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LionBird Bites Aggregation

Part of why decision making on follow-on rounds is so difficult is that it’s personal.

On the other hand, making decisions by committee tends to be challenging as well.

So how can VCs best utilize deal champions’ first-hand knowledge of a company while holding them accountable to biases?

It does not include the most important measure — estimation of risk adjusted rate of return above our hurdle rate — as in my experience this is impossible to forecast in any meaningful way at the early stage.

No reserve allocation process is perfect, but strict measurement of return on reserves coupled with internal documentation from deal leads on who we follow up on may be the best way to improve over time.

But the VC board member <> Founder relationship is a nuanced one, sometimes making tough feedback tough to deliver.

Why is this the case? You are dealing with human psychology.

When the facts of the world become misaligned with what you would like to be true of the world, you will generally find a way to reject the facts. It creates cognitive dissonance.

If this is the case, what can we as VCs do to help founders become more objective about their startups? Read on for more.

It’s always better when CEOs come to the conclusion on what needs to be changed in their businesses on their own.

On the flip side — it’s always worse if you as their VC backer have to be the bearer of bad news.

Generally, it’s a good idea not to disagree with them at that moment and just say “Ok, you are a brilliant person, I have no doubt you can turn it around”. But then what you must do is partner with them on a timeline and try to write down what are the leading indicators and benchmarks that things have actually turned around.

More from Annie Duke -
What you’ve done is brought the founder out of the moment and had them think about some version of themselves in the future.

The identity that we actually want to protect is that of us today, and we don’t really think about the person in the future who is going to exist as us. So we’re able to see that person more like we are an outside observer.

You’ve also agreed with them that you believe they can turn it around, but you’ve gotten them to tell you what “turn it around” means, and now you have benchmarks which become what I call “Kill criteria”. If you miss them, we will kill it (i.e., quit).

As VCs don’t always know what’s right but they do generally sit on a larger dataset of experience than most individual founders. They understand the reference class better.

That’s why when we see something in a company is going sideways, there is an obligation to deliver this information in a way that will be received.

If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually-independent commitments.

Can VCs be relied upon to invest in uncorrelated assets?

From Brad Gerstner’s recent 20 min VC interview -

I think diversification in many ways is the greatest myth perpetrated on the investing public.

The idea that risk mitigation is the equivalent of diversification…hell, look at a chart on any technology company over the course of the last 9 months — how much did diversification help you?

But how much diversification should LPs be looking for within the portfolios of the individual VC funds they invest in?

From Brad Gerstner again -

What people should pay me for is “Are you in a position to generate alpha?”. If that is the case — I want maximum dollars in the best ideas.

Perhaps the emphasis should instead be on whether a manager is sufficiently concentrated, not sufficiently diversified.

A lot of people diversify away their lack of conviction. They build portfolios that are not diversified, they’re de-worsified.

What he means is that diversification is a strategy to regress to the mean — that is, to be average. For those pursuing excellence, focus is a far better strategy.

On loss aversion

But loss aversion is hard to overcome.

In a challenging economic environment, how can we keep our investment decision processes free from outside influence?

The #1 thing I would tell my younger self is to be bolder. It is so inhuman to think…you almost have to take much more risk than you are capable of to be able to be the absolute best version of the strategy that you are implementing. It is so not obvious but that is the #1 takeaway.

How can you encourage a culture and decision making process where returns maximization is the guiding principle?

By lowering the political repercussions via removing attribution.

As long as the sunshine shines on us both, we are free to take the kinds of risk that you ought to take in a portfolio capable of asymmetric return. When there is a failure, there is no political repercussion because we’ve all agreed on each step of the way what we are going to do. It didn’t turn out the way we wanted it to but that’s just life in the big city, that’s life in VC.

How much energy should we as VCs expend trying to understand the macro economy?

We’ve had a decade+ where that was ok to do. But when you have massive volatility, it’s not acceptable as an investor just to say “well none of this matters”.

Price does matter, because what you can exit for is essential to the game. Multiple expansion hides many sins, and now the opposite is happening in a dramatic and historic way.”

On the other hand, it’s tough to predict the future.

Is there an option in-between ignoring cycles vs trying to know it all?

So we have to cope with a force that will have great impact but is largely unknowable. What, then, are we to do about cycles?”

