Master of 500 Hats

The Fail Factory

i look kinda scruffy in this Fast Company intvw, but it's mostly on target.

Thoughts on Angel List, "Social Proof", "Spray & Pray", & The Network Effects of Large Scale Investing

(ok folks, i've gotta take the kids to basketball practice in a few hours, so will try to power through this -- that means limited crazy fonts, profanity, wild pix... sorry little monsters, next time ;)

3 major points i plan to cover in this post:

1) Angel List Fucking Rocks. Period.  it's the single greatest innovation in our industry in the last 5 years (aside from LinkedIn, Facebook, Twitter, & Quora) and it's great for almost all participants. and while social proof can be abused / misused, so can gasoline... doesn't mean you shouldn't fill up your gas tank and go back to riding horses. if you want to effect change, either Engage Fully, or Compete.  inaction/boycotts are rarely useful & should be largely be ignored.

2) on average, "Spray & Pray" investing -- aka a High-Volume, Diversified & Quantitative Investment Strategy -- is not just "ok", it's actually BETTER than "Focused" investing (at least w/o insider or hidden knowledge).  in fact, it is incredibly hypocritical and patently FALSE for the VC industry -- which has NEGATIVE IRR over the past 10 years, and historically poor performance -- to criticize high-volume strategies as being somehow crazy.  if anything, their inaction and lack of innovation in the face of poor performance is the Insanity, and most of them (& their LPs) should be ashamed for lack of stewardship.

3) in the future, "Value-Added" investing will come more & more from domain-specific knowledge (engineering, product, design, marketing, customers) and less & less from investors with large networks & rolodexes who make "introductions", as their value is disrupted & marginalized by social platforms like LinkedIn, Quora, and Angel List.  specifically, regarding Consumer Internet & Web Infrastructure investing -- people who DO NOT have skills in programming, design (visual or other), scalability, SEO/SEM, design, social platforms, viral marketing, affiliate marketing, mobile devices, etc -- will begin to fail out of the investing industry, and will be of limited value other than writing checks quickly... perhaps at higher-than-market valuations in order to compete. which is much worse strategy than "spray & pray".

UPDATE: to clarify further for Fred Wilson & others -- i am NOT espousing a PURELY "spray & pray" philosophy... rather the full story on what i'm saying is that a quantitative, high-volume investment strategy filtered based on reasonable assessment of team, product, market, customer & revenue along with domain-specific expertise, and selective follow-on investment with incremental knowledge of company metrics and progress CAN result in good outcomes.

or at least i hope so, because that's what i'm doing.

alright, let's get started.

#1: Angel List is the Single Most Important Innovation in Venture Capital in the Past 5 Years

background -- links to a bunch of previous posts about Angel List that have been written by Scoble, Bryce, Jason, & Suster which i will summarize below:

Scoble: wow, Angel List is a pretty amazing hype machine for startups, and a great way for entrepreneurs to raise capital. had no idea how much impact it has... pretty cool.

Bryce: i don't like the social proof aspect / herd mentality generated by Angel List, and i've got plenty of quality dealflow. taking my ball and going home.

Jason: gee Bryce, that's small-minded. Venture Capital is/has changed, and you risk becoming irrelevant w/o participation. [+typical Jason no-holds-barred criticism, perhaps unfair perhaps not]

Suster: i like Angel List mostly, altho some parts of it give me pause. mostly good for investors and startups, altho some n00b angels are gonna get fucked.. and in meantime their lack of financial discipline could also fuck up the rest of us. caution: keep using but tread carefully.

other folks also weighed in via twitter; notably Naval, Shervin, Peter Chane (& Percival did nice funny ;)

so arguably i'm the most active current user of Angel List -- i've done ~20 deals there, either that i've listed and/or invested in. maybe George Zachary is more active but we're 1 & 2 i think. (funny how the biggest users of Angel List are actually VCs, eh?). it's not a majority of my activity, but it's significant -- 500 Startups has invested in ~100 deals since we got started last year, mostly at seed stage (altho we recently started our incubator / accelerator program in the past few months).  we plan to continue doing ~100 deals a year, and i'm sure Angel List will be a significant part of those (maybe 20+% ?)... altho even *i* can't possibly keep up with the deal pace that's currently happening on Angel List. but that's not a bad thing.

so here's my take:

1) i'm an unabashed fanboi, and i think Angel List is awesome -- for both startups and (most) investors.  it is likely the single greatest innovation in the venture capital industry since Paul Graham started Y Combinator 5 years ago. period. Nivi & Naval deserve high praise, both for AL & for VentureHacks.

2) there is perhaps a little too much emphasis on Social Proof, however Naval is not creating the herd mentality, rather he is simply recognizing its value and attempting to harness it.

