Jun 15

The Traction Cycle: Why Sectors Become Hot In Venture Investing And Who You Should Raise From

virtuous cycleI’ve said many times that traction is how venture investors get comfortable with sectors they don’t have experience in. When you’re raising early stage capital from angels or seed funds, it is easier to raise from people who understand your business; that usually means people with experience in the space.

If an angel or VC doesn’t have experience in a sector it is difficult for them to know if an idea is good so they fall back on traction. This is why every demo day pitch has a slide with a graph going up and to the right; they are trying to demonstrate traction of some kind.

This also explains why sectors become hot in VC. Once one company starts to do well, the number of VCs who have dug in and now have some level of experience with the sector increases. Take Uber for example, after more than five rounds of funding there are plenty of VCs who have experience with the on-demand space. That makes investing in companies that are “Uber for X” easier for those investors.

If you are in an established category, finding venture investors that are familiar with your space will be relatively easier than if you’re attacking a area that most people don’t have experience in. If you don’t happen to be in a well-understood sector, look for investors that have some background in your space since they will require less traction and proof points to get comfortable with your business.

Mar 15

Seedcamp Podcast

Carlos brought the latest batch of Seedcamp companies by the office on Monday, they are an impressive group, and afterwards we sat down and recorded an episode for his podcast. In it we discuss a bit about my background, security funding, technical founders, and the CTO summits; it isn’t too long at 24 minutes. I hope you enjoy it.

Jun 14

Why Traction is King

Traction is King

Traction is how investors who don’t know a space get comfortable enough to invest.

In Early Stage VC there is a ton of risk and if you’re not an expert in a space then traction is the best way to know if an idea is any good. The market has spoken.

If a VC or Angel is an expert in a sector then they can get comfortable without that traction.

Last night I was discussing this with another investor who pointed out that even when you’re an expert you may not be able to pick winners in a crowded market, so in that case traction is important even for an investor who knows the space. An example of this is when there were dozens of photo applications; it wasn’t until Instagram started to pull away from the pack that investors knew who to put serious money behind.

Ultimately this means that having traction will get you a higher valuation since it brings more investors to the table, which creates competition, and that drives up your valuation.

Oct 13

Crowd Funding: Angels, Not VCs, Will Get Disrupted

I wrote this before Angel List syndication was really being talked about. I’ve decided to post this and I’ll do a follow up on Angel List in a week or two, once I’ve had time to really think that through, but I still stand by what I’ve written below. 

There has been a lot of discussion about how the crowd funding portion of the Jobs Act will affect the startup investment community.  As part of my Kauffman Fellowship project, I spent some time researching the subject and came to the following conclusions.

First, it bears noting that crowd fundable companies are a superset to Startups (see Paul Graham’s essay for a good definition of Startup).  Funding for businesses that don’t have the potential to scale will be done via crowd funding, not by historical startup investors.

My belief is that traditional VC may be disrupted some but that angels and micro VC’s will need to make larger changes.

Why don’t VC’s get disrupted as much as Angels?

Deal flow:  Crowd Funding and general solicitation will give founders the ability to access a wider pool of capital.  For traditional angels this gives them greater access to deal flow but also more competition.

VC’s are looking at companies full time and they generally don’t need more deal flow, thus this will have a much larger effect on angels.

Winning deals:  When a deal is hot and different forms of funding are competing for access, who will win?

If a founder wants only cash, then crowd funding may have the upper hand here, but this is rarely the case.  Most founders want things in addition to money:

  • Access to a rolodex
  • A sounding board for ideas
  • Advice and another point of view
  • Follow on capital and / or fundraising help

While the crowd may theoretically be able to provide these functions, it would be in a very inefficient manner.  Soliciting advice from board members is a task, doing it from 75 angels would be a nightmare.

Follow on capital:  Savvy founders have already begun to worry about the “party round” where several angels or micro VC’s all invest a small amount.  The issue companies have run into is that no one is really invested enough to make the effort to ensure the company can raise further financing or lead a bridge in the case of a hiccup.  Better to have one or two investors who really care than ten who are simply interested.

Introductions:  Trying to figure out which of the 30 investors will give the best intro to a potential partner will be problematic.  Maybe a software platform can help with this, but if so I haven’t seen it yet.  If you happen to be developing one get in touch with me please.

Finally, many traditional venture firms have moved to B & C rounds.  When you need to deploy $600M it is much easier if you write big checks.  The industry is still in the process of a shake out, but those left standing will have more capital in the future if returns revert to the mean. (If they don’t then the whole ecosystem is going to have to change radically.)

For all of these reasons, I expect crowd funding to have a much larger effect on angel communities than on venture partnerships.  But either way, I’m looking forward to seeing it all play out.

