Posts from VC & Technology

Reserves

One of the unique things about early stage investing is the ability (and in my view, the need) to continue to invest in the companies for multiple rounds of investment.

Late stage, public market, private equity, real estate, and most other popular forms of investing typically involve a single or a time limited series of investments.

But at USV, we typically will make four to six investments in a “name” over five to seven years.

And we do this style of investing with a fixed pool of capital.

So we have gotten very analytical about modeling out our reserves for our follow on investments.

What we do is maintain a spreadsheet of every investment in a given fund and the likely amount and timing of future follow on investments as well as the probability of us having the opportunity to make those investments.

We then run a Monte Carlo simulation 1000 times and draw a distribution curve of outcomes and then manage our funds against that.

We have a “cushion” for error which is our ability to recycle roughly 20% of our funds and that has come in handy on every fund we have managed at USV.

I think the proper allocation of follow on capital into the portfolio and making sure you can follow your winners and defend your position in certain situations is absolutely critical to producing top tier returns.

It is not as important as portfolio selection (which comes from our thesis) or our work on the boards of our portfolio. Those two things are the most critical factors in our performance.

But I think capital allocation/fund management is third on the list and is a missed opportunity for many early stage investors.

Certainty Of Close

On Friday, I had two separate conversations with founders about fundraising strategies.

Both had an easier path that would likely get them to a closing quickly but might cost them some economics and a harder/longer path that would allow them to maximize economics.

I gave them both the same advice which is that certainty of close is super important, particularly early on in a venture when you see an opportunity and want to capture it before someone else does.

Most decisions are not black and white. There is usually a lot of grey in between. Fundraising is always like that. There is rarely an obvious right answer.

Many founders are advised to run a competitive process, get as many quality offers as you can, and use that competitive dynamic to maximize economics.

While that is a great strategy if you have the luxury of time on your side and the ability to spend several months focused on raising capital, there is often merit to the quick close that maximizes certainty over other things.

Both conversations on Friday ended in a discussion about people and how important they are in all of this. The answer to that is that they are the most important factor of all when raising capital.

If you are comfortable with the people involved and have a high degree of confidence that they will be great partners, then everything else is secondary. That is true for at least the first five years of a venture. At some point, in very late stage or public financings, the people issues lessen and you can optimize for other things.

But early on, if you optimize for anything, optimize for the people you work with. Otherwise you are taking on risks that can and will blow up in your face.

After that, I might put certainty of close next on the list, as long as the economics of the “bird in the hand” are ones you can live with and the people are known quantities. You can rarely go wrong with that combination.

Whales Not Unicorns

I have been vocal here that I do not like the term Unicorn to describe highly valued venture-backed startups. Unicorns are mythical creatures that don’t really exist and highly valued venture-backed startups do exist. They might be rare, but they are not fictional.

A better word would be Whales. And it turns out that the Whaling industry in the United States in the 18th and 19th centuries looked remarkably similar to today’s venture capital business.

Some of my friends and colleagues have been texting and tweeting about a book called VC: An American History by Tom Nicholas. So I got it on my Kindle and the first chapter is all about the Whaling industry and its similarities to the VC business.

Here are some photos I took of the first chapter on my phone.

This is a chart that plots the distribution of returns by whaling voyage vs venture capital fund.

This is a diagram that compares the structure of the whaling industry to the venture capital industry.

And this is a chart that shows the performance of the top 29 whaling agents. This is very similar to charts I have seen that compares the performance of the top venture capital firms.

So while Unicorns are made up creatures, Whales are not. And given the similarities between a highly successful venture capital investment and a highly successful whaling voyage, I am going to start calling the big winners in the venture industry Whales. I hope it catches on.

A Blast From The Past

I saw this in my twitter feed today.

Almost a decade ago, my friend John Heilemann interviewed John Doerr and me at Web 2.0.

It is interesting to go back a decade and see what we were talking about then.

Some of the same issues exist today. Some of the questions we debated have been answered now.

It’s about forty minutes long.