3) without question, Angel List provides greater visibility for a lot of startups raising capital who would otherwise not have as much access to investors. this is very good for entrepreneurs. and while Start Fund and Yuri/Ron investing in YC was a brilliant move w/ huge PR impact, BY FAR, Angel List is/will have 100x more impact on the industry than the Start Fund (which currently only focuses on YC companies).

4) for most investors, Angel List is helpful -- either to get access to dealflow they would not previously have seen, to supplement their existing dealflow, or to see what is happening at earlier stages and inform later stage decisions.  it's also helpful to connect investors to other investors (ex: i follow several hundred other investors on AL & i'm learning about them as much as startups).

5) for a few (mostly new, mostly angel, investors -- but not only them), Angel List accelerates herd mentality, and the emphasis on social proof can perhaps crowd out / overwhelm other useful signals (product, market, customers, revenue, team, etc).  for these investors, Angel List is kind of like Crack for Nerds... actually that's not it; it's more like Sex for Virgins. wait, here it is: Angel List is like Dangerous Sex with Super Models for Virgin Nerds.

yeah that's it -- imagine if you're Urkel and all of a sudden you get to find out who the newest Sports Illustrated hotties are, who they're screwing, and then SOMEHOW you discover an opportunity to SCREW THEM YOURSELF TOO! (omg, where do i sign?!?)  ok, so you get the picture.  this is probably why Bryce left the party. or maybe it's because he's a Mormon with 5 kids, and doesn't need to do any more screwing around... doh! (sorry i know that will offend some folks, but i couldn't resist... and Bryce is a friend even if i disagree with his stance.  Bryce: sorry if your kids are reading this.)

Now before i get into any real criticism of Angel List, let me again restate -- it's the single greatest innovation in Venture Capital since PG started YC 5 years ago.  it's awesome, and it has dramatic benefits for entrepreneurs... AND investors too.  it is likely the FIRST online system to have a material impact on the startup investing world (aside from valuation databases like VentureOne / VentureXpert / etc). Nivi & Naval also created VentureHacks, which (before Quora anyway) is the single most valuable resource for entrepreneurs in understanding venture capital & angel investors.  

So, what don't i like about Angel List?  not much. i don't like the fact that the voting arrows have a crappy UX, and it's a little hard to scroll through all the deals & investors sometimes... in fact, i'd even like a little MORE social signal, by figuring out a way to rate influence / reputation on Angel List, so that some investors count more than others (because they DO, not because i don't like a level playing field). but really, that's about it right now... and it's getting better all the time.

but to the extent Social Proof is a "problem" -- and i don't think it is, just its perception in weighting on Angel List relative to other items -- i CERTAINLY don't think you fix it by leaving.

as with most issues, Change happens either through VIOLENT participation, or VIOLENT competition.  in other words, most boycotts suck in terms of impact.  

either you engage fully and attempt to make change happen from within, or else you should go create a competitive alternative and attempt to make change by offering a better solution. either of these are rational perspectives, but non-participation is simply lame, & largely why i take Bryce to task for doing so (or at least, once he blogged about it publicly). silent non-participation is anyone's right, but vocal non-participation is like Cursing Darkness rather than Lighting a Candle.

#2: On Average "Spray & Pray" Beats the Shit Out of "Focused" Investing (btw it's called "Diversification")

i'd also like to clarify my investment philosophy and pace, and criticisms of "spray and pray" investing, as well as differences between me & other high-volume investors like Ron Conway (whom i still respect tremendously even if he thinks i'm an ass), First Round Capital, Y-Combinator, Tech Stars, and others.

Mark Suster was surprised when i took mild offense to his left-handed compliment about me being a "higher-volume investor who did well in spite of that behavior".  damned by faint praise, i will fully OWN the fact that i've called my fund 500 Startups and will probably always be known as a high-volume investor first, value-added investor second.  

in time, perhaps our fund will also be known for Design, Data, & Distribution, but for now i'm happy to be labeled as your Canonical Clueless Carefree Spray & Pray Bitch. i will now EMBRACE and REINFORCE the "Spray & Pray" label until i ABSOLUTELY DESTROY its relevance thru repetition and ridicule -- and furthermore i think it's the rest of you "focused investors" who think you add so much goddamn value that are full of it. BRING IT, mofos. (for the record, it's almost always 95% entrepreneur, 5% investor. "focused investing" is perhaps more accurately "focused selection" -- it's rarely the case that the investor adds much value after the investment, other than check... and if they do, it's mostly just introductions... more on that below.)

