May 13

Deal Flow Strategies

At Gotham Ventures we have a number of interns each year, and I often find myself explaining to them the mental models I use to understand the world of venture. I thought it might be useful to others to hear some of these thoughts, what follows is my mental model of deal flow strategies. 

In the world of venture there are a few different methods for finding great investments. There are three basic things that firms tend to focus on: Technology, Market, and Team. And different people and firms tend to try to optimize around those.

Market, Team, Technology

I tend to think of it as a triangle where a perfect company might be dead in the center but most tend to be stronger in one area and weaker in the others.

While everyone wants a company that is perfect in all three of these areas, that is a rarity so historically some firms are known to gravitate towards companies with more strength in one area or another. For instance, Kleiner Perkins is known to like companies with strong technology whereas Sequioa has often said that market size is king. Of course both firms would say that the team is also incredibly important, but they are willing to give up a little on the team for strength in another area.

This brings us to the idea of deal flow. When I was first starting to think about VC back in 2005 0r 2006 I met with David Strohm of Greylock. He was explaining to me the basics of venture capital and told me how he thought about his deal flow funnel. He relied upon 100 exceptional people in his Rolodex that would call him first. The math broke down like this:

The average person moves jobs once every 4 years so 25 of the 100 will be moving on any given year. Of those people, maybe 10 will go to startups, and of those maybe 1 will be really interesting. And that’s all he needed, 1 good deal a year.

This was clearly a gross simplification of what he did, but at the time I was a coder who knew nothing of the valley and so this was probably an appropriate level of depth. The real key to this line of thinking is simple, have a small but very high quality pool from which to draw deals.

Now let’s contrast this with Dave McClure’s approach to investing. Instead of having 100 people who call him first, Dave casts a very wide net. He is going to invest in 500 companies a year, so he needs a lot more than 100 people bringing him deals. He wants to see everything. Dave can argue that by seeing a huge number of deals he will have a better understanding of what is going on in the market than someone with a more limited scope, and therefore he will be better able to compare.

It should also be noted that these strategies are at different stages of the funding game, Dave is investing at the Seed stage while David was investing in Series A and B. However, I think there are plenty of Seed investors who follow David’s basic model today.

Another deal flow strategy that people have tried is to have a ‘captive market’. For instance, firms that are geographically focused in tech hubs where they are the only player, or firms that have partnered with a school. The partners at Borealis Ventures have executed on this type of strategy to great effect. They are located in Hanover NH, right next to Dartmouth College and a couple hours drive from Boston. By working closely with the college they have found great companies such as Glycofi and Adimab as they spun out technology from Dartmouth. This has led to some really big wins and great returns for the firm.

My final thoughts are on people who specialize in a certain area. By being or becoming experts in a field they then can become the “go-to” investor for that community. I tend to think of specialization as a more focused case of the first network strategy, but instead of narrowing your field by your network you go and create a new network to work with. Having said that, specialization is clearly a method that has worked for many investors and even some firms.



Mar 12

Why NYC Now


The last bubble was a bit crazy.

In the summer of 1999 I graduated school with a degree in CS and took a job in NYC with a startup. Well, that isn’t exactly true. The startup I agreed to work for, i33, was bought out, not once but twice, between my accepting the offer and my first day. 1999 was a crazy time.

Why am I telling you all of this? Well I wanted to give a little bit of a backdrop, for those that didn’t get to experience it, on how crazy things were at the height of the last bubble.

Anyway, things feel really different now.

11 years ago when I was new to NYC most of the programmers I knew worked for banks or, if they were lucky, hedge funds. They were expected to dress well, no hoodies, and programmers who worked at startups in NYC were seen as oddballs. When I told people I was a programmer at a startup, I left my first job for a company of 7 people, it wasn’t seen as a cool thing. It was more like I was living in my parents’ basement. This was because banks paid so well that the best coders went there, so either you weren’t as good as them or you were a bit crazy: turning down the money to take a flyer.

There were a couple hacker type gatherings; they mostly revolved around Unix programmers and beer. Again, they were a lot of fun, but a good turnout was 20 people; nothing like the NY Tech Meetup today.

Don’t get me wrong, there was a lot of unbounded optimism, but as a you coder there weren’t a lot of hero’s in the NY startup scene. I remember some really amazing programmers helping to start hedge funds. Hopefully, today they would start a big data company.

Things feel pretty different today. There are a bunch of tech savvy founders who are doing interesting things, and you can’t swing a dead cat without hitting a startup incubator. I believe NYC is close to, or has passed, the point where the ecosystem is self-sustaining and I’m really excited about tech here now.  I’m hoping that I can help young geeks do great things in NYC; basically I want to help techies succeed in NYC because I remember how overwhelming it was the last time.


Feb 12

I Love Living in the City

love-nycLike many of you, I expect, one of my new year’s resolutions was to start blogging again. To kick things off I thought I’d describe where I’m at and what I’m up to.

Let’s start with the obvious big changes. About 7 months ago I left SF to take a job at DFJ Gotham in NYC, and I really couldn’t be happier. Shortly I’m going to write a blog post about the NYC tech and startup scene, but not today. I’m back living in the financial district, a few blocks from my first apartment here in the city back in 1999. I must say, the neighborhood is so much more livable now.

The Job: I’m an associate at DFJ Gotham, an early stage venture fund where we invest mostly in Seed and A rounds of tech companies, and I’m learning a ton. The people I work with are awesome, and being at a small firm let’s me see how all the different parts of the business work. While USVP was an amazing experience I was sheltered from a lot of how the sausage was made when it came to the internal workings of a fund; now I’m the one making the sausage.

I know this sounds trite, but I’ve just been having such a blast. I love the “new” New York tech scene, my job, and all the great people I’ve been interacting with. It is really good to be home.