He goes on to say -
“First, we must be alert to what’s going on. As difficult as it is to know the future, it’s really not that hard to understand the present. What we need to do is “take the market’s temperature” and use that to try to figure out where we stand in cyclical terms as well as what that implies for our actions.”

He offers a checklist of specific questions you can ask yourself such as
- Do the media talking heads say the markets should be piled into or avoided?
- Are novel investment schemes readily accepted or dismissed out of hand?
- Are securities offerings and fund openings being treated as opportunities to get rich or possible pitfalls?
- Are price/earnings ratios high or low in the context of history, and are yield spreads tight or generous?

Assuming you are able to accurately gauge the market temperature, how can you translate that to action?

Quality companies are not desperate for capital right now, but they are certainly humbler than in 2021. When there is no agreed upon standard price, that’s potentially a great time to mutually explore if win-win deals can get done.

Why hasn’t the VC market adjusted to the current climate by just lowering startup valuations?

Are down rounds as destructive as we tend to believe?

Not necessarily.

I’d argue that in some cases the fact that there are investors willing to lead down rounds should serve as a signal that there is value in a company.

Looking at the glass half full — nobody would bother leading a down round in a company unless there is significant IP or revenue. And in fact this seems to be supported somewhat in the data.

Companies these past few months seem to be primarily concerned with optics, looking for creative ways to extend runways by issuing debt, like convertible loan notes, to tide them over until the market improves.

But those VCs with experience are advocating dealing with reality.

When you have a choice between a financing at a lower valuation and a financing with all kinds of crazy structure to try to maintain a previous valuation, negotiate the best price you can but do a clean financing with no structure.

Old school VCs never say no.

A firm “No,” along with a clearly articulated reason why, is the kindest way to help an entrepreneur that is fundraising.

I take pride in running an efficient, transparent investment process, which typically ends with a clear “no”. But lately I’ve been thinking about “not yet”.

Too many times, I’ve seen companies that I passed on move from “unfundable” to “oversubscribed” and kick myself that I couldn’t envision it.

Typically, I consoled myself that I made the best decision I could have given the information available to me at the time. But I’ve come to realize that these are not rare exceptions. Pivots happen, teams are re-arranged, and market opportunities arise that change a startup’s prospects for success.

So how can you position yourself to still invest in these cases without being an as*hole?

The right to optionality should be earned, through at a minimum, thoughtful feedback along with a ‘not yet’.

In practice though –

It’s awkward to tell an entrepreneur that you don’t believe they have the right CEO in place or that their market doesn’t exist (see Bite #32). Usually only the passage of time can fix these types of issues, so if you say no too soon or too definitively you are closing your opportunity to change your mind.

The answer when you can’t give clear feedback is to give clear value-add.

This demands a lot of work and therefore requires you to be very disciplined on how many “not yet” opportunities you follow. After all, “call options” cost money, and they require founders to agree to accept your investment when the tides turn for them.

Investment activity these past few months has slowed down significantly. Does this mean we should expect that the “pressure to deploy” will drive increased investment later this year?

I don’t think you’re going to make that call. These are partnerships, we are not going to put our partners in a headlock and drag them into the market.

Bottom line — they believe only 20–30% of the current dry powder will be deployed (!).

Not calling all the commitments during recessions does have precedent.

Regardless of whether LPs or GPs decide not to deploy all the recently raised dry powder — more investment dollars will be deployed into reserves in the next few years rather than new initial positions.

A move from 1:1 initial check to reserves ratio back to 1:2 by itself changes the effective amount of “dry powder” for new investments.

Bottom line
The “dry powder creating pressure to deploy” narrative is not as solid as some believe. Founders and their backers should not expect a white knight. The bar for traction and underlying fundamentals jumped dramatically overnight and those unable to catch up shouldn’t rely on any macro trends to make it easier.

And so, in venture capital, if you are doing it right, you are continuously investing in things that are non-consensus at the time of investment. And let me translate ‘non-consensus’: in sort of practical terms, it translates to crazy. You are investing in things that look like they are just nuts…The entire art of venture capital in our view is the big breakthrough for ideas. The nature of the big idea is that they are not that predictable.

If you are not investing in things that look like they are nuts, does this mean you’re doomed to median returns?

With few exceptions, everyone thinks they’re at least somewhat contrarian.

Which they can’t be, of course. By definition, most people are the consensus they think they’re outsmarting.

Instead, what most “contrarians” are doing is balancing traditional VC pattern matching with selective contrarianism.