"Spray & Pray" is usually a disparaging term used by those who don't about those who do. in almost every case where i hear it, it's biased commentary by large VCs who do later stage investing at a much lower volume. or else, it's by bloggers/press who can't think for themselves, and like to start interviews off with me in adversarial fashion... that is, before they realize i've gone toe-to-toe with Arrington for years, and 99% of them can't hold a candle to his masterful psychological warfare otherwise known as a "briefing". (once you've been through the trenches with Mike, everyone else seems like a walk in the park. there is a reason he's the best in the business, and most of you are no Mike Arrington).

so anyway, let's consider that most of the folks in the traditional venture business who are criticizing spray and pray HAVE HAD NEGATIVE IRRs OVER THE PAST TEN YEARS, and if you remove the top-performing 10-20 VCs from the #'s, the overall industry as a whole probably hasn't beaten the market for decades aside from a few years in the late 90's when the retail market would buy any bullshit that the investment bankers put on the market. and this from an illiquid asset class with high risk. you better be at least getting 15-20% returns on average, or you shouldn't be opening your piehole.

seriously now, i've been saying this for years -- it's sort of like someone who's had sequential disastrous monogamous marriages criticizing someone else who's single and dating the field. in other words -- you're just jealous because my job is more FUN than yours, and in general you SUCK at yours, whereas i actually have been both a programmer and a marketer for more than 10 years each, and sort of know what the hell i'm doing. or at the very least, i'm new enough to the investing field that we don't know for sure yet whether *I* suck, but we have PLENTY of evidence that *YOU* sure as hell do.

for the last time -- with VERY few exceptions, traditional VC investment practices have resulted in EXTREMELY POOR financial returns, and disparaging & biased remarks against high-volume investing are the height of hypocrisy. i will be happy to listen to criticism from folks like Benchmark, Sequoia, Greylock, Accel, Union Square, and others who have consistently out-performed on low-volume pace of investment for decades.  they at least can speak from authority (and to be fair, Mark Suster's GRP has done quite well in the past decade).  however, if you are ANYONE ELSE then please have a big cup of Shut The Eff Up because you don't have the 1st clue what the hell yer talking about.

to be more specific: if we look at the #'s, on average it's more likely that high-volume, spray & pray investing -- which i will going forward refer to as "a quantitative investment strategy" -- is likely to be successful than a "focused, low-volume" investing strategy.  in fact, it's hilarious that people like to refer to what i do as playing roulette or gambling, when it's exactly the case that the fools playing a low-volume strategy are the ones who are gambling -- they're betting on exactly ONE roulette square, when they know the odds of getting billion-dollar wins are astromonically higher than 40-1.  

whereas i'm basically trying to be the Billy Beane of Silicon Valley, betting on a bunch of short, fat first-basemen who consistently get on base.  I'm going after all the Ichiros, and i'm willing to do an incredible amount of scouting and early investment to figure that out, when most investors are lazy, want to bet on Barry Bonds and souped-up #'s, hoping they can hit a homerun when the fence is actually more like a mile away than just 300 yards.  good luck with that folks.  i'll stick to technical hitting, thank you.

again, it is tantamount to conspiracy that people who are failing miserably at venture capital investment with ridiculously poor IRRs are disparaging anyone else with a quantitative invesment strategy. kettle, black.

#3: Social Networks & Reputation Systems like LinkedIn, Quora, Angel List are Destroying & Marginalizing the Value of "Rolodex" & "Finance/MBA" Investors. Domain-Specific, Expert Investors are the New Black. Get Used To It.

now, let's talk about what VALUE-added investment is REALLY all about.

first: while value-added does include introductions & reputations, if this is all you are currently trading on, then prepare to get disrupted by things like LinkedIn, Quora, Facebook, Twitter, Angel List, etc.  most big name VCs over the years have PRIMARILY been trading on reputation and connections which are now MUCH less necessary due to the advent of social networks and other high-visibility communication platforms which are dramatically more transparent than they were 10 years ago.  this is likely to continue to accelerate rapidly, and in the future i will wager that investors with these backgrounds will be a hell of lot more valuable:

• Engineering & Programming
• Visual Design & Interaction Design
• Back-End Infrastructure & Scalability
• Large DB Systems Integration
• Front-End Scripting & Dynamic Content Integration / Rich Media 
• Analytical Marketing & Metrics
• Behavioral Psychology & Customer Development
• Paid & Organic Search (SEO/SEM)
• Social Networks, Social Media, Mobile Development & Marketing
• Affiliate Marketing & Direct Marketing
• Business Development, w/ Strong Engineering or Product bkgrd
• Enterprise Sales, w/ Strong Engineering or Product bkgrd
• Ad Copy Creation & Consumer Marketing
• Customer Service & Support
• Payments & E-Commerce
• Other forms of Online Marketing (Video, Blogs, Social, Mobile, Etc)

The list goes on, including many other specific skills in building & creating product, and in marketing & distributing to customers.  these are the 2 key areas of expertise: building product & distributing to customers. making or selling. creating or hustling.