<FEAR, an LA Punk Band, wrote “I Love Living in the City” about New York, and though the song is meant to be negative it made me homesick when I heard it the past few years. Enjoy.>


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.

Oct 10

Everything Old is New Again: WildFire is the Web 2.0 Version of FlashBase

The first startup I worked for, about a year after graduating college, was a small company named FlashBase located in NYC. I believe I was the 8th employee and the 3rd full time programmer, not counting the two founders who wore many hats.

FlashBase started life a web front end for database backends, which was a technology in search of a solution. Basically we allowed users to graphically create webforms; common uses were surveys, help boxes, and sweepstakes. During the attempt to raise a 2nd round of funding we made a pivot, and switched from a general tool to a specific solution: Sweepstakes.

DCLK Sweepstakes
Thanks to the wayback machine we can see the homepage a month after the aquisition. (The pre brand change site doesn't have images and hence looks pretty ugly.)

It turns out that getting opt-in mailings lists was important enough for people to actually pay for our product. And thus a business was born. We made a turn key solution for running sweepstakes. Which is why WildFire sounds so familair to me. WildFire is a platform for running sweepstakes and doing analytics around them. Essentially, it is the Web 2.0 version of Flashbase; better analytics and tools for virality I'm sure, but essentially the same product.


While web design has come a long way, the value proposition is the same: WildFire creates turnkey solutions for sweepstakes, user-generated video, photo, & essay-based contests, and coupon give-aways.

In the end, just as the dot com bust happened, our founders sold the company to DoubleClick for around 20M. Given the peak for the NASDAQ was in March selling in May was quite lucky, the slide had only just begun and people still thought that a recovery might happen. For the VC, Dawntreader, this was a pretty decent outcome since so little had been invested and the flip was quick.

So what does this mean for Wildfire, who has taken 4M? I suspect it is going to be a tough road to hoe. A 20M sale aint what it used to be, and buyout valuations are lower now than in 2000. I'm sure there is an arguement that Social changes everything, but having been there in the past I don't expect WildFire to be a "Big Company". For a month long campaign at the premium level ($250 + $5 a day) we are looking at $400. Let's say they can sell the company for 3x Revenue. So to reach a 20M sale they need 6.6M in revenue. To get that at $400 a pop you need to run 16,500 campaigns a year. Let me say, that's a lot of sweepstakes.


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.

Oct 09

Viral Loops: a Love Story

Over at TechCrunch guest blogger Adam Penenberg as put part of his new book Viral Loops up. It is the story of how Tim Draper got the viral loop into Hotmail. Given that investors love to see viral marketing theses days it is nice to see that one of the earlier loops was brought about by VC. 

At the next meeting at DFJ Tim Draper once again pushed the two young
entrepreneurs to insert a tagline into each message. Bhatia and Smith
were adamant about not adulterating email. It just wasn’t done. They
would feel like they were polluting emails with advertising, and what
about privacy issues? If someone is adding a tagline what else were
they doing? A user would wonder what else they had access to and they
were also fairly certain it was unethical. But Draper wouldn’t let it
go. The benefits, he contended, far outweighed the risks. If they were
predicating their entire business on the size of their user base, they
should be doing everything in their power to increase it as fast as
possible. “P.S. I love you. Get your free email at HoTMaiL.” The more
he said it, the more he liked it. (via TechCrunch)

Apparently this story was under contention for a while until the authors of Founders at Work dug up some corroborating evidence. So here is at least one case where the VC really did contribute more than just capital.

Oct 09

The Skills to Pay the Bills

Paul Kedrosky has a really nice article on revamping the venture model. The gist is that LP's should be more closely aligned with the GP's by changing fee structures and payouts. The only problem as I see it comes from the fact that the top tier VC's have the scarce resource: skill.

If one person has the scarce resource they will raise prices until they get to keep all of the excess profit in a business, and this is what happens in venture. Sure, LP's can drive down prices on firms that don't perform, but it is well known that you shouldn't be investing in firms that aren't top decile anyway. That leaves the top firms to charge whatever they want, and so they will get the excess profits. While I agree that LPs should try to renegotiate the contract I'm sure they will really have the power to do so over the long term. LPs provide capital, and until recently that wasn't a scarce resource. If it stays a scarce resource then we probably have larger problems and venture investing will be poor. If the economy turns around then once again the LPs power will diminish as capital rushes to the best managers.

Feb 09

Talk the walk

I had to create a talk for class on VC Lingo and ways in which early stage investors protect themselves in transactions. I thought I'd post the slides here in case anyone was interested.
Basics of VC Securities

View more presentations from artimage. (tags: vc venture)

Jan 09

Sports Metaphors and Venture Investing

I originally wrote this for my Field Study in Private Equity class, but I wanted to archive it here as well:

I recently heard that the difference between a sport and a game is that
you can intentionally lose in a sport. Try to intentionally lose at
craps, you can make the odds bad, but you can't ensure a loss. Now some
sports have more skill (signal) than luck (noise), for instance I can
never get lucky and beat Usian Bolt, but I just might get lucky and upset the world champion of Poker. So poker has a lot more noise in it than does running.

what does this have to do with venture you're asking. Simple, while
venture investing may not be a game (you could intentionally lose), it
is a very noisy sport. There are a whole lot of factors outside your
control that contribute to you wins or losses. Add to that the effect
that winners get earlier looks at better deals, and can get access to
deals based on their reputation that others might not, and it really
becomes tough to distinguish luck from skill.

Anyway, with the
signal to noise ratio so low it will be hard to tell who really has
talent vs. those that got lucky, at least if one is only looking at
returns. If you want to be a runner then you'll probably want to find a
different line of work; maybe this explains the large vc poker league in the valley.