There’s a common refrain that venture capital is a power law business, which implies that you need to be in the best companies in order to be successful. While it’s hard to argue with this, what most literature fails to discuss is how to consistently be in the best companies. After all, at the early stage it’s difficult (impossible?) to be so precise about what the best companies are/will be, hence the need to develop a portfolio. Even Midas List VCs consistently get it wrong.
What I’ve come to believe is that venture funds who experience sustained success do so because of the systems they have in place. By systems I mean the strategies put in place to help with sourcing, diligencing and winning allocations in the best companies. It may be hard to always get it right, but like in poker, playing high probability hands over a meaningful period of time means you will do better than the average. My intention with this post is to list some of the successful systems I’ve seen firms use, which hopefully helps emerging fund managers as they seek to evolve over time.
Systems for sourcing
Many firms have sought to innovate on deal flow systems that continually brings high quality founders into their orbit. Most important is getting access to these founders - or prospective founders - before the masses. For example:
- Y Combinator’s reputation and track record of having funded the likes of Airbnb, Stripe and Coinbase means they now get 45,000 founders applying to their incubator each year. Many of these are talented founding teams who haven’t yet settled on an idea
- Dave Fontenot runs a program for founders called HF0 that provides food, fancy lodging and a group of like-minded peers in exchange for early equity in the business. By building a desirable product for a subset of founders, Dave is able to attract interesting deal flow
- Contrary Capital has built networks and programs that identifies talent at universities across the US, often before they’ve started a company. An example is this program: https://contrary.com/blog/class-of-2024
- The partners of Everywhere Ventures are everywhere, constantly hosting meetups around the world and empowering scouts/members to both send them and propose investments
- Sequoia has started its own incubator program, Arc, that brings a steady stream of seed-stage founders into their orbit
- Funds like Bain Capital Ventures and Foundation Capital invest in pre-seed and seed scout funds to try and get an early look at promising companies before they officially raise
- Signalfire uses data science to create a map of founders + prospective founders, programmatically reaching out to them proactively when certain signals are triggered by their model
- Abstract Ventures has cultivated a network of top-tier multi-stage funds, becoming a frequent co-investor with them. Setting up this network is difficult, but once you’ve done enough favors for funds, you tend to get reciprocally invited into deals
- a16z were early to crypto, which as an industry had a key moment in the sun. By being early to a space that became interesting, they were able to build a relevant brand for founders and get preferential terms
- Sarah Tavel at Benchmark writes thoughtful blog posts to outline current areas of interest for her (such as this post on software eating services). By providing distilled insights, she’s able to put out a call to founders building the types of businesses she’s interested in
Some other strategies that have been effective, but are less specific to a particular firm include:
- Disgruntled associates and principals at multi-stage funds tend to be an interesting source of deal flow for seed funds, particularly where the associate/principal wanted to do the deal but was blocked by the partnership. Typically, they still want to see the company funded and are eager to refer it to another firm
- Enterprising alumni from successful startups like Doordash, Airbnb and Uber have set up communities and investment vehicles to attract and then invest in former colleagues leaving to start new companies. They can often be the first people to know about these companies being founded
- Having differentiated knowledge about a founder, business model or space that others are less aware of. In practice, the latter two are hard as there aren’t a ton of new business models nor unknown spaces (the world is an efficient place). However, it is possible to have proprietary knowledge about a founder that others don’t know due to your relationship with them
- Being embedded in various communities of founders and builders (e.g. open source projects or Discord channels) that haven’t become popularized provides unique access to founders
- Similarly, tapping strong but somewhat overlooked cohorts of founders can be advantageous. At 1984 Ventures, we set up a program called the Amazon Founders Program that made it easy for existing Amazonians and alumni to test their idea with us and potentially receive quick funding. We found that unlike various Silicon Valley companies like Stripe and Uber that were well covered by venture funds, Amazon was surprisingly overlooked - perhaps because it was Seattle and not San Francisco based
The main caveat with all these strategies is that they work until they don’t. Nothing in venture consistently generates deal flow other than hustle and creativity.
Systems for picking
It’s also possible to come up with an investment framework that results in a higher hit rate than the average. For example:
- Floodgate is a top tier seed fund that believes all great companies are built on the back of an “earned secret” that the founders have
- Keith Rabois at Founders Fund leans into his ability to pick founders, focusing on people he believe are top 1% in a meaningful way, honed by his many years as a startup founder and operator. He believes that this is an effective way to inflect the odds of success, which are otherwise measly at the seed stage
- At 1984 Ventures, we only invest when we believe the founders are solving a “screaming market need” and have the ability to rapidly ship software. This framework allows us to maximize the number of companies that achieve product market fit, of which a subset go on to become successful
- Bill Gurley at Benchmark came up with a framework for assessing marketplace companies. His framework proved to be accurate and he was also investing at a time of greenfield opportunity in marketplaces, which resulted in a string of very successful investments
- Adyin Senkut from Felicis Ventures believes that successful companies are built off the back of a trend that comes to fruition. As a result, his approach is to build an awareness of trends and seek out companies capitalizing from those trends. A subset of the trends end up eventuating, resulting in successful investments. Some examples of current trends that are playing out include a heightened consumer interest in personal nutrition, the rise of electric vehicles in Europe, and the rise of ADAS sensors in vehicles
- Brand -- brand tends to be the most powerful factor in attracting top founders and also in helping win deals.
- Sequoia can introduce you to its top tier roster of portfolio founders, some of whom are likely invaluable for you as a founder
- Having a Midas List investor on your cap table helps with attracting future investors
- Become so well known to founders all over the world by consistenlty being top of mind --> a16z
- What's unique is that brand can be built in advance of a crystallized track record
- Brand becomes self perpetuating because other investors send the top investors their best deals, hoping they invest and that they can bask in the halo of the top investor's reputation
- Be able to do something so impactful to the company that founders can't say no (i.e Winning)
- E.g. Harry Stebbings / Acquired / Logan Bartlett show podcast can get you distribution. This can also help with sourcing
- E.g. Ron Conway can make any introduction
- E.g. Kyle Poyar at Openview has become a guru of GTM metrics, which are very valuable to founders
- Having an exceptional track record tends to correlate with brand, and attracts founders who themselves feel like the "chosen ones" if the investor chooses them
- Hire luminaries onto your team who can attract founders (e.g. Ryan Petersen from Flexport, TJ Parker from Pillpack). They can also help with sourcing companies within their areas of expertise
- Being a sector specialist can help you source, diligence and win deals because of your perceived expertise (e.g. QED in fintech, Emergence in B2B SaaS). Obviously, the sector you pick needs to be fruitful and this approach gives you less flexibility to hunt for. This is why many people broadly/loosely define their area of focus
- Replicating successful businesses in other geographies (e.g. Rocket Internet)
- Play different games to everyone else
- E.g. inception stage funding of companies doesn't require funds to compete so hard with each other on deals
- And it might be that the risk of an inception stage company deliberately chosen is similar to a pre-seed
- Similarly, incubations don't involve competing for a founder
Being pushed to explain your investment to your partners and responding to their criticisms is important, because they're also practictioners looking closesly at startups. But sometimes, firms like BCV have too high of a bar of the types of deals they should do.
For these reasons, Sucasa was a great bet, even if it doesn't work out. You have differentiated knowledge on Mario than most. And there is an insight underpinning why it should work.