Disappointment

Being a Knicks fan teaches you a lot about disappointment. At one point this spring, we thought we were going to get a couple top free agents and the first pick in the draft. We ended up with a lot less.

Fortunately, I have learned a lot about disappointment in three decades of backing early-stage startups. Our business is one where a third of things we do don’t work out at all and another third deliver a lot less than we had hoped when we pulled the trigger. Only a third of our investments deliver on what we expected when we made them.

Fortunately about ten percent of the investments we make so vastly outperform our expectations, that they make up for everything else we do.

So we live with a lot of disappointment. And one of the questions I struggle with is how much of that disappointment do we share with the founders and teams we work with.

Certainly feedback helps founders. But if the feedback is too negative and too downbeat, it is not helpful and can also lead to tune-out.

So I have found that many times I need to bite my tongue and take the disappointment in stride and chalk it up to the cost of doing business in early-stage investing. You have to be an optimist to make early-stage investments and you can’t let the disappointments take that optimism out of you.

Which takes me back to the Knicks. It has been twenty years since the Knicks had a winning culture. That is a lot of losing to endure. But I keep buying the seasons tickets in hopes that things will change. I am going to stay positive and hope for the best.

Understanding Gender Bias In Venture Funding

USV portfolio company goTenna‘s founder and CEO Daniela Perdomo and USV analyst Dani Grant did some number crunching on VC funding and published the info last week.

The good news is that in business sectors where women are well represented in the customer set, women founders are raising more (on a pro-rata basis) than their male counterparts.

The bad news is in the rest of the business sectors, women founders raise a lot less (on a pro-rata basis) and in “deep tech” the numbers are particularly bad.

These conclusions ring true to me based on what I see in the market.

I believe women founders have made a lot of progress in the last decade in raising VC. There are many more of them approaching VC firms for capital and many more of them getting funded. But it seems most of the progress has been in sectors where women are well represented.

The progress in sectors where women are not as well represented is almost non-existent. We in the VC sector need to understand the conscious and unconscious biases at work when we meet with a women founder working in one of these under-represented sectors and fight them off.

Founders like Daniela, when they are successful, will help a lot. There is nothing like success to change people’s opinions, conscious and otherwise.

Why USV is Joining the Libra Association

A new blockchain & cryptocurrency project, Libra, was announced today. Libra has been incubated by Facebook. USV will be one of the founding members of the governing body, the Libra Association. Libra is a stable, fiat-backed cryptocurrency that will launch inside some of the world’s largest consumer-facing applications. We believe Libra has the potential to be the catalyst that brings the entire cryptocurrency and cryptoasset market into the mainstream.

When USV invested in Coinbase in early 2013, our rationale was that digital currencies and digital assets (like Bitcoin and beyond) were a breakthrough technology, similar to TCP/IP, HTTP and SMTP. But we also knew that it would take significant investment in the surrounding infrastructure to make them useful for businesses and consumers, just like it did with the Web back in the 80s and 90s. At the time of that investment, we wrote:

“There is much that must be built on top of of these digital currencies to make them work well enough to support real business at scale”

This has proven to be true. If we look back at the past 10 years since the invention of Bitcoin, we have seen a lot of infrastructure built to support an increasing variety of use cases. But there is still a long way to go.

We think about the crypto sector as the intersection of Finance 2.0 (“Money Crypto”) and Web 3.0 (“Tech Crypto”), and what we have seen is that the “Money Crypto” use cases have been the earlier to materialize, especially “slow money” use cases (those that don’t require high throughput):

For consumer use cases (including both Finance 2.0 and Web 3.0 use cases), the biggest barrier to date, beyond technical scalability, has been the rollout of crypto wallets to mainstream consumers. As of today, there is still no mainstream web browser with crypto built-in, no mainstream phone with crypto built-in, and relatively few mainstream applications with crypto built-in. As that changes, crypto assets have the potential to move from being curiosities for enthusiasts to being default internet and financial infrastructure.

