I’m in a reflective mood as Thanksgiving is around the corner, and I’ve been thinking a lot about motivation. If nothing else, entrepreneurs need a LOT of it to push through the valleys between the peaks.
When I think about it, I believe everyone’s motivations are driven by some combination of Love, Greed, and Fear. Some thoughts below on each one.
It’s easy to say that Love ought to be the strongest and most pure motivation. People will go to great lengths for the sake of love. They will suffer hardship and pursue perfection relentlessly because of love. We hope all the founders we back are driven deeply by love. For first time founders, that usually starts with the authentic love of a problem or the love of a product. For repeat founders, some of them just love the process of building and leading companies that make a difference.
Some founders just love to win, or at least to compete. I always remember when Michael Jordan came back to basketball late in his career, he responded to reporters who asked him “why?” and said “for the love of the game”.
We love love. The glorified hero is driven by love, and so is the glorified image of the transformative entrepreneur.
Just as it’s easy to celebrate Love as a wonderful motivation, it’s also easy to dismiss greed as a less-than-ideal one. ”It’s not about the money” is something we love to hear. I think it’s common in the current culture to think of greed as leading to short-term thinking. Or a winner-takes-all vs. expand the pie mentality.
But is greed really so bad? Is the desire to want more… maybe more than the next guy or gal really so bad? Maybe it’s just natural.
We love people who exhibit hunger. A relentless drive and desire to keep fighting. A sense that what they have or have accomplished simply isn’t enough – they are hungry for more. Isn’t that just greed in a more positive light?
I love hungry entrepreneurs. One quote I’ve been repeating recently is from my friend Ariel Diaz, the founder and CEO of Boundless. He talked about his frustration with entrepreneurs or tech pundits who talk about working smarter, or life-hacking, or pursuing balance. His view is:
“I was a rower. In rowing, technique matters. But when everyone has good technique, it turns out that if you can find a way to row harder, the boat will move faster”.
I’m greedy for more founders who exhibit that kind of hunger.
Again, being motivated by fear doesn’t seem great. Fear can lead to irrational choices, and fear can make you focus too much on the short term, or what people think of you, or the competition, or a whole host of other unproductive stuff.
But fear is an incredible motivator. So many of us are driven by fear. I know I am.
It’s not the healthiest thing in the world. But if you are honest, aren’t many of us driven deeply be a fear of failure? A fear of letting people down? A fear that in the end, someone looks at your accomplishments and says “myeh, he really didn’t do very much”?
Sounds kind of harsh, but I know so many people for whom this is the internal dialog, whether they are really aware of it or not. As Harold Abrahams said in the classic movie Chariots of Fire about how he feels before a 100-meter race:
“I will raise my eyes and look down that corridor; 4 feet wide, with 10 lonely seconds to justify my whole existence. But WILL I?”
Some of the most accomplished people I know are so insecure. That insecurity drives them to want to prove themselves over and over again. At an extreme, it’s pretty ugly. But it’s powerful, and I think that when in check, it’s a powerful motivator as well. As an investor, we sometimes love people who have “a chip on their shoulder” or “something to prove”. It’s a version of fear that we like quite a bit.
When I reflect on my own motivations, it’s a messy combination of Love, Greed, and Fear. And it’s messy because sometimes, Love makes me foolish, and Greed makes me short-sighted, and Fear makes me panic. But we are not simple creatures, and our motivations are mixed, whether we like it or not.
I gave a quick talk today at the Future Forward conference on “How VC’s Win, and How Things Are Changing”. It’s a topic I’ve been thinking about a lot.
My observation is that the Venture Capital business has changed significantly in the past 10 years because of much greater capital efficiency at the early stages, and much greater transparency around the process of fundraising and the performance and value of investors.
Put another way, the venture capital industry has become more mature, and increasingly, the market for the companies we invest in is more and more efficient. This creates challenges for investors.
When markets become more efficient, a couple things happen. First, it becomes much harder to find “value”. The way I see it, an efficient market means more competition for an investment, which in turn means that pricing will tend to be driven up to the point of discomfort relative to the risk. If you are investing very early, pricing may be good, but the perceived risk will be high (and a lot of smart investors will pass on an opportunity). But if you are investing after product-market fit, the price will be driven up to the point that an investment becomes harder and harder to justify given the remaining risks.