That might be that the idea is weird and quirky but the team is amazing and there is nothing contrarian about the team. Or you can have the opposite where someone has an amazing idea but an unproven team. & then the contrarian thing is do you bet on this team early on.

So in contrarian startups there are 1–2 things you want to take a risk on and the rest should be obvious

In other words — rather than trying to outsmart everyone, VCs often limit their contrarianism to very specific team or market insights that can be validated by the next round of financing (<24 months).

During times of market pullback, there is a flight to quality & a market that generally agrees with you is necessary to get portfolio companies financed. So while VCs will continue funding great companies, they will likely be “selectively contrarian”, investing in founders & ideas that are more obvious.

This weird thing happens when you take investors and put them in a board room with the other board members, and perhaps a lawyer to take minutes…

Everybody is trying to be the smartest person in the room…And although it’s usually done in a nice way, it can feel like a waste of time.

How do the best VCs avoid “smartest person in the room” syndrome while making an impact? Read on for tips from John Doerr, Reid Hoffman and others.

The best thing a good board member can do is bring 3–5 questions for a meeting, have half of those be questions the team hasn’t thought about and have one of them be truly useful. So being a good board member is not about telling people what needs to be done but asking them questions that they’ve not yet thought of.

In contrast, a good board member would have said: “We should evaluate the question about whether or not advertising might be our principal business model. Here are some of the arguments about why advertising might be a really central business model that we focus on. And if you have an alternative point of view, I’d like to understand that and help you drive your strategy and execution.”

The mistake isn’t disagreeing with the CEO. It’s disagreeing vehemently and unproductively without any basis in fact.

Another way of bringing humility into the board room is to speak last (which I’m not very good at).

Expert interviews are a great way of quickly gauging potential market demand for a new company. But when it comes to evaluating investment opportunities, experts often lack context and imagination.

The trick is to know how to interpret expert opinions and incorporate them into your investment process in the right way.

There is always something “wrong” with an opportunity — & it’s easier to sound smart by being negative on a concept that is harder to defend than to promote.

This is why as VCs we can’t outsource our investment judgment to experts who likely are not ruled by power law outcomes. A lot of this is a leap of faith, which is what makes this business so hard.

For most it’s the latter, & that’s fine. LPs deserve high quality due diligence that underscores their GPs’ value as responsible managers of their capital.

But for those of us that aspire to get more out of their investment selection process — how can we run a precise and useful investment due diligence process?

She uses this to stay in touch with her ”slope of conviction” during a process -
One thing I think very carefully about is the derivative function of my level of conviction over the course of time that we do diligence. Because in retrospect there is 100% correlation between the slope of that function and the deals that I do vs not.

And so I literally wake up every day and we have a numerical scale on which we measure this (our level of conviction). If that number is not trending upwards during the course of doing the work, that’s a signal to me that it’s likely that I’m not going to get there.

She is laser focused on uncovering issues that may actually impact her decision and avoids spending founders time on anything else -
We try to be transparent to the founders on what our key questions are and they can then focus on “just help us answer this one thing right now” vs sending them a list of 40 questions and having them run around collecting data.

So the issue is not asking too many questions, it’s asking the wrong questions with the wrong intent.

The one truism in venture is that the financial plan a founder puts in front of you likely isn’t going to come true. But that doesn’t mean you shouldn’t analyze it.

Or is it just saying “we will figure out how to improve margins by two points every year for the next 4 years”. That’s a very different type of thinking than spending time with the founder really diving into the business itself and tearing it down into the atomic unit and figuring out where they are going to put their time and energy.

For the rest of us: what might be done to objectively improve on our ability to assess founding teams in the future?

What you need is a partner that authentically and credibly owns this part of the due diligence process. One that feels as comfortable asking personal questions of founders as we are asking about business models and TAM.

Whether we’re talking about valuation or ownership targets, it’s hard to know when to make an exception in your investment strategy.

To stay sane in this business you have to have rules and you have to have a framework. If every decision is a brand new blank slate decision you’ll go crazy. We do have rules, and we make some exceptions.

However, if we only achieve our targets 40% or 50% of the time can we truly, in good faith, say we have a strategy?

This is based on our internal benchmarks for how long it usually takes and allows us to pre-empt the classic “waiting for lawyers to turn this around” excuses by agreeing upon a schedule up front with minimum turn around times.

