CB Insights published this report on the relatively performance of seed VC’s and non seed VC’s. It’s pretty interesting.
Some quick thoughts.
1. There is a danger in looking at averages. Venture tends to be a game of asymmetric outcomes, and it’s not just the companies, but also the investors in those companies. In the report, the claim is that seed rounds with larger VC’s fare better in terms of their percentage probability of raising their next round of financing. The stat here is 54% if the round has a seed VC, and 59% if the round has a large VC and seed VC. However, the best seed funds far outperform this statistic. Anecdotal data is that the best seed funds that we work with often see a 60%+ hit rate for outside-led follow-on rounds (our number is in the 70%+ range). As in all things in venture, the best performers are what matters, and I would love to see how this data stacks up for the top tier funds. My guess is that the top-tier seed funds would do better.
2. There are two strategies for seed investing among larger funds. One strategy is to do relatively few seed investments, and to treat those more or less similarly to a full-scale investment. The lead partner feels like their reputation is on the line, and the company went through what is more or less a full process. I would expect those scenarios to have a pretty high hit-rate of seed to follow-on, probably in-line with the top-tier seed funds. The second strategy is to do many many seed investments and see what sticks. This is the classic case of a large VC building a basket of options. This happens a bit less these days than it used to, but it’s still fairly common and opens the door to meaningful signaling risk. And I can tell you for sure that the hit rate of those seeds is far below the 54% mark, even for very good funds. How does one tell which bucket you are in if you are a founder? See my post here.
3. I didn’t look that closely at the report, so I’m unsure about 2 things regarding the data (but perhaps the answer is there somewhere). The first is what is included in a “follow-on” round? Even in an option seed scenario, there is usually some sort of a second bite at an apple or seed extension. And usually, if it’s a matter of a few hundred thousand dollars, the big VC will participate in that round. Is a $1M seed extension counted as a successful follow-on round? If the big VC is in the seed and writes another $100K check in the seed extension, I could see that still being counted favorably because a) it is a follow-on round and b) there is a big VC in that round. The second question is how complete this data is. A number of large VCs make seed bets under different entities, so it’s not immediately obvious whether they are investors (unless you are an industry insider, in which case, it’s widely known). Also, many seed investments never make it onto a larger funds website until they do raise another round of financing, which again could skew the data. That said, perhaps CB Insights found a way to adjust for these, it just wasn’t immediately obvious to me.
Quick parting thoughts for entrepreneurs:
1. The report does show that even if it’s completely accurate, you are better off taking money from a seed focused VC fund. This makes sense, as it’s helpful to have other folks around the table who do seed investing for a living, have relevant expertise, and have the time and incentives to really help you to win.
2. Signaling risk is an issue. It’s not a complete deal killer, but it’s not a non-issue. We often invest with larger funds and have a great partnership with quite a few of them. The right fund can create a bunch of leverage through their portfolio support services, deep relationships in specific industries, and ability to quickly add more capital to a company if things are working. But, I generally encourage entrepreneurs to make sure that they are being considered as close to a “full scale” investment as possible, even if it means going through a bit more of a rigorous process to get the initial “yes”.
3. Like the companies we invest in, the performance of the funds that participate in the early-stage ecosystem will exhibit a power-law. The best funds will outperform, the average funds will underperform. It’s important to be considered one of “the best” in some sector or sub-category of any market, whether you are an investor or company. Sarah Lacy has a nice write-up on that here.
Every now and then, I get a big reminder of just how helpful it is for entrepreneurs to have co-founders.
Of course, having the wrong co-founders is really damaging. Also, there are many successful founders who have done great without a meaningful co-founder. But for the most part, I tend to agree that the best performing early stage teams are led by at least two or three founders who are meaningful co-owners with complimentary skill sets.
There are lots of reasons for this. But beyond the practical stuff, I think a big part of the benefit is largely emotional. Couple examples.
First, I think having co-founders smooths out the emotional roller-coaster of being an entrepreneur.
My partners and I co-founded NextView together and are all equal partners. We’ve known each other for a long time, but have grown closer as colleagues and friends over the years we have been working together. Each Christmas, we treat ourselves to a nice dinner with our wives and often reminisce on the past year.
