56 investments into Homebrew IV(ever), the pivot we made in 2022 to investing our own personal dollars in an evergreen fashion, we’re in a reflective mood. The almost four years of operating in this new normal represents a ‘fund cycle’ of sorts, so we probably have enough early data to reflect on this style of venture investing versus the more traditional LP-backed deployment of our first decade. One of the most clear differences is how we treat startup valuation in our entry point. And it’s a meaningful change!
Whereas before, as a lead seed VC in a portfolio model structure, the negotiation would be a tradeoff (for us) between ownership target, check size, current fund size and total number of investments we wanted to reach for that vehicle. Now we offer a (mostly) consistently sized supporting check, are stage agnostic (although 90% of the 56 have been pre-seed/seed), possess no ownership requirement, and have an open-ended timeline. Essentially pricing, as a top line absolute concern, is less of modeled variable for us, and more of a signal to inform our decision. Valuation contributes to our conversation around four questions we ask ourselves:
A. What were the founders optimizing for? Maximizing valuation? Minimizing dilution? Enough capital to cleanly execute to next milestones? Or maybe a bit underfunded? All things being equal, we understand the market dictates prices, but just like a startup’s strategy can differ whether their strategic true north KPI is growth or margin or customer count or something else, so will the goals of a round lead you to different results. An initial financing can often be one of the first telling data points on what matters to a founding team, whom if we invest, we hope to be able to support for years to come.
B. Did the founders’ decision around pricing help or hurt the quality of the cap table? ‘Best’ investors or just the auction winners? Were there folks we believe are good partners to early stage companies who walked because of terms? Is there a lead investor and if so, are they underwriting to the same type of outcome, on the same timelines, that we’re seeking? Obviously impossible to fully know unless the founders are super transparent, and potentially subjective, but on our checklist.
C. Will the next financing be made more difficult because of the pricing set now? Good rule of thumb is to imagine what has to be achieved for the company to be worth 3x more the next time they raise. While this is likely overly precise, since startups are power laws so in hindsight the majority of a company’s financings were ridiculously cheap or insanely expensive, early on, in the Seed/A round, it’s at least a useful exercise. Start with too high a seed valuation and the degree of difficulty to get to a clean Series A is just that much harder. Since we’re investing our own capital and not playing the AUM “how much capital can I get into this company” game, our financial interests are more similar to founder/team needs: clean outcomes where everyone makes money at the end. Ahh, alignment is a beautiful thing.
D. What do we have to believe to imagine we can return 20x, 50x, 100x on this investment? Tied to the above, which is more about the pit stops along the way, we think of each dollar we invest as opportunity cost – it could have gone into a different startup. Homebrew IV hasn’t changed its return benchmarks and so while it’s still very much taking the risks involved to find generational startups early, the higher the entry cost the more we need to be convinced there’s a Large, Urgent, and Valuable problem to be solved, with a margin structure and outcome multiple.
We still firmly believe that if you are running an institutional capital firm you should err towards concentration – owning enough of your winners in order to move the needle on returns is the “easiest” way to outperform. But for our current playbook, Satya and I are hypothesizing that these four considerations will matter more to Homebrew IV’s financial performance than trying to hit an ownership target. Just need to wait 10 more years to be sure 😉