How this works out depends on the intention of each side. If there is mutual interest in doing a deal and there is clear communication of any special circumstances that’s fine. However, if the founder is interested in soliciting other offers, this process makes it easier to uncover that and you can then can decide how best to proceed.

Part of a founder’s job is getting a competitive process going for their financing to get the best deal with the highest quality investors. But this should be handled in the right way. Using data, process alignment and transparent communication to ensure you reach an end result faster should be positive for all parties involved, regardless of outcome.

But what about investing in CEOs that are not “nice”, or that are overly defensive, or that are not likely to be easily “coached”? Isn’t life too short to partner with founders that you may not always get along with?
If it’s a good business then no.

Founders are different, they are people that don’t just accept the status quo, they challenge it. These are people that embrace challenges and want to take on the world and change it for the better. & so you want to lean into that characteristic.

Execution is about being efficient, persistent, proactive, aggressive, hiring high-performers, and firing under performers. In Kaplan’s model, execution is on the opposite side of agreeableness, and the being open to criticism and quality listening and people pleasing that comprise that trait.

“It’s not saying that you should hire a jerk, but that you hire someone who has a sense of urgency,” says Kaplan. “In many cases, they ruffle some feathers, but in a CEO, you probably want that.”

For the record — I prefer nice people to assholes (see the bottom *). And things like integrity are red lines, for obvious reasons.

When I think about what’s best for our LPs — it’s not necessarily my enjoyment of my journey with founders. A VC’s job is to generate good outcomes, and to achieve that we have to learn to work with a wide range of people, some of whom may be less agreeable. We have to figure out how we can best support the great founders despite any flaws & quirks that may make them unique but also perhaps challenging to get along with.

— — — — — — — — -
*This Bite is more philosophical than personal. All of the CEOs I work with are incredible people who I greatly respect and have been lucky to partner with.

If she can’t, then our reserves should be even smaller, and if she can do better than the fund as a whole, our reserve ought to be bigger, but that is the valid way to think about reserves in my opinion ie what is the equilibrium where the multiple on reserves is the same as the multiple on first checks?

Naturally, after hearing this I did some stalking of this “follow-on specialist” to better understand her secret formula.

Whether we like it or not, it’s in my DNA that every opportunity I see, even if it’s the first pitch, I’m thinking through: is there an exit path for this company? And if there is, what does that mean and how do we make sure they are correctly on that path?

To maintain neutrality Iris doesn’t lead any deals and only owns decision making for and is measured on the performance of the follow-on investment checkbook.

More on her day-to-day -
In practice, I’m very clear when I start working with a company: you need to have a fundraising roadmap the same way that you have a product roadmap.

I get to know the founders — if not in the pitch process than as soon as we write that first check in. Then when they are getting ready to fundraise I’m their first pitch, and I’m helping them set up their data room, build their financial model, prepping them for what a DD process is going to look like, making intros and hopefully I’m spending my time in the background talking to the series A and B investors to better understand what are the sectors they are looking at, what are the metrics that they are honed in on that would make them excited about an opportunity, facilitating those types of introductions.

I’d imagine that bundling her job as head of reserves with deep involvement in portfolio fundraising should lead to superior follow-on insights. And we can all apply those best practices to our jobs as VCs.

But I definitely would not copy/paste here — unless you have the right person, incentives, internal alignment and org structure in place, don’t try this at home.

Besides your brand, terms and speed, the most important element to winning a competitive deal is how you make a founder feel.

How can you implement this insight into your process?

Phin Barnes, formerly at First Round Capital, conceptualizes your investment process as a “pre-investment product”.

Given the amount of founders entering the digital health world for the first time, how do we stay engaged pre-investment in a value-add way? & how do you scale this activity beyond time intensive 1on1 meetings?

To answer this we recently interviewed 20+ stealth mode digital health founders. Our key takeaway: it’s about providing immediate value in every interaction but also about setting expectations up front for what you can expect from us at any given stage.

To support this, we’ve developed (work in progress) an internal library of highly tactical resources with the very specific “Israeli stealth mode digital health founder” persona in mind. I’d be happy to discuss the learnings with anyone that wants to reach out.

Whatever it is you choose to focus on, differentiating on how you want the pre-investment product to be perceived is a critical piece of building your reputation as an investor.

So what’s a better approach?

