefit from his poignant insights.

Ezra: Thanks David for doing this. You are a man of the people. Let’s start – you built a reputation as an ultra-nice, transparent, likable guy in an era where Venture Capital was rather opaque. But as VCs now fight for the moniker of most “founder friendly” and are no longer chair tossing curmudgeons, do you still find niceness an effective strategy for winning the hearts and minds of entrepreneurs? Or are you become surly just to differentiate? 

David: I can tell you with great certainty, that I have never thrown a chair. I don’t think I will start any time soon.

First, thanks for the kind words about my reputation. I am hopeful that it is well-earned. I firmly believe that startups are the byproduct of incredibly hard working and thoughtful entrepreneurs, really great markets, and some luck. My role is to support those entrepreneurs in any way that I can — certainly with money, but also with all sorts of support (recruiting, fundraising, publicity, strategy, etc.). So it isn’t really about being a nice guy. It is about being a supportive guy. It is about understanding that we are all in this together and doing everything I can to be on your side and help you build something big and great. Are there others who view the venture business this way? Sure. There are some folks out there. There are a lot more pretending they do than the ones who actually do. But there are others who are truly entrepreneur first. I’m glad that there are more of them these days. Those are the VCs I want to work with.

Ezra: Those are the VCs I want to work with too! But here’s the thing…I once heard Bill Gurley say “Whenever you hear a VC speak, know that she is speaking to the entrepreneur she hasn’t met yet” – namely, recognize that investors are always marketing themselves. Do you agree with that? How do you – either as a fellow investor or as an entrepreneur – discern who is genuine and who is transactional? I’ve made a lot of mistakes in my first four years, so are your instincts better than mine or it simply a matter of experience/existing relationships?

David: I do think that good VCs understand that they need to market themselves. Some VCs have taller tales to tell than others. But it is awfully hard to be what you aren’t over an extended period of time. So one of the best ways to tell if a VC is full of shit is to spend a bunch of time with him or her. The more time you spend with them, the clearer the picture you will get of how they view the world. It is exactly the same way with entrepreneurs. When an entrepreneur is pitching a VC, she is putting her best foot forward. If you are excited about the deal, spend some more time with the entrepreneur — you will either grow to like that entrepreneur more or less. If it is less, move on quickly. If it is more, then it is worth doing some more work.

So if you’ve spent time with a VC and find yourself liking them more, what work do you do next? Reference checks. And lots of them. There is no better way to know what it is like to work with someone than to actually speak with someone who has worked with that person. VCs are really easy to reference. We list our portfolios on our websites. Look at the companies in which we’ve invested and call those entrepreneurs. See what they are like to work with. I make it even easier for entrepreneurs I’m interested in working with. I give them a list of all the founders and CEOs I’ve worked with over the last 15 years. All of them. And I encourage them to call the folks I’ve worked with. Because you can fake it when you meet someone for an hour. But you can’t fake it for 11 years (which is how long I’ve been working with Splunk so far — I’m still on the board) or 14 years (which is how long I worked with Ebates before it was sold for a billion dollars to Rakuten) or 15 years (which is how long I’ve been working with Rene Lacerte across two companies so far).

There are lots of great venture capitalists out there. You just need to do your homework to find out who they really are.

Ezra: Great thoughts, thanks. You know, when I first discovered you David, you were something of a prolific blogger. Now you’re something of a non-existent blogger, with a stellar 3 posts in the past 24 months. What on earth happened? And is it indicative of something larger, more fundamental in either your own personality or the venture ecosystem?

David: I suppose my lack of blogging is mostly about being too busy. When I started VentureBlog, I was new to the world of venture capital and had a lot of time on my hands. There were no other VC bloggers at that time, so everything I thought about made a good blog post. These days there are lots of VC bloggers and not a lot of new stuff being discussed. That said, I really should write more. I have been contemplating a series of posts about the things I’ve learned in my first 15 years in the venture business. So don’t give up hope. Keep your eyes on VentureBlog.

Ezra: Quite the cliffhanger – I’m sure many fans will now be refreshing religiously. Given the saturation of blogging, if you were a young person entering the venture scene today, what would be your strategy for making a mark and standing out – besides the requisites of being transparent, make winning investments, good follow through, etc: Apprentice a lot and say little? Be funny and silly? Do something scandalous for the free Gawker PR? Pick up skateboarding and become a Vine star? 

David: Wow. This is the million dollar question. Or, if things go well, it is the billion dollar question. How does anyone differentiate his or herself in the venture business? In some ways I got a little lucky and hopped into blogging early. And then I started podcasting early as well. I’ve been a little more consistent in recording VentureCast these days than I have been in writing VentureBlog. And then I decided that the world needed another conference, so 9 years ago I created a conference called The Lobby. It has been going strong ever since. In fact, I now have a digital media Lobby conference and an enterprise version of the conference as well. So should a new VC jump into blogging or podcasting or creating a conference? Probably not. If you want to really differentiate yourself, you’ll need to come up with something new. Maybe you’ll write a novel making fun of the venture business. Maybe you’ll create a series of online classes that reach millions of people. Maybe you’ll get a television show. Maybe you’ll just be an amazing networker. Who knows? The key is to use some medium to share your passion for startups and make clear to entrepreneurs what makes you different. You may be able to do that in a rap album. You may be able to do that in a picture book. Whatever it takes to connect with entrepreneurs and get them excited about telling you what they’re working on next.