Jul 13

Anti-authoritarian Founders or My New Dress Code

Recently a founder whom I respect, Michael of Reputation.com, was speaking to a group of investors and said something that struck a chord with me:

 Most founders have an anti-authoritarian view while most investors don’t.

I definitely identify with founders on this, and recently wrote about being a cypherpunk back in High school. The hacker scene I grew up in was distinctly subversive & anarchic. I believe that is why I love founders who fly in the face of convention to try to disrupt incumbents and change the world. If I can be personal for a moment and tell you a personal shame of mine: when I went to business school I bought new clothes in an effort to fit in. Recently I’ve come to see this as a mistake. To be our best we shouldn’t strive to fit in but to stand out. So if you’re on your way in to pitch me wear whatever you would to the office, I just want your best ideas. In exchange, please don’t be surprised if I am wearing this t-shirt: defconshirt

Jan 11

FB: Take the Money and Run

Tyler Shields (@txs), an old friend and colleague,  asked me the following:

I know you have some education and experience in the business world so I was curious what your thoughts were on something. I was debating with some folks about the Facebook valuation and what the results of this Goldman’s Sachs back channel IPO is going to be. If you had the chance would you throw money into the pile or would you wait and hold? Also do you think they are overvalued or fairly valued at approx 50B$?

So I first took this to mean would he invest if he had access to GS, then I figured maybe he meant would you dump if you were an FB employee. So I have both answers.

Let’s start with value. (Since that will inform whether you want to put money in.)

Some context-

  • Google is worth 200B.
  • AOL is worth 2.5B
  • Yahoo is worth 21B

Now everyone who has bet against high FB valuations in the past has been wrong. And I can see that FB might be worth twice what Yahoo is, and they have just surpassed Google in traffic. So Maybe 50B is a fair price. BUT, part of the Goldman valuation has to do with the fact that they can make fees by selling parts of that 1.5B fund to their clients. And they will likely get to do the eventual IPO, which will earn them more fees. So Goldman has a revenue stream that most of us can’t count on.

Possibly the most telling data point would be Digital Sky Technologies, the Russian firm. They are already an investor, and they have a pretty big stake. If anyone has a decent idea of what’s really going on it’s them. If they put in more money, then you’d hope they did their due diligence. So if I’m arm chair quarterbacking I say it is probably a fair valuation.

On the other hand, if I really had 10 million and GS came to me I’d say no. The reason is simple, you don’t get to see the books (the way GS and DST did). If you can’t do your own due diligence then you’re a sucker; pure and simple. Sure, you might make a lot of money, but you can also make a lot by betting on red in Vegas. Doesn’t make you smart.

Now, if you’re asking what I’d do if I’m an FB employee:

This is actually an easier answer.


Though it always depends on your personal situation, most people would tell you to take some money off the table. What happens if the company explodes? You not only lose your job, but also your nest egg. That’s not smart. The common answer is to not hold your companies stock (everyone cites Ennron here). But this is FB, the hottest investment in the world. So maybe you limit yourself to 10% of your nest egg… If you’ve got 10M in stock, I’d dump as much as they let me. (I think it is 10-15%) Why not take some of that risk away.

Also, you have to expect that you have a ton of unvested options. (Maybe not, but my guess is they use ’em to keep you there.) So even if you sold your vested portion, you still have plenty of exposure.

There you have it, my un-asked-for advice to current FaceBook employees.

Sep 10

Welcome Back Kotter – Some Thoughts on VC Allocations

It has been too long since I've posted here. All the regular excuses apply. I have a new job, I've been trying to work out more, dingo's ate my baby, etc. etc.

A few weeks ago I sat down with Brent Ahrens of Canaan Partners to talk about the industry and basically catch up. We got to discussing the state of venture and Brent said something that I wanted to play with a bit more; he said that the amount of money going into venture was pretty steady (the bubble years aside). Essentially he was pointing out that the graph of money allocated to venture should should be pretty linear rising along with GDP and the market. I thought it would be fun to graph this and see how accurate it is.

Turns out the NVCA beat me to it. 🙂

US VC Investment as percent of Mkt
As we can see, commitments are slightly above average, but not widely out of whack.

Since 2002, commitments have run just slightly above the historical average (0.146% versus 0.139%).

Since 2002, investments have run slightly below the historical average (0.155% versus 0.164%).

<via It Ain’t Broke: The Past, Present, and Future of Venture Capital by Steven N. Kaplan and Josh Lerner>

Also, investments are slightly below average. But this is hardly the giant overhang that people have been discussing. If anything, the situation should be getting better as the bubble funds from 1999 begin to totally exit the market since their 10 year investment periods are running out. (We can look at Elevation as an example of a high profile fund that can no longer make new investments no matter how much dry powder it has.)

Given this, the contrarian in me says that now should be a fine time to invest in angel and venture. Now if I can just find that spare 20K in change in my couch.