Second, firms in a more efficient market need to find more and better ways to compete. Relying on charm and reputation doesn’t get you very far in a world where entrepreneurs are increasingly less enamored by a VC’s brand or historic legacy, and entrepreneurs are more savvy about asking the question “what do I really get from taking your money vs. someone else’s?”.
So, this is forcing VC’s to seriously rethink the way they compete in the market. Those that don’t evolve will have a pretty tough time, I think. Specifically, I’ve seen innovations in the following areas:
- Sourcing in new, less competitive geographies (for example: US firms focusing on Europe, Brazil, etc)
- Finding leveraged ways to tap into different founder communities (for example: General Catalyst’s Rough Draft initiative, or FRC’s Dorm Room Fund)
- Using data and technology to identify talent
Winning (systematically finding ways to help companies be more successful and also win competitive deals)
- Using AUM to “productize” value-add. (for example: OpenView on the growth equity side and A16Z on venture)
- Leveraging the human capital of the portfolio to give value to the “platform” (for example: the FRC community)
- Tuning investment models to specific kinds of investing (for example: seed funds, sector focused funds, etc)
But by far, I think the single more important thing a fund can do is to improve their selection. I’ve blogged about this before, and I continue to think that there is a big opportunity here and we just don’t know what the answer is just yet. Getting better at sourcing and winning is important. But I actually think that the biggest difference will be the ability to look at an opportunity, and say “yes” when others say “no”… and be non-consensus “right”.
** One fun thing about this conference is that there was someone from Collective Next who was creating a mini illustration/idea map of the talk in real-time. Pretty cool – see below!
Nearly all VC investors have an ownership percentage they are shooting for. For most large funds, it’s 20%. I’ve blogged about the mysterious 20% ownership threshold before.
If it seems arbitrary, that’s because it is. Usually, this ownership number is justified based on what would be considered an ownership that is “meaningful” for a fund. But that logic kind of falls apart when you consider that “meaningful” should be totally relative to fund size.
Here’s what I mean. Take an example of a company that exits for $400M (which is relatively heroic when you consider the vast majority of successful exits are far below this level). If a $200M VC fund has 20% ownership, this exit returns 40% of that VC’s fund. That’s pretty meaningful! If that same VC were able to produce 5 exits of this scale, that would return 2X on the fund. Pretty good (but funny enough, still not spectacular considering that that is $2B in enterprise value).
But if that same VC is operating out of a $400M fund, those exits are HALF as meaningful. Each $400M exit returns 20% of the fund, and the 5 combined only return a 1X. Obviously, it gets worse or better as the fund size increases or decreases. You would think then that this would necessitate that larger funds target more ownership, but that ends up not really being the case. Instead, those funds try to invest in companies that can be “bigger”, but at the early stage, it’s hard to differentiate companies that could be $400M exits vs. $1B exits.
The reason that larger funds can’t consistently target more ownership (say, 30%+) is because of competition in the market. There are enough players out there that ownership tends to settle at the 20% range for new series A investors (and often series B investors).
One weapon that large funds do have is more capital. This can be leveraged in a couple ways. First, a larger fund is more able to wait. The thinking goes “if I’m going to only get 20% ownership anyway, why don’t I wait until the next round, and then invest. I might have to invest more ($10-15M instead of $5) but I still get similar ownership and presumably a lot less risk.
The other thing larger funds are able to do is compete more aggressively on the series A by expanding round size. The large fund may say to the founder,” wouldn’t you rather just raise $8M instead of $5M for the same (or marginally more) dilution?” It ends up being a pretty compelling argument. Although cost basis does matter to all investors, in a world where you are probably only going to get 20% ownership, the difference between investing $4, $5, or $6M to get there isn’t that meaningful.