Compounding at high rates over an investment career is very hard, but doing it by finding something that doubles, then moving on to another thing that doubles, and so on and so on is, in my opinion, nearly impossible…It’s much more feasible to have great insights about a small number of potentially huge winners, recognize how truly rare such insights and winners are, and not counteract them by selling prematurely.

This sounds great, but as VCs we can’t hold onto an asset for decades, and as asset managers we have to intersect & optimize three distinct variables — value, speed & certainty.

Regarding certainty, beyond position concentration consider -
a) Firm implications — have you demonstrated success as a firm? b) Fund implications — have you generated an attractive return in the fund?
c) Partner implications — do your LPs care about timely distributions?

& with this I’ll leave you with one last thought from the memo that stuck out to me -
..one of the hardest things is to be patient and maintain your position as long as doing so is warranted on the basis of the prospective return and risk…When you look at the chart for something that’s gone up and to the right for 20 years, think about all the times a holder would have had to convince himself not to sell.
Note that, according to Charlie Munger, he’s made almost all his money from three or four big winners. What if he had scaled out early?

How can you keep up with the pace of the market without compromising decision making?

Of course, if you’re an early stage VC it’s more about following great people than great companies, and you probably shouldn’t fall in love with your own ideas.

VCs like to say that they make their money through their best bets but they make their name through their worst bets. That isn’t true.

For Doug Leone @ Sequoia, there is a simple answer to why he works closely with his struggling investments — it’s about being a badass.

It’s clear that they not only did a great job recovering investments (taking a fund that was at .3x and bringing it up to close to 2x) but in building an emotional narrative that connects with future partners and defines their values.

If a company is started by an entrepreneur with a track record of success, then the company is no more likely to succeed if it is funded by a top-tier venture capital firm or one in the lower tier. Thus, prior success is a public signal of quality.

What’s the right way to pass on an investment?

And then even if you put a lot of thought into it the founders will often say “well you know you said it wasn’t a big market but it actually is a big market” or “you said this but it’s actually this”.

“Or most people lie and say it’s something else, and then the founder iterates on the feedback…leading the founder off track.

Frankly the #1 reason I pass is that I am just not impressed by the founders. How can you say that? How can you tell someone to their face “sorry the reason I didn’t want to invest in you was because of you”…The incentives just aren’t there for a VC to say “Look, you’re just not impressive enough.”

It’s a tricky dilemma, but there may be a solution.

As an industry we’re not great at passing on investments. How can we do better?

Is this good enough?
To be clear, this is only meant to be sent to founders that you met once or twice. If you send this to someone that you’ve been engaging with for a long time, you’re probably just a jerk.

While I’m not totally sure whether this will be well received by founders, it seems worth the experiment if it allows you to be more transparent with founders while saving yourself time.

How can you to look past the news cycle?

Correlation Ventures released a great study answering a simple question
Q: In retrospect, was the year immediately following the 2001 and 2008 shocks a relatively good or bad time to be investing in the U.S. venture market?

A: Yes! Realized multiples increased significantly immediately following 2001 & 2008 (look at the two bar charts on the right side).

In the 2nd chart below: look at the slope of the lines following ’01 & ‘08

What to make of this?

As Adam Fisher @ Bessemer wrote in his must-read blog post-
“Time diversification is a real thing in venture capital, including during periods like this…Three years from now when you look back, you will realize the biggest investment mistakes you made were in the 12 months preceding this crisis, not in the first 12 months following it.”

The math says the best way to ensure you have a hit is to diversify your portfolio, but over simplified models have limited utility in real life. Usually when you scale the number of investments you make the quality of the portfolio goes down.

So what’s the best way to think about how many companies to invest in as a VC?

First some basic math-
assuming you have a ~4% chance of 10x+ realized multiple on any investment, you should be investing in >15 companies for a 60% chance of an outlier, >20 companies for an 80% chance and ~24 for a 90% chance (but of course 10x won’t do the single handed job of returning the fund if you have an equal weighted portfolio of 20+ positions).

From that starting point — to determine how many companies you should actually invest in, consider what is your edge and what your constraints are.

For example, in terms of deal flow, if you’re seeing deals that are as good as the ones that you’re doing but you’re saying no to those, you can probably afford to grow your portfolio size.

In terms of risk tolerance — the more concentrated your portfolio, the larger the impact of upside and downside scenarios. This is because higher ownership in a smaller number of companies means you have less chances to hit an outlier but if you do, it’s likely you’ll own more of it at the time of exit.