On the other hand, skills i bet won't be important as much in the future:

• having (only) a big rolodex or (offline) network
• having a traditional MBA or investment banking background

Both of these are still important, but will become commoditized and marginalized by the availability of such information from online systems for social networks & reputation, and by the relentless advance of access to capital from a variety of channels.

To the extent these areas ARE still relevant, they will be dominated by those who are most visible and most relevant on Facebook, Twitter, LinkedIn, Quora... and Angel List.  most VCs barely blog, and have no idea what it means to engage on any of these systems, much less build them or market them.  (most angels too, but they seem to be a little more savvy).

and while most people think of me & 500 Startups as Crazy Spray-and-Pray, what we are REALLY all about is value-added investing based on domain-specific knowledge from the first group.  

our team includes engineers, marketers, designers who have worked at companies like PayPal & Google & Mint & YouTube, and our mentor network currently does many of the jobs in the first group at companies like Facebook, LinkedIn, Twitter, Groupon, LivingSocial, Zynga, Twilio, SlideShare, Zong, etc.

we also are quite unique in that we run domain-specific conferences on social platforms & marketing (Smash Summit), on design & user experience (Warm Gun), on startup metrics (Lean Startup w/ Eric Ries, another 500 advisor), on messaging & communications (Inbox Love), and we reach a global network of 100+ companies across 3 continents and over 10 countries (and visit them via trips like GeeksOnaPlane).  we webcast our accelerator talks live to anyone in the world who wants to tune in.  and yes, i am bragging, because i'm sick & tired of people thinking we are anything as simple as "spray & pray" investors.  

i challenge ANYONE or ANY firm on the planet to show me the list of "value-added" resources they can bring to the table compared to us, even though we are barely one year old.  we are NOT simply spray-and-pray investors -- we are The Next Generation. we are What's Coming. and we Got Next.

We Are Legion. Expect Us.

 

gotta take the kids to basketball, so i'm leaving it right here for now.

(drops mike on floor, walks off stage, raises 2 fingers to audience... in RubberBandits style).

 

GeeksOnaPlane East Asia 2010: Startups Are Global. You Should Be Too.

TechCrunch just posted the fourth and final GoaP video (see below) from our GeeksOnaPlane Asia 2010 trip (Shanghai, Beijing, Seoul, Singapore, Tokyo), produced by the awesome Ben Henretig at Micro-Documentaries.com, and Kris Krug also included an incredible photo essay of our trip as well.

As we wrapup our social media tour of China, South Korea, Singapore, and Japan, i'd also like to announce 500 Startups just made our first investment in China, in ChinaNetCloud.  Congrats Steve & James, and welcome to the family.

Startups & Entrepreneurship are a global phenomenon. Start something already.

Fire in The Valley, Fire in My Belly... and Yes, Mike, I Have Stopped Beating My Wife.

So i've been debating whether to write this post all day. 

Unfortunately i probably have more balls than sense, but it drives me fucking insane to see some bullshit superangel conspiracy theory get whipped into a frenzy by people who weren't there, have no idea what the hell was discussed, and are ready to believe anything when someone yells FIRE!

so here goes nothing... first a few clarifications:

- mike arrington is a friend, an imposing figure, and a hard-nosed, hard-working journalist. that said, he's dead fucking wrong about there being some story around " collusion" (def'n). makes for great red meat on TechMeme & Twitter, but it's just so much horseshit.

- yesterday i was invited to a dinner with some well-known startup investors to discuss the latest & greatest in tech & startups. the agenda was drinks, good food, & shooting the breeze... it wasn't to collude, to price fix, to put out a hit on Paul Graham, or generally bust a cap in any founder's ass (ok maybe Zuck & Jobs have it coming, but people might notice if we shoved them furtively into Davy Jones' Locker). Yes: it was a private affair, and No: mike wasn't invited. neither was Barack Obama, your mom, nor any of 500 other friggin' awesome people in silicon valley or around the world.  meh... whatever -- i don't get to go to every cool kid party in the valley either.  sorry, mike... but if you want, i'll knock one back with you before we go onstage Monday morning at Disrupt.