During one of these dinners a couple years ago, we were reminiscing on our first year getting NextView going. We were in a good mood, and one of my partners remarked:
“We’ve come a long way from that Thai lunch”
My response to that was: “What Thai lunch?”
It turns out, 8 months prior this, we had heard some disappointing news that took the wind out of our sails a bit. We then went to lunch together, and had a bit of a solemn discussion about what had happened.
The funny thing was, I didn’t really think much of what had happened, and that day was just like any other day having lunch with my partners. It wasn’t that big a deal. But for one of my partners, it’s was an early low point, and one that stuck out in his memory a few months later.
The point is that starting a business has many highs and lows. Some of those lows are very obvious, and it’s nice to have co-founders to share the disappointment with. But a lot of times, the lows aren’t all that bad, they just happen to hit you at a time when you are particularly fatigued or emotionally vulnerable.
When that happens, it’s nice to have co-founders who remember those incidents like just another thai lunch. It smooths out the roller-coaster.
Second, having co-founders allows for rests in between sprints.
Founding a company is strangely both a marathon AND a series of sprints. I notice this quite a lot with seed stage companies. When the business is new, there is a lot of excitement and passion. Often, the team and founders can sprint at near top-speed for the first 12-18 months and conquer the immediate obstacles ahead.
But, after these companies see some success, raise a series A, and continue to build the business, you realize that there is so much more to do. Employees fatigue, early business assumptions fail, competitors become aggressive, bad hires start to hurt. Etc etc. You feel the pressure to continue sprinting, but you look back and say “I’ve been sprinting for two years, and I don’t think I can keep sprinting for the next 3, 4, 5, or more”.
Co-founders give you a bit of leeway so that the ship can keep moving fast even if all of you aren’t sprinting at the same time, all the time. Not that much leeway, but a bit.
Again, from our experience, my partners and I pride ourselves as being hungry and dedicating the prime years of our careers to NextView. Venture is not an early retirement job for us after we got hit bThis is very much our startup and our baby.
As a result, we sprint pretty hard all the time. But things happen outside of work that make sprinting continuously difficult. For me, that happened the middle of last year when my Dad passed away after a prolonged bout with cancer.
My parents both live in Hong Kong, so over the years, I’ve taken somewhat frequent trips to visit him during his treatment. But when he took a turn for the worse in the beginning of 2012, that activity amped up quite a bit. My little daughters both earned priorty status on United over those few months from frequent trips, and I was a bit of an emotional zombie for a time.
Trust me, even though I felt like I was working hard, I wasn’t at my best. Having partners allowed us as a team to continue making promising investments, and relieved a bit of pressure on me to sprint quite as hard during a time when it just wasn’t possible. I appreciated it a ton, and am super-excited about a number of the investments we made during that period.
I know that starting a venture capital firm is fairly different from starting a technology company. But I think that the emotional benefits of having great co-founders is pretty similar.
The NY Techstars program is a few months away. The latest SeedCamp class just swung by Boston earlier this week. And Boston’s Techstars class started this past Monday. I know some of the teams, and have met some of the founders briefly. It’s an exciting class!
Techstars and many other accelerators are “mentorship driven”. This means that in the first few weeks, teams are bombarded with many many mentors. Some are just smart folks with no direct experience in your business, some are investors, some are entrepreneurs or operators with deep relevant experience.
With about half of the teams I talk to, I learn that they have gotten conflicting advice from equally smart and impressive people. It’s confusing, and hard to make sense of. Also, with almost all teams, there is a desire early on to impress people you are talking to. You get excited when a mentor gives you positive feedback and is interested in your story, and you get discouraged if a mentor thinks there are major problems or just doesn’t get what you are doing.
I find that the best teams soak in the feedback they receive, but quite quickly take that feedback and translate it into maniacal focus. Teams that struggle have a hard time making sense of different streams of advice and end up being handicapped by trying to be all things to all people.
My basic advice is this. When you take meetings with mentors, you will get a sense pretty quickly of whether you are talking to a skeptic, or a believer.