Once we have crypto-compatibility built-in to applications, browsers, and phones, many new behaviors and use cases will emerge. The financial system, in general, will become more accessible (smartphone adoption is outpacing bank account adoption globally). Payments can become faster, more reliable and less expensive. Magical new user experiences will be possible due to interoperability and reduced friction, the same way that the Web’s native interoperability unlocked countless new use cases and experiences. And, perhaps most importantly, we will open the door to self-sovereign digital identities (private keys) that are the underpinnings of user-controlled privacy and control of data.

So as we think about the potential drivers for mainstream crypto adoption, a simple, fully-collateralized, cryptocurrency used inside the world’s largest applications, touching hundreds of millions or billions of consumers, is perhaps the most promising one. It is our hope that Libra will serve as a major on-ramp to cryptocurrencies and cryptoassets, to the benefit of the entire ecosystem.

USV will be joining as a founding member of the Libra Association, the governing body that will manage both the Libra technology and the Libra Reserve. As one of the initial 20 members of the Association, we will have the opportunity to participate in design and policy choices that will shape the network. It is worth noting that Facebook will be just one equal member of the Association, which was an important factor in our decision to join.

This will be a large and complex undertaking, as there are many unresolved and challenging questions, involving the technology itself (security, privacy, path to decentralization), the regulatory environment, and the nature of the ongoing governance. In some ways, the initial Association resembles a constitutional convention, where the main goal is to draft the long-term governance mechanisms themselves.

To be clear, we view this as both an ecosystem investment and a financial investment. In addition to participating in the governance process at the Libra Association, USV plans to invest in the Libra Reserve, which will provide the stability for the currency. This is an unusual type of investment for us, but we have learned that investing in the crypto sector requires us to explore a variety of new investment structures.

We appreciate that Facebook invited USV to be an initial founding member of the Libra Association and we take our role in that seriously. We will advocate for those things that USV values most: openness, transparency, decentralization, and permissionless innovation. We think that those features will help accelerate adoption within the entire crypto ecosystem — including our many existing investments in the space — and also help Libra succeed in its goals.

This has also been posted on usv.com.

Secrets Of Sand Hill Road

One of the many great things about vacations is reading books. Vacation is the one time that I can really prioritize reading books (as opposed to everything else I read).

I just finished Scott Kupor‘s Secrets Of Sand Hill Road, a book for entrepreneurs about rasing capital from venture firms.

Scott makes the point numerous times in the book that the capital raising process is asymmetric for entrepreneurs in that they do it a few times in their career and VCs do it every day.

That is true for the pitch meetings, the negotiation process, and the post financing relationship too.

What Scott does in this book is break down every part of the process and explain it in plain english so that entrepreneurs can understand what’s going on and why it matters to them.

That last part is important, this book is written for entrepreneurs, not VCs.

Scott uses real world examples, mostly investments made over the last decade by his firm A16Z, to make the lessons he is delivering more “real.”

And he uses spreadhseet examples in one chapter and shows how various events can change the cap table for everyone.

It’s very much a “how to” book, more practical than theoretical.

There have been other books written about this topic, I like Brad Feld and Jason Mendelson’s Venture Deals, which is on its third edition now.

Jeff Bussgang’s Mastering The VC Game is also great.

You could teach an MBA or undegraduate course on capital raising for entreprenuers with these three books.

It would be a great course.

If you plan to be raising venture capital for your startup and don’t have the benefit of experience or a fantastic course on the topic, I would strongly recommend you pick up Scott’s book, or all three books, and spend some time reading them now or on your next vacation.

Seven to Ten Years

I have worked in three venture capital firms over the last thirty-three years and am intimately familiar with the performance of the fifteen (ish) venture funds raised and invested by these three firms. Much of what I have written about fund management and investment performance here at AVC over the last sixteen years comes from my observations of these funds and firms.

Starting in the mid-00s, The Gotham Gal and I started investing in other venture capital funds, always limiting these investments to firms where we knew the partners well and had sat on boards with them.