- startups & investors bitch & moan about price (aka valuation) all day long, but i don't really give a damn what other people think most of the time. buy or don't buy. negotiate or don't. This is America, This is Capitalism, and it's a Free Fucking Country. me? i like convertible notes just fine, albeit usually with some kind of cap. sometimes a deal is "too expensive", sometimes entrepreneurs really are "awesome". usually, we're all W-W-W-WRONG about 10 different reasons why shit is gonna fail anyway.  you still in?  yeah, me too... so ante up, mofo. you're here in Silicon Valley because you're trying to change the world, or at least build a better mouse trap. either way, odds are against us. deal with it.

- from an entrepreneur's perspective, Paul Graham & YCombinator are killing it right now... and bully for them.  sometimes you got leverage, sometime you don't. regardless, PG should be commended for innovating on the venture model, and for encouraging startups to push the envelope -- on both product, and price.  still, people should realize the wheel comes around for everyone, and it's a small valley.  people on both sides shouldn't get too comfortable, and shouldn't try to fuck with each other too much.  Personally i prefer to leave a little more on the table for the other person, and focus more on building a long-term relationship and less on the tactical zero-sum crap. 

regardless: haters gonna hate, players gonna play.  just focus on the important stuff (build product, solve problems, get customers, make money... and don't be evil... much ;)

- my fund 500 Startups is investing in 7 or 8 YC startups out of the recent batch, and they are some very smart young entrepreneurs with some great business opportunities.  most of them will fail, but that won't stop them from starting, or me from investing.  and sure, the pre-money is definitely on the high side compared to rest of market / previous years.  so be it.  Mercedes Benz ain't cheap either.... but that shit is SHINY.  if you don't like it, don't buy it.

- innovation & investing is not about price.  it's about finding great entrepreneurs to build solid companies, and solve customer problems.  price matters, but innovation & execution matter a helluva lot more. find good people, bet on them, help them succeed. try to improve the ecosystem, and try not to be a dick (that last one is actually hard... it's sort of easy to be an asshole as an investor).

- at the dinner, there was a fair amount of kvetching about convertible notes, capped or not, hi/lo valuation, optimal structure of term sheets, where the industry was headed, who was innovating and who wasn't, and 10 million other things of which 3 were kind of interesting and 9,999,997 weren't unless you like arguing about 409a stock option pricing. 

however, in addition to pricing & valuation, some of the more interesting things discussed were:
 1) how can we increase access to startup capital (new geographies, new investors, Second Market, etc)
 2) how can we increase M&A for startups & increase awareness of startups for non-tech acquirers
 3) how can we increase startup innovation (more smart entrepreneurs, cool new platforms, better techniques for mentoring / entrepreneurship)

of course, none of that shit is nearly as sexy or exciting as how we're going to screw over some n00b startup founder at YC, beat the crap out of some clueless old dinosaur VCs whose IRR sucks ass, or hide our secret tinfoil cabal / conspiracy at Bin 38 from the Valiant Fourth Estate. 

in short: if it Bleeds, it Leads... and Fuck. That. Noise. about Fair & Balanced, right?

on the other hand -- some folks really are trying to innovate in venture capital, support & invest in thousands of entrepreneurs, that employ millions of people, who create billions of dollars in value, for customers and shareholders around the world. we ain't trying to kill the Man in the Arena, mike... we're rooting for him (or her).

naah, screw that shit & lets get back to Collusion cuz that sells newspapers.

and like Gordon said: Greed is Good... even if we're counting page views instead of dollars.

as for lil ol' me?

i'm here to Disrupt, motherfucker.  so go right ahead & Hate On Me.

If I could give you the world
On a silver platter
Would it even matter?
You’d still be mad at me

If I could find in all this
A dozen roses
Which I would give to you
You’d still be miserable

In reality, I’m gonna be who I be
And I don’t feel no faults
For all the lies that you bought
You can try as you may
Break me down but I say
That it ain’t up to you
Gone and do what you do

(Chorus)
Hate on me, hater
Now or later
‘Coz I’m gonna do me
You’ll be mad, baby
Go ‘head and hate
Go ‘head and hate on me, hate on
‘Coz I’m not afraid of it
What I got I paid for
You can hate on me

Ooh, if I gave you peaches
Out of my own garden
And I made you a peach pie
Would you slap me high

What if I gave you diamonds
Out of my own womb
Would you feel the love in that,
Or ask “why not the moon”?

If I gave you sanity
For the whole of humanity,
Had all the solutions
For the pain and pollution

No matter where I live,
Despite the things I give,
You’ll always be this way
So go ‘head and….

You cannot hate on me
‘Cuz my mind is free
Feel my destiny
So shall it be

"Hate On Me" – Jill Scott

The Lean VC: a Silicon Valley story about Innovation, Incubation, & Iteration.

Here are slides from my talk at the GROW conference (Vancouver, August 2010) on changes in the venture capital industry.

For more info on this topic, read my blog post "Moneyball for Startups".

