Seed Stage VCs Compete With One Another But Not How You Imagine

There are more than 200 “micro VCs” (fund sizes < $100m), a number which has grown significantly over the last decade and even since just 2013 when we started Homebrew. Folks who aren’t in the trenches of early stage investing often assume that this sheer volume makes “competition” my #1 worry. Quite the opposite – I feel near zero competitive pressure from 95% of similarly sized funds. Most have different strategies, focus areas and networks. They tend to fill in rounds around our lead or fund companies that wouldn’t be a good mutual fit for Homebrew. They can be successful (or not) without impacting my business. Availability of capital does not equal commodification of capital.

So what about the other 5% of funds? In my worldview there are ~10 seed funds that focus exclusively on this stage of company, in areas we’re interested in and also credibly seek to lead rounds. Some also have operating experience (since Satya and I believe that’s an important part of our value proposition). Most have been around longer than we have and have proven to be good investors. But yet I still think of them holistically as coopetition, not pure competition. Why?

1. Many seed deals have two leads, which means we are collaborating with them as often as we’re competing

2. You spend a lot of time together in the marketplace and have chance to share notes about what’s changing in the environment, how to help entrepreneurs generally. Seed stage is cordial and relationship driven.

3. Most opportunities we don’t all see/agree on – that is, out of every 100 seed startups, you can expect consensus on very few so it’s not often that we and our peer funds are all looking at the same deal and trying to win it.

So for me the competition at seed stage isn’t about winning deals, it’s about seeing deals. I want to be in that handful of funds that a founder (or their advisors) want to talk with about their NewCo. It’s not enough to be thought of as a generally nice guy; fund returns are made on being able to be among the first to see opportunities. Our Fund I was heavy marketplaces, API/SDK, SaaS and Direct to Consumer. In Fund II besides extending in those competencies we’re spending an increased amount of time on enterprise/industrial hardware and enterprise collaboration (among others). And we think a lot about what we need to do in these areas to be in a founder’s Top Five. And it’s not trying to be all things to all people but rather concentrating on sets of relationships, competencies and companies. For a new VC, this is probably the hardest aspect of building dealflow.

Posted in VC 5

Has Mobile Killed The Fast Follower Strategy? Sure Looks That Way…

Has mobile killed the “fast follower” strategy? The ability of a second-mover company to mimic (copy?) a more innovative competitor and eventually own the market? In 2010, Entrepreneur Steve Blank suggested the data shows you’re better off fast following than originating – citing companies like Google who benefited from combining somebody else’s business model with their search technology.

Now just a few years later, it feels like mobile has increasingly rewarded being first to market with a product that people want – especially in the Consumer market. Instagram, Snapchat, Line, Twitter, Foursquare comes to mind as mobile-first innovators who have been able to hold off imitations by larger tech companies and fast follow startups.

Here are some hypotheses why:

  • Time to Market Delayed By iOS App Store Approvals: On the web you could just push code and control your own release cycle. iOS inserts a delay while Apple reviews and approves your app. The first mover has already cleared this hurdle and subsequent app updates have less friction due to Apple’s familiarity with the product. Fast follower needs to essentially get approval to launch.
  • Discovery Has Changed: iOS App Store promotion and word-of-mouth via social media are much bigger distribution forces today than three years ago. Sure a fast follower with a marketing budget can drive paid installs and ad-based promotion, but organic and editorial discovery is more important with mobile. This favors the innovator, not the mimic. When was the last time Apple featured a fast follower app? They want to drive the new, hot, best-looking apps because that’s what keeps iPhone as the platform of choice.
  • Changing Impact of Social: Using Facebook Connect, Twitter Followers and address books, access to social graphs have become a commodity. Sure you can innovate on virality, but smaller first movers can scale quickly. Fast followers typically exploited their existing distribution footprint but this isn’t as meaningful an advantage in the social mobile world. Purely anecdotal, but clicking on a link is easy where I’ll often need to hear about an app from a friend before I go through the multiple clicks required to install.
  • Apps Tend to Be Single Purpose So Bolting Feature Into Larger App Doesn’t Work: Classic fast follow move was to just ship someone’s product as a feature on your already bloated client software or as another tab on your website. Mobile apps tend to be designed for speed and single purpose – you click on a “button” (app icon) and something is expected to happen. Facebook just adding another feature to what is already a very complex app isn’t as much of a threat to startups anymore.
  • The Impact of Design: Ok, stay with me here. The rise of “good design” as user expectation is often understood to be about pixels and beauty. I believe it’s deeper than that, especially on mobile devices – these phones and tablets you lovingly caress in your hands and hold close to your face; which literally get warm with use. Purrrrrrrr. Love is a component of good design. That is, innovators usually really really love what they’re building and this comes through in their design. Little flourishes. Fast followers are driven primarily by fear or greed. I’d hold that these root motivations can be unconsciously felt in their products. I don’t have specific examples – maybe Instagram vs other photo services with filters; or Snapchat vs lookalikes.