Ezra: A few weeks ago you announced a large investment in MassDrop, a community platform for enthusiasts of a wide variety of interests. It’s actually quite apropos, and reflective of your entire track record: in addition to MassDrop you’re also on the boards of vastly different companies ranging from Splunk to Stumbleupon to Bill.com, just to name a few. At the same time, over the past few years the VC world has become far more specialized – with firms such as Emergence Capital, IA Ventures, ForeRunner – many firms now also boast partners with deep domain specific knowledge. Simply put: you are a generalist living in a specialist’s world. So how do you do it? How do you compete? Do entrepreneurs value your generalist lens? Or, is the question fundamentally wrong – that you are an absolute expert at building growth companies, or asking the right questions, irrespective of your expertise in any specific field.

David: There are all sorts of ways to be a VC. I’m not sure which one is best. I am sure which one is best for me. I like lots of different businesses. On the one hand, I think consumer businesses are amazing. They naturally appeal to VCs because we are consumers. So we think to ourselves, “that is awesome. I’d use that.” And that can create excitement around a business. On the other hand, I have also had the good fortune to work with spectacular enterprise teams and seen what it looks like when that works. I funded Splunk when three founders and a great idea. Eleven years later I still sit on the board and it is a multi-billion dollar company and there are 1,500 or so employees. It is hard to not get excited about that. I am sure that there are VCs out there who can share valuable insights because of their focus on a particular space. But I think that most of what I do as a VC is broadly generalizable across companies. My job is to help make entrepreneurs successful and that is something that requires experience and perspective and patience and faith, but doesn’t necessary require a particular industry specialization. I suppose it is possible that after 20 years working with startups across the spectrum, I have become an expert in both enterprise and consumer businesses. But I think it is more likely that I have become an expert at being helpful — I am happy to help the entrepreneurs with whom I work recruit great people, raise capital, develop growth strategies, connect with partners, get good press, not fight with each other, design great t-shirts, motivate their troupes, judge Halloween competitions, and a million other things. There is no one qualification for the venture business and there is no one approach that guarantees success. So I’m just making it up as I go along.

Ezra: A year or two ago I heard you say that August was “notorious” for losing an extra $500k-$1M on deals for routinely going one bridge too far. You added that overall, it was worth it, because it built genuine long-term authenticity and trust with founders. But I have to wonder if that’s a bit too easy… a fitting strategy for such a “nice” guy. Further, a multi-decade, very successful GP recently advised me that funds “live and die by the quality of their follow on investment.” Do you agree with that? How do you balance and juxtapose those two interests? Or, is it simply that you’ve done the math and $20M worth of failed extensions is a palatable “marketing” (or testimonial) expense for a $450M fund?

David: I suppose the good news is that we have a pretty small number of companies that fail outright. So most of the time we aren’t really losing another million dollars. Most of the time, we are supporting great entrepreneurs and helping them to find a good home for their businesses when they aren’t working. But it is certainly the case that we do, on occasion, invest an additional million dollars when we could have cut off the investment earlier. I don’t think it is really marketing dollars. I think it is more about supporting your entrepreneurs while they are still fighting the good fight. And some of the time that money makes all the difference in the world. Some of the time, companies are able to get to profitability on that last million dollars or find the right acquirer, or get to some better outcome. And in those instances, we’ve made a great economic decision, not just a great relationship decision.

As for follow on investments, whoever told you that funds live and die based upon the quality of their follow on investments has an odd view of the stuff that’s important from where I sit. That isn’t to say that follow on isn’t important. It certainly can be. But it is so much more important to find great companies and invest in them in the first place then to figure out how much to invest in a follow on round. That said, we own a big percentage of three of our most promising companies right now because we invested in those companies early and then led subsequent financings as well. If those companies are successful, we will reap the benefits of having been early investors and then having doubled down on those businesses. But the more important financings will certainly have been the initial financings, even if the subsequent ones ultimately drive real value as well.

Ezra: I also heard you say maybe a year ago that you should only invest in an entrepreneur or team that you’d want to be friends with and that you’d in fact de-prioritize an otherwise healthy, growing, business if you weren’t extremely passionate about the team. I’ve taken that advice to heart and it’s helped me a lot in my filter. Where I’ve personally struggled is falling in love with “people” that I think are extraordinary – deep domain experts, thoughtful, self-aware, intellectually curious – but where its unclear if they have the founding skills or acumen to build a great company…perhaps they weren’t able to communicate a clear go-to-market vision or have really unreasonable growth or hiring expectations, whatever it might be. I always find myself stuck in that spot. What’s your approach? Do you err on the side of backing people that you “click” with and that have a really unique approach to a market? Do you try and convince them to find external help? Do you wait and see while building the relationship? Or it case specific and you’ve taken many approaches?