The Lean VC: a Silicon Valley 2.0 Story

View more presentations from Dave McClure.

 

Dave McClure talk about seed investing on GigaOm

Recent video interview i did over at GigaOm with LizGannes:

500 Startups

... and BOOM goes the Dynamite.

500 Startups

 

MoneyBall for Startups: Invest BEFORE Product/Market Fit, Double-Down AFTER.

My apologies... this is a long piece (~2500 words).  Not for the faint of heart. If you want the short story, read the abstract below & 3 core assertions, then cut to the conclusions at the bottom.

Abstract: VC funds are getting smaller (good), & angel investors are growing (also good), but both need to get smarter & innovate. Startup costs have come down dramatically in the last 5-10 years, and online distribution via Search, Social, Mobile platforms (aka Google, Facebook, Apple) have become mainstream consumer marketing channels. Meanwhile acquisitions are up, but deal sizes are down as mature companies buy startup companies ever earlier in their development cycle.

What does this mean? What opportunities/pitfalls does it present for investors?

Let's start with 2 intial observations about the current market for investors, and for startups.

Assertion #1: Most consumer internet investors (angels, seed funds, big VCs) have no clue what the fuck they're doing. Except for a few brand names, most large funds >$150-250M will die in the next 3-5 years... and that's a good thing. Still, smaller investors will need to innovate and differentiate in order to attract proprietary, quality dealflow and survive.

Recently some very smart folks have been talking about the relative [upside/downside] of being a [small/big] investor in tech, and specifically the changes & challenges going on in venture capital in the last decade. Due to reductions in CapX rqmts & median exit size, it's tough to be a large fund (say, over $250M?) that invests in consumer internet. However, while i agree there is a Moneyball "small-ball-is-beautiful-baby" story going on in venture, that summary is too concise... and it misses a more significant point re: differentiation in investor domain expertise & services (or lack thereof), and the importance of staging follow-on investment based on product/market maturity (more on that later).

IMHO, whether or not your fund is large or small is not the primary issue in consumer internet investing. While my biased belief is $10M-100M seed funds are a lot easier to manage & more entrepreneur-aligned than "traditional" $250-500M+ funds, there will likely be a few winners and LOTS of losers at both ends of the spectrum. Probably more BIG fund losers than small fund losers, but still there are many other factors than fund size that will predict for success or failure.

No, the primary issue is that investors of all shapes and sizes have become incredibly lazy and complacent over the past two decades, measured by both activity and by IRR.  Meanwhile, the consumer internet has brought a tsunami of technological & behavioral change which has resulted in stunning reductions in time & cost needed to distribute products and services to the over 2-3B connected people on the planet.

Let's examine that more closely:

The INTERNET has changed life DRAMATICALLY for BILLIONS around the globe -- yet most VCs & lawyers still close deals via fax & snail mail.

Fuck. That. Noise.

Most consumer internet investors, large or small, have no goddamn clue what they are doing. They are getting killed on IRR, and most of them should be put down & put out of their misery... NOW.  Their investment thesis is suspect, their domain-specific skills are limited or non-existent, and their desire & ability to innovate is minimal. They are simply collecting fees, waiting for the next tee time.

Well ATTENTION K-MART SHOPPERS -- you, Mister VC 1.0, are about to be DECIMATED... and it's a Schumpeterian Fate that is both deserved and overdue.

HURRY UP & DIE ALREADY, U FRIGGIN' PATHETIC DINOSAURS.

indeed: most VCs are Dinosaurs, and the World Wide Web is an Asteroid that hit the planet in a slow-motion cataclysmic explosion 15 years ago. It may take another 5 years for the ash clouds & nuclear winter of Browsers, Search Engines, Social Networks, & Mobile Devices to kill all the T-Rexes, but it's a done deal. The marsupials are taking over and in 2015 there will be a lot more investors that look like Jeff Clavier, First Round Capital, Y-Combinator, TechStars, Betaworks, & Founder Collective than any Sand Hill VC (funny how all the innovation is from non-valley investors, isn't it?).

Now let's take a look at changes that have occurred, & how to adapt as a Lean Investor 2.0:

Assertion #2: There is tremendous opportunity in building revenue-focused consumer internet startups for $1-5M that a) attain some level of commercial viability, b) acquire customers predictably using online distribution channels (Search, Social, Mobile), and c) can later be sold for $25-$250M.

Historically, Venture Capital has been about the use of large, risky, CapX spending to accomplish two primary & typically expensive goals:

1) Build Product.

2) Acquire Customers.