Investors also talk about the concept of “buying up”. This means increasing ownership in a company over time. Again, larger funds are able to do this better by using their capital as a weapon and leading or co-leading later rounds, trying to do super-pro rata in the next round, or buying secondaries. But these situations are pretty hard to predict, so it’s tough for funds to try to do this systematically.
Where “buying up” gets a bit hairy is in the seed to series A rounds. This is why investor signaling is an issue. Almost all large funds are trying to get to 20% ownership, and in truth, they are expecting (hoping) for more than 20% ownership for a company that they seed. But for funds that make smaller, passive bets at the seed stage (eg <$500K) they are likely to have much less ownership than their target. Thus, these funds will need to try to increase ownership significantly to hit their 20% bogey.
For example, if a seed round happens at $5M post money, and the VC invested $500K, that VC owns 10% of the company. This VC now needs to buy an additional 10% at least at the next round to hit their target ownership. This implies:
- If the big VC isn’t trying to buy up, there is a risk that new investors will wonder if there is something about the company that makes it less attractive (negative signaling)
- If you want a new outside VC investor, you will end up with an additional 10% dilution if you are trying to keep everyone happy (assuming other seed investors just want to take their pro-rata or less).
And most VC’s that employ a high-velocity seed strategy invest less than $500K, which amplifies the problem.
Ultimately, companies raise capital from good investors if they are working on a big problem and are showing exceptional progress. The dynamics around VC ownership come into play once a few different investors are interested in a company’s round. But in the final innings of discussions with investors and deal negotiations, I find many entrepreneurs to be pretty surprised at how ownership targets drive the dynamics of the deal. It’s a little arbitrary, but it pays to be thoughtful about this stuff because it can have meaningful downstream implications.
I was chatting with Nick Chirls from Betaworks recently and we talked a bit about Angelist syndicates and the incentives surrounding it. Betaworks was one of the first investors to use Syndicates on the platform in their investment with Estimote (a really cool company, BTW).
Nick reminded of an interesting perverse incentive that syndicates creates. Note, this IN NO WAY drove Betaworks’ decisions in this case, but he just pointed out that these incentive will exist almost by definition of how syndicates works. Essentially, Angelist syndicates creates an incentive to:
- Invest a little less
- Be less price sensitive
- Have a lower bar
Why? The answer is a) “free” leverage on one’s dollars and b) deal-by-deal carry.
On a), this drives the price sensitivity. As an investor, you are essentially now able to get more of an economic interest in a company than before on the same dollars. Thus, you are on balance more tolerant of risk (thus lower bar) and can get the same financial outcome even if you invest at a slightly higher price (thus less price sensitive). Or, another approach is to say that you can now get the same economic interest with a smaller investment (this, invest less).
The other (and to me, the bigger) issue here is the incentive around deal by deal carry. In early stage investing, deal-by-deal carry is awesome for the person doing the investing (the VC or the angel), and is pretty bad for that person’s investors. Almost no early stage funds have deal-by-deal carry. The reason is that the riskiness of early stage investing means that one has to build a portfolio of investments to be successful. Our profits in this portfolio of investments drive our carry in the fund.
But obviously, a VC or angel should be required to return their investors’ capital first before really earning that carry on the profit. However, this is not the case with deal by deal carry. You can lose money overall, but earn a nice chunk of carry along the way.
Simple example: Let’s say I’m a $10M fund. I invest in 10 companies at $1M each. If 9 completely fail and 1 makes a 9X return, I have returned $9M of the $10M. I earn no carry.
Now let’s say I’m an angelist syndicator. Let’s say I make a small investments in 10 companies, but attract $1M in syndicate capital for each of those companies. So, it’s like a $10M fund. If 9 fail and 1 makes 9X, I am able to get a carry on that 1 9X return. So, if I charge a 20% carry, I make 20% x $8M, which is $1.6M (of which Angelist takes a cut). That’s pretty awesome when my overall performance was actually a loss of capital.
Of course, because each syndicate has different investors, there is no way to force me to pay back my overall principal before taking carry. But the incentives in this situation is for me to be more risk loving overall. And if I can get really good leverage on my dollars, I could basically write pretty small checks into a lot of companies, but bank on the beautiful benefits of deal by deal carry to save the day for me.