Early on, you should really listen to the feedback of the skeptics. Seek that feedback out. What you will find is that quickly, that skepticism will take familiar patterns. You will identify either 1-2 fundamental assumptions about your business they think is wrong, and/or 1/2 risks to the business that they think is just too great or too hard to overcome.
In the first half of the program, look yourself in the mirror. Are the skeptics right? Is there a fundamental problem? If so, do you need to do a great pivot? If not, are there risks that are truly great and are they surmountable?
The answer to these questions might actually be no. You might believe in your heart of hearts that the skeptics are wrong. The fundamental assumptions of your business are counter-intuitive, but you have the data, conviction, or experience to know your assumptions are right. The risks that seem too great are surmountable, and you think you know how to do it.
If that is the answer, then don’t be bashful about your conviction. The second half of an accelerator program should be focused on the true believers. The skeptics can only advance you so far, but after a while, they will either never be convinced, or their feedback will prove shallow since they will be stuck on the same issues over and over again. The true believers are willing to go further with you on the journey, but will help you identify pitfalls you are likely to face further down the path. They will help you address these issues, give you more tactical feedback, and probably point you in the direction of other true believers are will likely be your advocates and investors come demo day.
When demo day comes around, tell a controversial story. Talk about secrets, as Peter Thiel suggests. ”Most people think X… but the truth is Y.”
That’s the best pitch. Lots of people may hate it, but it will be more likely that the people who don’t will love it, and be thrilled to help you see success. I think it’s also more likely that they will think that what you are doing is really BIG.
Good luck! I’m excited to hear your story, whether I end up being a skeptic or believer.
Early stage companies are often refining their stories or narratives. It’s important for lots of reasons – inspiring team members, recruiting, creating focus, getting effective press, fundraising, etc.
From a fundraising perspective, one of the challenges of telling one’s story is that as an early stage company, you are by definition very very small, but you are trying to convince an investor that you can be very very big. I’ve talked about the need VC’s to shoot for HUGE outcomes before.
Telling a BIG story isn’t always that easy. Some market opportunities aren’t obvious at all. For example, it was hard to do a bottoms-up or top-down analysis of a business like TaskRabbit in the early days because the company was creating a market that didn’t really exist. Yet, Leah Busque was able to convince some investors (and now quite a few others) that what they are trying to do is indeed very big.
Sometimes, companies try to use analogies to cast a big vision. Other times, they use buzz words or put themselves in the path of mega-trends. For example:
- We are Pinterest for X
- We are a Big Data company
- We are harnessing the power of collaborative consumption to create a platform for native ads
Sometimes, an elaborate story can work. But I think most of the time, simplicity wins. The problem with simplicity is that it’s harder to suspend disbelief. Everyone “gets” the story, they just don’t necessarily believe it. But fundraising is about finding true believers, no converting skeptics.
Two stories I always remember that illustrate this point. Both were about 4 or 5 years ago before I co-founded NextView.
The first was when I was looking at an investment in the series A for a company named Lumos Labs. It’s a company that makes brain training games, mainly targeted at adults. At the time, the company was quite early, and had less than a hundred thousand users. Conventional VC wisdom is usually that gaming companies are hard to back because they are hit-driven. Also, it appeared that this market was perhaps a little small, and the novelty was wearing off in the wake of Brain Age and other similar games popular on the Nintendo DS system. That said, I liked the founder and was trying to figure out how to position the company internally as “big enough”. I did a due diligence call with one of the company’s seed investors, who happened to be an old boss and friend from Ebay named Michael Dearing.
During the call, I asked about market size, and how he saw the company evolving. Was this going to be a platform for other game developers? Was the company going to go into other types of software or products around brain training and aging? Was virtual goods an additional monetization option?
Michael thought about the question for a moment. Then he responded pretty matter-of-factly: “I just think they are going to find lots and lots of people who want to play their games.”
That wasn’t the answer I was hoping for. But, turns out he was right. The company has had over 25M members and I believe is doing very well.
The second story happened later that same year (or maybe the year after). This time, I was meeting with John Katzman. John is the founder of a number of education companies, including Princeton Review and 2U. At this point, I was talking to join about the series A for 2U (known at the time at 2Tor) when the company was pre-launch.