Now in the past, PRODUCT has meant building a variety of expensive things (big iron, disk drives, personal computers, packaged software, computer chips, designer drugs, network routers, browsers, search engines, social networks, etc) with lots of people over periods of years.  We're talking 50-100+ people spending 3-7 years building shit, with no offsetting revenue for quite some time. That's a lot of headcount and expense before you even get to your first customer.

And to make that even worse, many of the VC-funded startup companies target CUSTOMERS have been large, enterprise companies in tech and/or government entities with looooooong sales cycles requiring expensive, direct, dedicated sales force... that also cost shitloads of time & money.  Or large mass-marketing sales & marketing campaigns conducted via expensive print, radio, & television marketing. And the sales cycle was annual, requiring ongoing efforts to hit quarterly or annual sales targets via license revenue and maintenance support and upgrades.

Finally, many of these companies were being built/financed to go public over a series of many years and multiple capital raises where the amount of ownership by the entrepreneur was quite small (usually single-digit %'s) and the target exits were huge, hundred-million if not billion-dollar outcomes.

Fast Forward to Twenty-Ten, and let's take a look at these fundamentals, with a specific lens on the consumer market & internet startups:

• PRODUCT now typically means a website or service, run on low-/no-cost open source software, hosted in the cloud on low-cost servers, developed in a few months (or a WEEKEND!) by a small team of 1-5 developers, who continuously test & iterate in real-time with online customers

• MARKETing now typically means using a variety of online distribution channels via paid & organic search (SEM/SEO) on Google, viral/social amplification on new media platforms & social networks like Facebook, Twitter, & YouTube, and the quickly-growing mobile platforms of Apple iPhone & Google Android. With the exception of search, most of these distribution channels didn't exist 5 years ago, yet they now easily reach over 100M-500M+ users, with very low cost and measurable marketing campaigns such that even a small team can reach billions of people globally.

• REVENUE can now be collected easily via a variety of online payment, transactional e-commerce, digital goods, subscription billing, lead generation, CPM/CPC/CPA advertising.  Many people buy things online now, and many companies are even bought for usage & users ahead of revenue.  In other words: Brothers Are Gettin' Paid, Yo. Cash Money, G. It's aaaaalll goooooood, mah nizzle.

So to summarize: PRODUCT development cycles are shorter, required materials & resources are free or low-cost, development teams are smaller, and new services mashup & build on top of old services that already deliver terrific value in the cloud via features, data, network effects, & APIs. MARKETing costs are lower, due to a variety of broadly-available, low-cost, online distribution channels, which can be used in more measurable and predictable ways than ever before. high-bandwidth to the home means video and other data-intensive media are commonly available to anyone with cable or satellite TV. REVENUE can be generated simply & continuously, via direct business models & online payment methods that are becoming mainstream all over the world... such as mobile payments even in the remotest, poorest economies.

Finally, as more tech & internet companies mature and become profitable, they in turn are a larger source of exits & liquidity as they attempt to acquire startups with innovative technology & desirable products & services.  By utilizing their larger customer base as a way to leverage distribution, they can acquire smaller companies who want low-cost ways to access new customers.  However, as more of these companies mature & compete for acquisitions, many startups are getting bought up earlier in their lifecycle at smaller dollar amounts than if they had to grow to IPO-required size.  And as even non-technology companies attempt to acquire innovation & expertise in online services, more but smaller exits is a likely ongoing trend.

Okay, so that's a lot of crystal-ball gazing into the near-future, but now let's take a look at some emerging best practices & fundamentals for investing in Consumer Internet startups.

Assertion #3: Startup investment can be staged in 3 distinct phases with explicit goals & outcomes:

1) PRODUCT = Customer Problem/Solution Discovery (MVP), User Experience / Usability

2) MARKET = Market Sizing, Campaign Testing, Customer Acquisition Cost(s) & Conversion

3) REVENUE = Expand Revenue and/or Market Share, Optimize for *PROFITABLE* Revenue.

Largely, this is about applying techniques in Customer Development (Steve Blank) and The Lean Startup (Eric Ries) to investing, and in particular how to research, improve, & identify Product/Market Fit (Sean Ellis, Marc Andreesen), otherwise known as "TRACTION", before and after you invest.

This is really the key to my investment thesis: Invest BEFORE product/market fit, measure/test to see if the team is finding it, and if so, then exercise your pro-rata follow-on investment opportunity AFTER they have achieved product/market fit.  It's sort of like counting cards at the blackjack table while betting low, then when you're more than halfway thru the deck and you see it's loaded with face cards & tens, then you start increasing your betting & doubling-down.

Let's face it -- most venture investors are sheep.  We like unfair advantages.  We want to know that there is already customers, revenue, and that elusive thing called TRACTION.  Unfortunately, if it's obvious that there is already customers, revenue, and TRACTION then there will likely be a LOT of other investors at the trough, the competition will be fierce, and as a result the price to invest will be high.

