Over the last few months, I’ve spoken to a number of investors who work in the early stage startup space. It seems that many of them have come to the same conclusion I had in my earlier blog post, Angel Odds vs. Venture Odds, which was that they really had to go broad in investing to try to find those few Google super-investments to generate the bulk of the fund’s returns.
The numbers they propose are staggering: 50-100 investments over the life of a fund! If 100, that’s 20 investments per year if spread out over 5 years (typical life of fund). Some of them may even try to front load the investments, exceeding the 20 and perhaps going up to as much as 30-50. That’s about 1 investment accepted, negotiated, gone through due diligence, lining up a wire, and docs signed and delivered every 2-3 weeks. If you’ve ever invested, you know how difficult that process can be.
Some thoughts on this, from the perspective of working on the measly 16 investments I’ve done over the last 3.5+ years:
1. Investor management of this number of startups will be challenging. What will it mean to have 20+ startups emailing you for help, meetings, introductions, advice, etc? Time management will be very difficult.
Entrepreneurs will have to be prepared to find ways of capturing dwindling time slices of the investors, and working hard to deserve more time. By deserving more time, I mean it is natural that the more successful startups will get more time as they have the best chance to return the most money to the fund.
2. Investor teams will need to increase, but paying for them may be difficult as early stage funds are typically smaller in size, and thus management fees collected will also be proportionally smaller.
3. It will be interesting to see how the money being moved around can be optimized. Typically capital calls are made to limited partners when an investment happens. If there are a lot of capital calls, making and collecting a huge volume of capital calls can be a lot of work on the fund personnel and limited partners. Capital calls may work differently for these early stage funds.
4. In this world of proliferating me-too products, it may be impossible to not invest in startups which overlap in plan. Many investors and entrepreneurs worry about their plans being discovered by competitors or near competitors. This is why we don’t like investing in startups who are competitive to one another. But if they are investing in 50-100 startups, I wonder how they avoid competitive conflicts? Or should they even care?
5. Can 50-100 quality startups be found in one area even if it is in the Bay area, the startup capital of the world? It may be that going far afield will need to happen in order to find quality startups. This will strain time commitments for investors to travel and keep tabs on investments far away. It will also mean entrepreneurs may only get as much help as they can remotely.
6. Entrepreneurs should be prepared for what I call “survival of the fittest” and “ruthless culling”. Given the limited attention time of the investor in the face of overwhelming numbers, entrepreneurs need to work extra hard to prove they deserve more investor time. The best will get more help, and get follow on investment. Those that do not get follow on investment may find this is a detriment to them getting more money.
Entrepreneurs will have to get over the fact that while they think they are the coolest kid on the block, in the face of being in group of cool kids, their own coolness will be the norm and therefore commonplace and they will have to find ways to be even cooler than their peers. Being commonplace in a group of equally cool kids could mean neglect as the even cooler kids get more attention and help.
Despite all this, I firmly believe this is the way to play the early stage startup game from an investor point of view. It is the only way to raise the probability that they will find the Google super-investments that will create the oversized return of the fund.

I went to Dave McClure’s Startup2Startup last night and we listened to Mark Fletcher recount his current startup commandments. Mark has had a great history in startups, having built ONElist back in the day which merged with eGroups and got acquired by my old alma mater Yahoo. Then he built Bloglines which sold to IAC in 2005. Now he is working on another startup called SnapGroups, which got announced and was supposed to launch last night, but unfortunately also came out with a nasty bug and kind of stifled the launch..!
One of his slides had to do with startup business models, which was more in the area of talking about startup business building strategy than just strictly revenue models. For his 3 startups, including his current one, he listed his startup strategies (me paraphrasing here and imperfect memory at work):
ONElist: Raise lots of money (~$46MM), grow big fast, hire a lot of guys, dominate the market before anyone else, go IPO
Bloglines: Raise a bit of money ($200K), hire small team, build great product, flip it.
SnapGroups: Spend as little as possible ($6K) using lean startup methods, outsource everything, work on something he’s passionate about, no exit strategy to shoot for.
It was a trip back in history for me, as I came into the startup world via Yahoo, and lived through the times as Mark had. What was amazing to me was the difference in strategy given what was in vogue at the time.
During the dotcom boom years, it was just build as fast as possible and get huge before everyone else, and then go for IPO. This of course didn’t work anymore after the dotcom bust, and the introduction of Sarbanes Oxley which basically killed the IPO market even as it attempted to fix the bad accounting problems and protect the shareholder. Also, the excesses of the dotcom era were completely gone, and also gone with it the ability to IPO on little or no revenue.
Then along came the post dotcom bust years and it seemed that the M&A market for startups heated up. So now it was cool to get a bit of investment, and then build something that a Yahoo or Google wanted, and then get bought. At this point, we saw that it was getting cheaper and cheaper to launch web products, and over time, a lot of people jumped on the flipping bandwagon.