For those of you who know 2U, it’s an incredibly promising and disruptive company. They partner with top universities to offer full degree programs online. The pitch to schools is that they can expand their impact many times over, without sacrificing quality, and grant full degrees even though most or all classes are taken online. Today, the company partners with great schools like UNC, Georgetown, Duke, USC, and Northwestern to name a few.
When he introduced the company to me, he could have told a very big, broad story about the future of education, the pressure facing brick and mortar shools, and the promise of the internet to disrupt the classroom. But, he didn’t lead with that. He had a very simple pitch:
“Without exception, online education sucks. We think it can be really great.”
I think there was an expletive in there somewhere
Even today, 5 years later, that same idea is on the homepage of their website.
Wonderfully simple… and big.
I saw this recent list published by PrivCo today, and I couldn’t stop myself from writing a quick post.
It’s actually a teaser report for readers to go purchase the full report and underlying data. I have to say, DO NOT BUY this report. Even if the data is accurate, the marketing is so misleading I think one should avoid it out of sheer principle. The report is here.
The title of the report is “Top 20 Tech Venture Capital Firms of 2012″
The chart in the main body is titled “PrivCo’s Ranking of the Most Successful Venture Capital Firms (2012)”
The giveaway is in the subtitle below that: “ranked by total number of private tech co. exits”.
Hmmm… ok, this is wrong in so many ways.
No disrespect to the outstanding firms on the list. Many of them are really excellent and deserve to be on anyone’s top 20 list. But there are some very obvious omissions and clear mistakes from the list if you are judging based on 2012 exits.
First obvious problem – Facebook went public in 2012. There is no way on earth any publication should be able to share a list of top firms in 2012 without putting the earliest backers of Facebook at the very very top. That would be Accel and Greylock, which are number 8 and 16 respectively.
Second obvious problem, I don’t see the underlying data, but there are some funds that had many many solid exits in 2012 that are not on this list. Most puzzling to me is the omission of General Catalyst. In 2012, they have IPOs for Demandware, Kayak and Brightcove. That’s Billions of dollars in exits, and I imagine they must have had many other smaller exits as well. I’m puzzled why they wouldn’t make the list even under PrivCo’s metrics. Consider also the omission of CRV (Yammer series A investors) and USV (Indeed series A investors).
The bigger issue is just that the headline and the actual data for performance are so skewed. Main problems in a nutshell:
1. Ownership, cost basis, and preferences matters. You could own a lot of a company at a very low cost basis at exit, and do fantastically well. You could own very little of a company at exit and not do nearly as well as it would seem. You could own stock that is junior to other investors and actually lose money in a mediocre sale. Not taking these things into account is like judging a basketball team by the number of dunks they have, not by their number of wins.
2. Exits in a given year is a misleading statistic, because it might mask the underlying funds underneath those investments. If all the exits in 2012 come out of the same fund, then perhaps that is a great year. But if a fund has 5 small exits, and all 5 are out of 4 different funds, well, that’s not very good at all.
3. Venture Capital performance tends to be about outlier, outsized returns that drive fund economics. The one great exit can be much more meaningful than dozens of mediocre exits. Moreover, one great exit for a $1B fund might return a lot of money, but only return a relatively small percentage of the fund. Whereas a more modest exit for a $75M fund could return the whole fund. From the perspective of a $5M investor in those funds, the more modest exit is much much better than the big exit.
4. More should not be better. You just can’t look at exits in the vacuum of an overall fund. The theoretically best VC in the world makes only 1 investment in 1 successful company. Yes, based on number of exits, that fund would not look very good. Measuring based on volume of exits tends to favor funds that make lots and lots of investments, even if each investment is tiny and/or a tiny percentage of their funds. The best funds tend to have relatively concentrated portfolios rather than a “spray and pray” approach. Now, this isn’t always true, but that’s why you need to factor in ownership, cost basis, and preferences.
Ultimately, I just think it’s misleading to put a headline like that on a report called “The Top 20 Venture Capital Firms” without taking these factors into full account. And I’m honestly shocked that other sites with sophisticated writers republished the post. Ugh.