And The Gotham Gal started angel investing around the same time, often writing the first check into startups. She has made something like 140 angel investments over the last dozen years, mostly into companies founded by women.

We keep good records on these personal investments and I now have another data set to observe.

Across these three sources of data (my firms, other firms, angel investments), there are well over 1000 individual angel, seed, and early stage venture capital investments over four decades.

I have no plans to publish this data. It is not in a single database and there is a ton of confidential information in it.

But I can observe things about this data and have been doing so and will continue to do so.

One of the great truths about early stage investments is that you have to be patient with them. The losses come early and the winners take longer to realize.

It takes seven to ten years to get to real liquidity in a portfolio of early stage venture investments. You can’t short cut it. It just takes time. But come years seven, eight, nine, and ten the returns will start coming in.

I am not sure why seven to ten years and not five to seven or not ten to fifteen. It’s seven to ten. That’s how it has always been and seemingly always will be.

Unsafe Notes

I was reminded yesterday how much of a shit show raising seed capital via SAFE notes is. I can’t and won’t get into why I was reminded of that, but let’s just say nobody wants to go there.

So I thought I’d repost the important parts of a post I wrote on this topic a couple years ago.


I have never been a fan of convertible notes. USV has done quite a few convertible and SAFE notes. We are not opposed to convertible and SAFE notes and will not let the form of security the founder wants to use get between us and investing in a company that we like.

But I continue to think that convertible and SAFE notes are not in the best interests of the founder(s).

Here is why:

  1. They defer the issue of valuation and, more importantly, dilution, until a later date. I think dilution is way too important of an issue to defer, for even a second.
  2. They obfuscate the amount of dilution the founder(s) is taking. I believe a founding team should know exactly how much of the company they own at every second of the journey. Notes hide this from them, particularly the less sophisticated founders.
  3. They can build up, like a house of cards, on top of each other and then come crashing down on the founder(s) at some point when a priced round actually happens. This is the worst thing about notes and doing more than one is almost always a problem in the making.
  4. They put the founder in the difficult position of promising an amount of ownership to an angel/seed investor that they cannot actually deliver down the round when the notes convert. I cannot tell you how many angry pissed off angel investors I have had to talk off the ledge when we are leading a priced round and they see the cap table and they own a LOT less than they thought they did. And they blame the founder(s) or us for it and it is honestly not anyone’s fault other than the harebrained structure (notes) they used to finance their company.

The Series A focused VC firms that often lead the first priced rounds get to see this nightmare unfold all the time. The company has been around for a few years and has financed itself along the way with all sorts of various notes at various caps (or no cap) and finally the whole fucking mess is resolved and nobody owns anywhere near as much as they had thought. Sometimes we get blamed for leading such a dilutive round, but I don’t care so much about that, I care about the fact that we are allowing these young companies to finance themselves in a way that allows such a thing to happen.

Here are some suggestions for the entire angel/seed sector (founders, angel investors, seed investors, lawyers):

  1. Do priced equity rounds instead of notes. As I wrote seven years ago, the cost of doing a simple seed equity deal has come way down. It can easily be done for less than $5k in a few days and we do that quite often.
  2. The first convertible or SAFE note issued in a company should have a cap on the total amount of notes than can be issued. A number like $1mm or max $2mm sounds right to me.
  3. Don’t do multiple rounds of notes with multiple caps. It always ends badly for everyone, including the founder.
  4. Founders should insist that their lawyers publish, to them and the angel/seed investors, a “pro-forma” cap table at the closing of the note that shows how much of the company each of them would own if the note converted immediately at different prices. This “pro-forma” cap table should be updated each and every time another note is isssued. Most importantly, we cannot and should not continue to allow founders to issue notes to investors and not understand how much dilution they are taking on each time they do it. This is WRONG.

Honestly, I wish the whole scourge of notes would go away and we could go back to the way things were done for the first twenty years I was in the venture capital business. I think it would be a better thing for everyone. But if we can’t put the genie back in the bottle, we can at least bottle it up a bit better. Because it causes a lot of problems for everyone.