This should come to roost at some point, because over time, syndicate members will stop following an angel who loses money on average. But this won’t happen very quickly as long as I catch a hot deal now and then. Even if I lost money along the way, but got a 20X on one investment, I think that one 20X would be enough to attract more capital behind me for a few years. Obviously, not all actors on angelist are going to do unnatural things because of these dynamics (the best definitely won’t). But these incentives definitely exist and aren’t great for a “follower” on angelist, or for any investor in any early-stage fund that gets deal-by-deal carry.
I think Nick is going to have some specific thoughts and reactions to this, so I look forward to continuing the discussion!
I continue to be on a kick towards better and more systematic decision-making.
One exercise I’ve tried is to codify my mental decision-tree for early stage investing. Essentially, it is the internal dialog I tend to have with myself when evaluating companies. But by charting it out, it helped me to be more explicit about what attributes I’m looking for, and how my opinion about different attributes feeds into an ultimate decision.
Rather than replicate the entire decision three, I thought I’d share just a flavor. The first high-level questions I ask are:
1. Is this an awesome founder?
2. Is this a market I want to have an investment in? This incorporates both the total size potential of the opportunity and the attractiveness of the market itself.
3. Is there strong founder market fit? Is this an authentic idea, and does the capability of the founding team map well towards the needs of the market in the early stages of the business?
Here is the tree with some commentary on the different combinations below.
So, a couple combinations:
- If 1 = yes, 2 = no, it’s usually a no. I’m generally a believer that markets beat teams. But that said, I’m actually typically very open minded about what markets I’d like to have an investment in.
- If 1=yes, 2=yes, and 3=no, I think it’s difficult to invest pre-product and before some evidence of product/market ft. I think founder/market fit is incredibly important early on. We have invested in some companies of this profile where we loved the founder but our perception was that founder/market fit wasn’t that strong (ThredUp is a good example). But in those cases, very early metrics went a long way towards mitigating the risk.
- If 1=YES YES YES then we might still move forward early on. Basically, this is the rare (0.01% of less) exception where you feel like you have HAVE to back a truly extraordinary founder. In the case where this extraordinary founder is pursuing an unattractive market, we need to ask ourselves, is this founder wrong about the market, or could we be wrong?. We still tend to have a bias that markets tend to win, but we will dig to figure out if we aren’t missing something. If the market is attractive and there just isn’t great founder/market fit, we will be open minded as well. There are just some rare entrepreneurs that you want to be in business with in almost any circumstance. But it’s definitely a very small minority. Jack Dorsey comes to mind here with Square. Not exactly founder/market fit, but it didn’t really matter.
- Sub-point: Actually, in a way, Jack did have founder/market fit with square because of what the company required. His personal brand and influence in the technology industry enabled him to raise large amounts of capital with relatively little traction and get to the very top of all major financial institutions, both pretty important advantages in starting a payments company of this sort.
- If 1 = Yes, 2 = yes, 3=yes, then I’d seriously consider investing pre-launch. This isn’t a formula by any means, but I find that when founders I really like are going after an authentic idea in a space I like, I’m much more willing to jump in pre-product. This describes quite a few of our portfolio companies actually. Not all will work out, but in many cases, I feel perfectly fine about having taken the plunge.
- If 1 = No, 2 = yes, 3=yes, then I’d need to see some evidence of product market fit or traction. Even then, it’s really hard to get excited about an investment unless I’m really excited about the people leading the company. But I am also congizent that how one comes off in a fundraise is not always perfectly correlated with their capabilities – and there is something about delivering results that makes you think twice about your first impressions of people. If the reason that 1=No is because of any fear of integrity or something similar, then it is really a no-go. But if it’s more of a question about capabilities, then it’s important to stay open-minded. It’s easy to underestimate people.
Of course, there is a lot more going through my mind, plus some really important “softer” considerations that are beautifully articulated by my old colleague Bijan here. The point of this post isn’t to say that this is the right way to do things or to say that I follow this approach strictly. But I did think it would be interesting for founders to see an attempt at simplifying what is usually the black box of an investor’s mind.