If his analysis is accurate, what can we as investors in startups do to prepare?

“Well, your business sucks. You can’t avoid cyclicality. I have a strategy for when I think yields are going to expand, and when they’re going to contract. I always have a game to play, because you’re going to always have boom-bust cycles.

In contrast, the VC business is low barriers to entry, high barriers to exit. So, as markets start to boom, the amount of capital that comes into the category is immense. But when the market breaks, the capital that doesn’t have a mechanism to go away quickly, because it’s already been committed to 10-year+ windows.”

So does this mean we should pack our bags and head home?

“The vast majority of the average returns over a multi-decade window are right at the end of the cycle. And so, if you get conservative and pull back and miss- like there were venture firms in 96, who said “this is way too overheated, we’re pulling back” And they missed 97, 98, 99. So, there’s this saying: “the best way to protect against the downside, is to enjoy every last bit of the upside”.”

“I have heard some venture capitalists at other firms recall that their best investments…only happened because someone slammed the table and forced the decision…for what it’s worth the best investments at Spark have been times where our entire team was over the moon about the founder, product & mission.”

How common is group based vs independent decision making in VC?

Implementation comes in many flavors. For some entertaining reads on how others implement decision making, click below:

This includes-

How can VC partnerships work as effective teams when the incentives are stacked against them?

Assuming one of your values is that you invest as a team, here are three ways to align incentives, culture and processes accordingly-

— —

It is possible to foster an environment where you perform better as a group than as a random collection of individuals. But it does require losing a few points of efficiency to gain a few points of culture.

Some deals are so clearly compelling that you have to compete with others to win them. How can you do so without resorting to selling on price/speed?

The idea is that founders should be able to get advice from the people they want, to get money from the cheapest source and to leave the control provisions typical of VC-led rounds behind. However, almost a decade later, the business of investing in startups hasn’t fundamentally evolved.

Why might this be the case?

So why not raise at higher valuations from *dumb* money and then add advisors who earn equity?

& skin in the game:
“…the one thing that an experienced VC partner can *uniquely* provide you is someone who has a strong incentive (because they own a lot of your company), and a very different perspective and experience base. That’s the old-fashioned “Investor as a Partner” model.”

Let’s see if this decade can change the equation that makes the bundle so strong.

So how can you tell if a startup is in a category that can support multiple winners?

There is a chapter on fragmented markets (= market share of the top 8 firms <50%) which itself is worth the price of the book. While a prerequisite to fragmentation is low overall barriers to entry, the book lists 10 additional causes of fragmented markets (mostly related to lack of economies of scale). Importantly, it only takes one of these for an industry to be fragmented.

There is an old saying in VC:

“I don’t worry about the investments I passed on, I have enough to worry about with the companies I did invest in.”

That is exactly the wrong approach to VC where investment misses can cost you far more than losses.

So how can we productively revisit our bad decisions?

To do so, add one slide to your weekly meeting deck which includes the following points for discussion:

Ideally as a VC you are engaging with founders you want to back in a value-add way well before they begin raising money. But sometimes it’s unavoidable: speed of decision making becomes a factor in winning a deal that you want.

If you are in position to be one of the top choices of an entrepreneur but don’t have long to build conviction, how can you speed up your internal processes?

Prepare for this scenario ahead of time. For example, from Frontline:
If a Partner thinks a great deal is about to be missed they are able to get all the other Partners to cancel anything non-compulsory in their calendar over the next week to get the due diligence, calls, meetings, investment committee etc. done within 5–7 days.

Can we effectively separate the work of VCs into discrete tasks and delegate to junior personnel?

What Noam proved -

Makes sense. When analyzing later stage companies, GPs can carve out more discrete objective tasks related to historical analysis without losing richness of primary source. Early stage is more subjective and details are lost when delegating responsibility.

One catch: in Noam’s study, the amount of structural leverage was measured as the ratio of junior investment personnel to senior investment personnel. What about the trend towards hiring “value add” or “platform” oriented personnel?

I’d assume if hiring “value add” staff enables your firm to provide founders with a meaningful advantage that they can’t get in the open market, this can make sense (note: reducing vendor procurement friction is not enough of an advantage). The danger of course is that if you have all these staff on hand I’d have to imagine there is a pressure to use them.

So what are some good ways to think about reserve allocations?