So how can you invest at low-cost, then figure out when to follow-on to increase your value?

it's pretty simple, actually.

INVEST EARLY at LOW COST in people you think are smart and have built some promising products. understand if they know how to iterate and use customer feedback to improve their product and/or marketing.  learn how to understand conversion metrics for their business & customer value.

then IF you see the metrics improving & customer / business value increasing... then DOUBLE-DOWN.

however this happens in 3 distinct stages:

1) PRODUCT: Discover a [large enough] customer segment with a meaningful problem / strong desire, and develop a functional solution for them to use (Minimum Viable Product aka MVP).  I also call this when ACTIVATION happens.  You should also make sure the user experience is compelling enough for them to use it more than once (RETENTION).

2) MARKET: Test for scalable distribution channels that allow you to acquire large # of customers at cost less than what you will generate (ideally, at <20-50% of annual revenue so you have some cushion).  You may also find you have to go back to #1 and change some things, or discover entirely different marketing campaigns & concepts to get to scale.  If you're lucky you may even discover a way to get your users to spread the word for you (word-of-mouth and/or viral features).

3) REVENUE: hopefully your MVP is already obviously valuable enough that people will pay something non-zero for it. regardless, the goal is to test & optimize for product/market(ing) combinations that generate cash-flow positive outcomes at scale, over short periods of time (or longer periods if you have financing structure to merit).  i tend to prefer business models with low complexity, such as direct transactional or e-commerce models, subscription billing models, or lead-gen / affiliate models.

Ideally you'd like to be able to invest in a functional product AFTER the entrepreneur has already got it working, but sometimes they aren't there yet, and often they will have to pivot regardless in order to find an interesting segment that scales & is profitable.  Still, i'd like to think most entrepreneurs who understand their customer can build a functional MVP in 3-6 months, for <$100K. Sometimes it takes longer / more capital, but most times it doesn't.  If they look like they figure it out, double-down.

Next, you'd like to be able to improve the user experience and engagement / retention, get them to increase their love for the product.  If you can do this well enough, your customers will become your marketing... at very low cost.  Even if you can't get to strong word-of-mouth or viral marketing, you can still hopefully reduce customer acquisition cost by getting incremental social amplification.  Regardless, your job is to discover SOME kind of scalable distribution channel that seems like it COULD be optimized to a point where it's cash-flow positive at some point in the future.  Hopefully this doesn't take more than $1-2M and 6-12 months to figure out.  But most of this spend should be on MARKETING channels & testing, NOT on adding more features... you can pivot to discover new customer use cases, but DO NOT keep adding features.  in fact, you might want to remove them (see KILL A FEATURE). If it looks like you've got scalable distribution, even if not quite break-even, then double-down.

Finally, now that you have functional product (hopefully AWESOME product with strong activation / retention / referral metrics), and you have some ideas on scalable distribution that converts to non-zero revenue events (or proxy events such as long usage or referral / affiliate / lead-gen behavior, advertising CPM/CPC/CPA), now you need to tune to get to profitability within some finite period of time that you can finance and/or stretch to achieve.  This is where it can sometimes get quite expensive, and it could take years to get to profitability for some businesses, but i'd like to think that my startups can figure this out in $1-5M and 1-2 years. Again, if it looks like you can get there, then double-down.

 In summary, you should be thinking about stages for risk-reduction & company value creation that look like this:

1) Product: $0-100K, 3-6 months to develop basic MVP that's functional & useful for at least a few customers. Get to small product/market fit.

2) Market: $100K-$2M, 6-12 months to test marketing & distribution channels, understand scalability & customer acquisition cost, conversion to some non-zero revenue event. Get to large product/market fit.

3) Revenue: $1-5M, 6-24 months to optimize product/market fit and get to cash-flow positive.

I might edit this a little bit, as i'm in a rush to finish publishing and get back to other projects, but i think this has captured most of what i wanted to say for now.

Appreciate feedback & commentary on anything that doesn't make sense, could be improved, or can be streamlined.

 

 

 

 

 

 

 

 

 

You've Seen This Shit B4. Move Along.

It's Classic. It's Timeless. It's Godawful Fucking Ugly (but colorful). 

And i swear and wave my arms a lot.

If you still find this shit interesting, here's the latest & greatest 

(maybe 1 new slide, maybe not).

Startup Metrics 4 Pirates (July 2010)

View more presentations from Dave McClure.

Startup 2.0: a Silicon Valley Story

Slides from my talk for Echelon 2010 (Singapore):

Startup 2.0: a Silicon Valley Story

View more presentations from Dave McClure.