This post is definitely a work-in-progress – perhaps there are many examples of fast follow mobile apps that have gained tremendous usage or the strategy will become more successful again as mobile matures, but as an investor in mobile applications, definitely thinking about these questions.

Founders, “Why” Matters as Much as “What” & “How”

tldr: mission-driven founders kick more a$$

As Homebrew ramps up its investing, I’ve been really impressed by the quality of founders we’re seeing raising seed rounds. Although any investor ends up saying “no” 99 out of 100 times, many of the companies that weren’t a great fit for us have gone on to raise strong rounds and I’m sure many will be quite successful. Satya and I enjoy being transparent about our values and happy to iterate in public, so here’s something we believe:

Founders who can answer “Why” have a competitive advantage over those who can’t, and tend to be better fits for Homebrew.

The average pitch contains substantial time dedicated to the “what” and the “how.” What is the market you’re serving? What is the product you’re building? What is the customer pain you’re addressing? How will you build your product? How will you recruit a team? How will you get customers? All of these questions are essential and certainly factor into any investment decision we make.

That said, “what” and “how” haven’t been sufficient to get us to YES. In the handful of investments we’ve made to date and the termsheets we generated this week (it’s been busy), there has consistently been a strong “Why” as well.

Why are you taking years from your life to work on this problem? Why does your company deserve to exist and why is the world a better place when it succeeds? Founders who can answer the “why” are usually called “mission-driven.” It doesn’t mean they’re necessarily curing cancer or solving global warming (although they might be). Rather there’s a deep conviction that they’re on a personal crusade, one which you need to get on board with RIGHT NOW.

Mission-driven founders energize us. Mission-driven founders also have a competitive advantage in the marketplace. We believe they are better recruiters – not just warm bodies, but the best, most talented people who have many choices and want to work for something which matters. Mission-driven founders seem to commit a little more to their startups because they are giving their heart, not just their brain to the effort. Mission-driven founders build strong cultures.

“How” and “What” can be logically derived. “Why” needs to be felt. And just like funk, it can’t be faked.

If you are a founder who knows Why and you’re working in the Bottom Up Economy helping SMBs, developers and consumers drive economic growth, Homebrew would be honored to hear from you.

If you’re a superstar working for a CEO who you think can’t answer the Why, we’re happy to try and find you a new home because, hey, why not? 🙂

I Don’t Want to Meet Your Company at Demo Day

As a new seed fund you might imagine Homebrew hustles to incubator demo days, taking notes and then chasing down founders to make an in-person connection. Nope. If you see me at a demo day, it’s likely to show support for the incubator itself, not to discover the Next Big Thing. Why? Because if I’m meeting a founding team for the first time on demo day I messed up. Given Homebrew’s commitment to go “all in” for our founders (leading financing rounds, operational guidance) and our fund’s thematic focus (the Bottom Up Economy), if I’m doing my job we’ll have found one another earlier, even if fundraising activity hasn’t begun.

It’s not because I want a sneak peek, or to try and pressure you into taking money before you have the chance to make a market. Rather I’m hoping we can see how each other work, maybe even work together by hopping off a whiteboard to talk through a design issue, product strategy or distribution hack you’ve been struggling to solve. I’m more interested in the way you think, communicate and lead, than your Keynote pitch skills. A termsheet should be just another milestone within a long relationship. When you talk with Homebrew, we don’t act one way before we wire you money and different afterwards.

Some founders (or incubator founders) will read this and raise an eyebrow, assuming there’s a hidden agenda on our part, or that there’s signaling risk in talking with investors in a staggered fashion. Maybe insisting that the unveiling of a company and subsequent funding auction yields the highest valuation. I realize that in aggregate some of these statements may be true (well, not the hidden agenda part). Thankfully we don’t want to invest in the aggregate company. And we have no problem being part of competitive/collaborative fundraising efforts. You want to kick off your raise on demo day and close quickly to create urgency? No problem, we’re excited to support that but the probability of our participation increases dramatically if we’ve had the chance to see you develop as a company and know that you too have had the opportunity to get to know us.

Making 10 or fewer investments each year gives us the ability to look for opportunities where there’s great culture fit between Homebrew and founders. Deal terms matter but people matter even more. We want to work furiously to help mission-driven founders build the companies they imagine. Ones that last a long time.

Aside from our model and ambitions, I’d suggest that if you’re in an incubator, early on identify a handful of funds that you want to get to know better. Funds that are likely to lead or otherwise participate in your seed round. Express that interest and spend some time together before you hit the stage with your ‘up and to the right’ graph. At the end of the day do this not because it’s what investors may want but because it will help inform your decisions.