David: It is an old trope but I stand by it — it is all about the people. Great entrepreneurs build great companies. There are some surprising exceptions to the rule. But, for the most part, amazing businesses are built by people with whom you would love to work. That is a rule I do not break. People, People, People.

But here’s the thing. I back a very small fraction of the entrepreneurs with whom I meet. And I definitely do not back all of the entrepreneurs I like. I don’t even back all of the entrepreneurs I love. I back great entrepreneurs with whom I’m excited to work, but only if think they will build a great business. And great businesses are hard to build. They require you to be smart and thoughtful and a good sales person and have a great idea, etc. etc. But more than anything else, a great business requires a great market. And great markets are hard to find. Most businesses are too small for a traditional venture fund. Some have too much competition. Some are not likely defensible in the long run. Some have sales cycles that are too long. All of these issues add up to either a great market or a less than great market and it is very hard to build a big business on a less than great market.

So what do I look at when investing — people, people, markets, people. Great people and a great market will build an amazing business. It is the killer combination. And it is stunningly rare.

Ezra: Do you think you would you re-write any of your prior answer if you were a pre-seed/seed investor as opposed to primarily a Series A/B investor?

David: Absolutely. I would probably answer all of them differently. The angel business is very different from being a Series A investor. You have different information at the time of investing. You likely have a smaller fund. You will have different resources when it comes time to doing follow on investments. And when it comes time to supporting your investments in good times and in bad times you will have different resources as well. The one thing that I suspect would be pretty consistent is that it is all about the people. People, People, Markets, People!

Ezra: Looking at your investment history, the vast vast majority of your investments have been in the Bay Area. It probably doesn’t come as a surprise that as an investor with Chicago Ventures I have to believe that I can drive meaningful returns from my perch in the Midwest or else I’d find a different job. But I might well wrong be wrong, so best to find out know I suppose! SO: What’s your take on the future of outperforming startup companies from a geographic perspective? Do you expect to focus the large majority of your attention on the Bay Area for the foreseeable future? If so, do you buy that the potential for greatness is not incumbent to one geographic region? Or, do you view the Bay Area as an exponentially compounding flywheel – with the compounding knowledge of its accomplished founders & advisors cultivating an increasing delta between the Valley and everywhere else in the world?

David: Good news — no need to move or find a new profession. I think there will be amazing business all around the world. In fact, we’ve invested in some great businesses in the Chicago area. The founders of Avant Credit are some of the best entrepreneurs with whom we’ve ever worked. They are building an incredible business. As a firm, we’ve backed a number of companies throughout the county (New York, DC, Texas, Washington, etc.) and throughout the world (Germany, Israel, Canada, etc.). We back amazing entrepreneurs wherever they are. In fact, there are real advantages to company building outside of the Bay Area — easier recruiting, lower costs, etc.

So why are nearly all of the companies in which I’ve invested in the Bay Area. In part because of proximity. I am necessarily going to hear about a lot more local businesses than those outside of the Bay Area. In part because of resources. The Bay Area has an astonishing entrepreneurial ecosystem. There are a huge number of founders, funders and friends within a 50 mile radius. It is hard to understate the value of a near limitless pool of advisors, investors and support inn close proximity. It doesn’t make it impossible to create and scale a business elsewhere in the country, but it certainly makes it easier in the Bay Area.

Ezra: As we come to close, I want to ask about your support network. The startup world is not an easy industry – I daresay it’s at its most cutthroat in history and seemingly playing for the biggest stakes (and biggest payoffs) in history. The stresses on family, emotions and psyche for all players in the ecosystem should not be understated. And as investors, though we might be spared from the pressure of having to directly lay off employees, we’re affected as de facto therapists – juggling dozens of high intensity issues across the portfolio. So while you’ve been profiled as a prolific giver, we don’t know much about your support and mentorship networks. And I’m fascinated because you’re always expressing positivity, confidence and humility. So how do you do it & who helps you? Is your family a big part of that? Do you still lean on early mentors in your career? Your partners? Friends completely outside the ecosystem?

David: Ezra, this is such a good question. No one really thinks about the psychological challenges of the world of entrepreneurship. It is MUCH harder on entrepreneurs themselves. I know many entrepreneurs who find themselves depressed, isolated, feeling deeply inadequate. It is very clear that being a CEO is a lonely job. I recommend to all of my portfolio CEOs that they should either join a CEO group (there are lots of great ones out there) or hire a CEO coach. At least that way you will be able to discuss the challenges you are facing with someone who understands what you are going through. As far as VCs go, I wouldn’t say that there are similar groups. I don’t know of any CEO group equivalent for VCs, but it would probably be a good idea. I do spend a reasonable amount of time chatting with other VCs. And my conference — The Lobby — is an opportunity for VCs to get together and chat about the challenges of the markets, etc. But I think we VCs would be well served by a better support structure. I suppose other than looking to my friends who are VCs, I mostly turn to my wife Pamela. She is sometimes a sympathetic ear, sometimes a kick in the pants, and always a very good advisor. But, truthfully, I’m so grateful to be a VC and work with such an amazing group of talented entrepreneurs. I guess I’m just not a worrier. That’s not really my nature.

 

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