Soon, flipping became tough also because it was easy to copy somebody else and now the market was flooded with me-too products. Everybody called on the corporate development teams of the Googles and Yahoos of the world and it became impossible to get their attention. They didn’t want to hear about you if you were too small; they only had so much time and only could focus on those opportunities that yielded the largest results for them. Yeah you thought you were cool, but against that kind of competition you weren’t cool enough.
Somewhere in there, along came Ycombinator who proved that you could build something with so little capital and get it launched that it started being copied everywhere. Also, the world shifted to providing so many outsourced services and resources that you could build something by using other peoples’ servers, open source code, and even excellent coders from other parts of the globe. Other companies would do the heavy lifting on commoditized services while you could focus on the core differentiator of your service.
Enter the economic downturn of 2008 and now M&A was difficult because major companies were pulling back to conserve cash and survive. They were also questioning their M&A strategies prior to this because they were buying startups for huge sums of money but wondering where all that hockey stick growth had gone to, after destroying the incentives of the brainchilds of the startup by making them rich and then watching them leave. Flipping became not so easy.
College kids couldn’t find jobs any more; nobody was hiring. Plus, they keep hearing from their peers that working at large corporations sucks. Enter also the rise of a ton of resources like Ycombinator to jumpstart tech startups in a number of locations. Starting up became the in-thing and now we see tons of people trying to do this in a super cheap, fail fast, be adaptable way.
Despite the obvious indicators, I have found that entrepreneurs still are sticking to last era’s strategies. Mark was smart; he watched the market and then built quickly to exploit the advantages of the era he built in. But today, I still meet entrepreneurs who are building to pre-dotcom bust year concept of building users fast and then thinking they can raise money later!
Even investors are stuck in last era’s strategies. The consequence of raising ever larger funds meant that they were hoping for the huge deals that were present in dotcom boom years, but now that strategy doesn’t work so well with the IPO market so slow and the presence of large enough startups worthy to put that much capital in so scarce. They add in the fact that initial capital requirements are so low, that often they find great startups who don’t need or want their enormous amounts of cash.
I also changed my investment criteria. Many startups I funded before the 2008 economic downturn still had dotcom boom year or flipping strategies, and had burn rates to match. But then as we crossed into 2008, I started seeing that either strategy now created enormous downside risk of failure, and so had to now go for startups who were smaller, followed the lean strategy, and looked seriously at producing revenue sooner than later.
Mark’s message was incredibly insightful, which is that this world is a constantly shifting place, and that you have to be nimble enough to switch strategies when the world changes on you. You also have to be observant enough to know when to make those changes, and not get locked into past views which may not be valid in today’s world.

Dave McClure posed to Jeffrey Veen and me an interesting question over Twitter which was:
WHY aren’t there more consumer internet VCs w/ graphic design skills?
This is something I’ve been thinking about for quite a while now. When I started angel investing and advising startups, I discovered that pretty much I was the only design guy out there angel investing, or at least that I could find. By that, I mean someone who worked in design in the industry, then switched careers and became an investor full time. For me, I felt that it was a specialty that would make unique in that I could help startups in the area of design and user experience.
However, I had always thought about why there weren’t other design folks out there doing angel investing. Here are the reasons I came up with below. Note that I lump together the design disciplines of visual design, interaction design, and user/usability researchers.
1. There just aren’t that many designers out there, relative to other disciplines. Anybody who has tried to hire designers knows that it is super hard, harder than hiring engineers which is already hard. Think about how many students graduate with design degrees; the number is incredibly low compared to the number of computer science graduates coming from engineering schools. This makes the probability of finding designers who become investors very, very low.
2. Now, take the very low number of designers out there, and meld that with the probability of experiencing a windfall of cash. This windfall of cash can be from any source, like a large inheritance, or winning lotto, or being an early person at a startup who had a mega-exit. Any of these cases (and others) is of extremely low probability. So again, low number of designers melded with low probability of windfall of cash to enable angel investing results in a super low possibility of this happening at all.
3. Of the people we meet in general with a lot of cash, who really wants to angel invest? I have queried some of my affluent friends and they’re just not into it. Some of them don’t want to, some don’t feel the least bit qualified to do it, some know nothing about it and aren’t interested in it. If this is true, then if we take the low number of designers who also have enough spare cash to angel invest, those who feel like investing in startups results in another very low number.
4. Knowing a bit how the venture fund industry works, I’ve been told that it’s super hard to join up with a fund. It’s not like applying for a regular job. Commitment at a fund can be a number of years, ranging from 5 to 10. Thus, adding someone to a fund’s staff takes a lot of deliberation as it is not good for someone to leave a fund’s team in the middle of a fund’s life. A fund’s pool of money is often raised on the fact that there is trust in a team to invest their money properly. If that team is disrupted, it could cause investors in the fund to pull out. Pulling from a limited pool of possible candidates, and the very low probability that any of them have any sort of design background results in just about nobody joining up with funds who are also designers.