So see you at demo day, but it’ll be sitting in the first few rows giving you a thumbs up for the progress you’ve made, not leaning over to the person next to us asking “what was that company’s name again?”

The Seed+ vs Pre-A Round Financing

Our venture fund Homebrew is focused on seed stage because that’s where we can be of most value to entrepreneurs by going “all in” for them early: leading a round, bringing on other great investors, putting together a board and helping them build the product/company/culture they imagine. Since we launched in May, there have also been a surprising number of what I’d call “special opportunities” – namely, companies which have raised a seed within the last two years looking to replenish their coffers without doing a full next round.

You write your principles in pen and your business plan in pencil, so we’re definitely taking a look at these, although we haven’t invested in any yet (all our commitments to date have been in true seed rounds). As we review them there are clearly two different scenarios, one of which is way more attractive than the other:

One I’d call the Seed+ — that means the team hasn’t yet hit the milestones they hoped to accomplish with the capital from their seed financing and need funding to continue. The reasons for the miss are varied – market developed more slowly, distribution took longer, team struggled to hire or hit their stride. Seed+ rounds seem to be priced at the same terms of seed (obviously dilutive), or slightly improved terms recognizing progress team has made. When evaluating Seed+ we ask the following:

  • Current investors: are they still supportive? are any putting more money in?
  • Team: how is morale? are founders still confident, or has the slog started to take its toll? Have they lost any key team members?
  • Deal: are founders properly assessing the value created to date, or lack there of?
  • Why?: Why are they running out of money? If it was an external event they couldn’t control, are they now executing as expected? If it was internal to the company has the issue been resolved?

Sometimes founders/current investors will tell us it’s worth bridging because it’s a small technical team and they can probably soft land if this doesn’t work out. That’s not of interest to us – in fact, probably a negative signal. As venture investors we’re not looking to say “let’s put a little more money in on this seed+ and likely outcome is they sell to Yahoo and we get our money back.” We need teams that still have the conviction they’ll build a company of merit and value.

If it’s not a Seed+ plus then it’s what I’d call a Pre-A. These startups have enough momentum to likely raise an A round at reasonable terms but are betting if they hit just a few more milestones, they’ll be in a position of even greater leverage. These are sexy as hell because not only is it a company heading in the right direction but a team that believes in itself enough to make a thoughtful, somewhat non-traditional decision. Many times Pre-A rounds will be taken fully by current investors but founders may want to bring in a new party as another pair of helping hands. Even better if, like Homebrew, they’re a seed institution that is likely to follow on in the A round. Pre-As are usually structured as a convertible, with a cap and/or discount to the A round.

Hopefully this helps entrepreneurs who are approaching their next funding decision. If you have any questions or want to discuss Homebrew investing, you can email me hunter at homebrew dot co.

For an Operator, Becoming a VC Isn’t the “Best of Both Worlds”

“Wow, that’s like best of both worlds for you. Investing other people’s money and getting to work on a bunch of cool products.” I heard this pretty often as I started to tell friends and former co-workers about Homebrew, our seed stage venture fund. While our experience and passion around product design will hopefully be a major reason entrepreneurs want to work with us, “best of both worlds” isn’t just the wrong way to look at becoming a VC, it’s actually harmful for both the investor and entrepreneur. The entrepreneur should be building the company they want to see exist and the investor should be assessing the entrepreneur’s capability to do so.

My first year of angel investing I fell into classic “operator turned investor” traps. During pitches I’d get excited about a company because I could imagine how I’d go about solving the problem identified or the product described. Instead I should have focused on the founder’s understanding of the problem and how they were going to solve it. Many times when working with a team my advice would often sound like “well here’s how I would do it…” That’s fine but only a B+ answer. What’s way more valuable is to understand the capabilities of the team, help them establish the framework within which to make a decision and then guide them towards execution. As I spent several more years investing and advising I was able to self-correct these tendencies and become more valuable to companies.

With Homebrew I knew I was making a distinct choice to become a product-centric investor, not a player-coach. My goal is to invest in strong exceptional teams who have the ability to succeed on their own, and help them increase the probability, scale and velocity of that success. And we intend to do that via our own time, a strong group of entrepreneur advisors, the right co-investors, the broader Homebrew community and a set of other ideas we’re still, uh, brewing.

I’m a tremendous believer in the value of operators turned professional investors (duh) but it’s perfectly legit for a founder to ask these investors “I respect what you were able to build but help me understand how you intend to translate that experience into helping me build the company, the product, the team and the culture that I want to build.” The best answers will be centered on growing your capabilities, not touting theirs.

Posted in VC | Tagged 1