So when you’re in that mode, you’re always asking: is my wisdom overtly greater than the wisdom of the crowds? Index investing kind of assumes this is not the case, unless you know something that you’re sure you know. The problem that I think most people have is that they believe they know more than the rest of the market because they are on the board or they know the founders better. But I give the market a lot of credit for being able to select what the good series A candidates are.

What I found is that, had I gone all-in every time a tier-1 investment firm followed, we would have lost money as much as not. But if we had done that and invested when we knew something explicitly, our follow-on investing skill would have gone up dramatically.

A lot of VCs won’t invest in companies where they believe they won’t be able to add operational value. This strikes me as an ok filter when applied at a high level to portfolio construction, but can be silly as rationale to dismiss an individual deal.

If you are thinking of investing in an opportunity that looks promising but that you can’t add much value to beyond being a good financial partner, here are three filters that may help you decide whether to do the deal:

Having recently finished reading it…I’d be surprised if others have actually read every page in the book. It’s very academic.
Luckily for you, I’ll share my key takeaways below.

A question that’s been on my mind for a while now is whether this vintage’s returns will be harmed by larger funds raised and rising valuations.

What strikes me is that they structure their involvement similar to private equity firms in terms of exit scenarios, governance and ownership targets:
— Exit case: They first check whether the top talent has stuck around and whether they have the right attitude. They then examine financials in detail. Lastly, they assess the landscape of potential buyers. If there are no logical buyers in sight, Tech-Rx won’t step in.

— Financial: Tech-Rx invests between $500,000 and $5 million into companies, taking 50 percent of the common stock, offering 20 percent to any new management it brings in, and leaving 30 percent for existing shareholders and founders.

So the next time you are tempted to restructure a startup, it’s worth considering whether you are well structured yourself to do so. Most VCs aren’t.

What is the goal of founder reference checks?

Beyond validating what a founder has or has not done and checking if they are psychos, IMO reference checks should focus on:
- What are the founder’s weaknesses?
- Did they really stand out in the past?
- Is this someone I can work well with?

Here is how to hone in on these three points in an impactful way.

From Trifecta Capital:
— What type of team members complement Jane’s weaknesses? (sometimes reference checks are hesitant to share any weaknesses, this illicits a response)

#2: How much does this person really stand out?
Two direct but good questions:
— What makes you believe this person is extraordinary?
— And what’s the most impressive or impactful thing that Jane did for the company?

So we’ve revamped our format.

This version is geared towards the fundamentals of early-stage, pre-traction investing with a focus on: the team, market, strategy, and “intangibles”. We find this helps us to contextualize opportunity cost and to focus on the fundamentals of an opportunity, rather than who else is investing or what kind of valuation we’re getting.

Making investment scoring useful but practical is always a challenge, and we’ll continue to tweak this going forward.

I met an investor recently who, as part of his introduction, proudly mentioned his firm has invested in 15 companies in the past years, none of which have gone out of business to date.

How embarrassing for him.

So if you are over optimizing for investing in cockroach and zombie startups that never die, you can pat yourself in the back, because nobody else will.

When evaluating startups targeting technologically conservative end users (think shipping brokers, small business owners, etc), being able to assess likely speed of adoption is critical.

But market timing is notoriously tricky. How can you better predict the diffusion of innovations in slow moving markets?

Ok, so nobody can consistently predict market timing. But what about rate of adoption?

1) Relative advantage
The degree to which new items are perceived as better than an existing, established idea (not only in objective economic terms, but also in feelings like social prestige and satisfaction).

2) Compatibility
How much change in behavior does the innovation represent and is it interoperable with previous practices? Includes fit with sociocultural values, previously introduced ideas and problem/solution fit.

3) Complexity
The degree to which an innovation is perceived as difficult to understand and use.

4) Trialability
Can the target market try your item out without much consequence if they decide to back out?

5) Observability
The degree to which the results of an innovation are visible to others (ie easy to observe and communicate).

Ok, obviously. But as we all know, founders are really good at covering up issues among themselves during the fundraising process. So how can you dig deeper into founder dynamics without intruding?

- How did you guys divide the pie and how long did it take to divide the pie?

- What’s been the biggest question or issue that’s come between you?

- Have you been able to have authentic conversations about your strengths and weaknesses?

Some VCs are perceived as a**holes.

Not you obviously. But maybe your partners are?

If it turns out that your NPS is crap, what can you do about it?

Communication, constructive feedback and responsiveness? I agree, sounds too hard

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