5. If you look at who are typical venture fund partners, they are most likely ex-business people or ex-entrepreneurs. These seem to be the favorite candidates for becoming investors as they have experience in managing investments or acquisitions, or have worked in a startup and have some knowledge in startups and how to spot other good entrepreneurs. Designers are more likely to NOT have experienced these conditions and generally are not specifically looked for when a venture fund is recruiting for partners.
6. As one path to gaining successful experience as an entrepreneur, resulting in a potential windfall of cash to enable them to angel invest, designers might become a founder of a startup and grow it to an exit. However, most designers in pre-2002 days, were hired in later stages of a startup’s life, thus limiting their potential return as their stock allocation and strike price are not as attractive as if they came into a startup much earlier. Therefore, even during the dotcom boom years, designers may have been able to reap in a lot of cash, but probably not enough cash to freely angel invest in post-2002 years.
If we expand the list to include design agencies, then there are design companies who invest. For example, Method Design did have an investment operation, and fuseproject is currently making small investments into some of the startups they encounter.
Still, individuals remain almost non-existent.
While all that may be true up to today, I also think that this may change in future years. For example, starting an internet company is a lot easier today than it was in years past. There is a lot more literature about entrepreneurism and general acceptance that entrepreneurism is an OK career choice. Also, it is possible to build something and not be a coder, which most designers are not. There are many inexpensive avenues to getting something built, and use of open source code and other hosted services make creating web businesses much easier.
Also, it is my belief that with the number of me-too products being so high, and the ease that one can create copycat products, design is finally becoming a true competitive advantage as core services are pretty much the same, but it is the user experience and design of the product that allows a me-too product to win over its competitors.
So going forward, we may see a bunch of designers who are part of startups from a very early stage, and thus can have enough equity to get them a substantial cash windfall upon exit, which can then result in enough spare cash to start angel investing. Over a period of time, if they get good at angel investing, then they may get noticed enough to raise their own funds, or join up with a venture fund.

When I first tried to raise a small fund back in 2006, I heard about venture fund odds on investments which was that for every 10 investments a fund made, about half would fail, 2-3 would return a little bit, and then there would be the 1 that would return everything that was lost on the failed startups and then some.
It seemed to make sense and also drove the original reason why I thought I should invest more often than not. If I put more bets out there, then theoretically I should have more chances to make my money back…right?
To date, I’ve made 16 investments and two exits. I invested more broadly than most angels, except for the super angels. But looking at the internet industry, the sad state of the economy, and the way early stage angel investing has progressed for me over the last 3 years, I have come to the conclusion that the one in ten odds for this biz doesn’t apply to us; for us angels, it’s more like one in 20, or 30, or even worse.
Why do I think this:
1. The economy sucks. Probability of exits is much much lower.
2. The economy sucks. Making money is harder. Paying consumers are harder to come by. Businesses are already slow in committing to pay for a service.
3. The internet is too crowded. Me-too products are all over the place, creating blur in consumers’ minds, and making it harder to attract customers.
4. The internet is too crowded. Truly unique products and services are super hard to find now, so gaining a competitive advantage is tougher.
5. Too many small business opportunities on the internet. The probability of starting a great small business is a lot more likely. But finding a suitor with a small business is tough because it may not generate enough revenue to be attractive enough to be acquired.
6. Angel investors typically invest in the earliest, most risky time for startups. Venture funds (except for the early stage funds) usually invest after the very earliest money in. Once startups get to a size that is attractive to a venture fund, a lot of risk is taken out already; we don’t have that luxury. We typically go in when there is just an idea, and maybe a prototype built, and occasionally a business up and running. We don’t know if the startup will fail in a few months or not; there is no history that we can look at. With that kind of risk profile for our typical investment, it would make sense that their would be more failures in our portfolio than for a venture fund portfolio.
7. Those that survive have a high probability of needing additional rounds of funding for growth. If we can follow on invest, that helps a lot. But most of us can’t do that. We may have enough capital to put one round of investment, but most likely can’t invest more money in a subsequent round. Thus, dilution will limit our investment unless we get lucky and find a startup that does not require further rounds. The more investment rounds after the initial round, the more we get diluted.
So all this means that it’s super hard to find that Google super-investment that makes back all that we lost and then some.
Solutions?
Ron Conway combats this by going super wide and doing more investments than we could ever hope to do. This increases the probability of finding a Google in his portfolio.
We could try to find more startups that are capital efficient, and that make money from beginning. Those that do not require a lot of cash to scale means they may not need another round. If they make money, then this also reduces the probability of needing more rounds of investment. Of course, companies like this are incredibly hard to find. Nor can we accurately predict what amount of money they will need later.
If we could follow on, this would help a lot. How about playing Lotto and winning a bucket of cash to play with?
Now, if more venture funds played in the early stage space, combining broad, early stage investment with follow on investments into the winners, this would seem to be a perfect combination. However, in thinking how many venture funds operate, it seems like there are problems with making this approach a success.
Any other possible solutions?