Editor's note: Our Post Seed VC event is coming up on Dec. 1 in San Francisco. We'll have Chamath Palihapitiya (Founder of Social Capital), Aydin Senkut (Felicis), Jeff Lawson (Founder & CEO, Twilio) and more. Check out the full lineup and register for tickets before they jump! Post Seed is brought to you by Vator, Bullpen Capital, and Haystack.
There has been a big debate over the last few years over whether the Series A crunch is real or not. What everyone can agree on, though, is that there are definitely more seed and early stage funds now than ever before, and more people willing to give money to young companies looking to make it big.
But just who are these funds and venture capitalists that run them? What kinds of investments do they like making, and how do they see themselves in the VC landscape?
We're highlighting key members of the community to find out.
Paul Arnold is founder of Switch Ventures.
Arnold was a senior executive at AppDirect, helping build it from a small startup into the unicorn valuation, it has today. He oversaw company-wide operations, built and led multiple teams, and learned what it takes for a startup to scale rapidly.
Prior to AppDirect, Arnold was with McKinsey & Company in Silicon Valley. He worked with C-suite, Board, and frontline employees to drive changes. Working in technology, finance, and consumer products, he focused on strategy and operations.
VatorNews: What is your investment philosophy or methodology?
Paul Arnold: I invest in seed stage companies and I take a very predictive analytics approach to founders. What I mean by that is, we've spent a lot of time building out our database around founders, all the founders that are known in the last 15 years, and identifying characteristics, or pockets of founders, that perform really well. I spend a disproportionate amount of time talking to folks that come out of that analysis, and making bets there.
So, it's a predictive and analytical approach to investing, but it's also very much a founder-first approach to investing, where my first filter is identifying the types of people I know I'm interested in and taking it from there.
VN: What do you like to invest in? What are your categories of interest?
PA: I invest across all kinds of IT industries, whether its enterprise or consumer or e-commerce or marketplaces.
I'm not a category-driven investor. I really am a generalist across the Internet. I don't invest in healthcare. I don't invest in energy or science, or many other spaces, but pretty much anything you find on the Internet is a space I'm interested in investing in. I haven't invested in hardware and that's not really my sweet spot. It's not that it's impossible but it just hasn't been where I've found most of my activity.
There are a couple of reasons I'm a generalist. One is because I have such a tight thesis around people I feel like it allows me to open up around categories. The second thing is, as an investor, these categories come and go in trends—you know, SaaS is really hot this year, SaaS is not hot next year. Virtual reality's hot this year, virtual reality's not hot next year. Across my whole fund, I like to have a balance of those things.
A lot of funds pursue a focused strategy and a lot of them get into trouble because of it too.
VN: What would you say are the top investments you have been a part of? What stood out about those investments in particular?
PA: PolicyGenius is an exciting one. It's a consumer insurance online broker in New York, and the founder's a dynamic woman who is a very strong leader, and knows a lot about insurance. I had strong confidence in her and the idea made a lot of sense. Insurance is an industry that needs disruption and her insights about how it needed to be disrupted really resonated with me. That's a company I've invested in three times, in their seed round, their Series A and again in their Series B round. I'm a big fan, and it's a company I've been with pretty early. It was one of my first investments and it has done well.
Another company that's pretty exciting is Mode Analytics, which is a data analyst platform, for data analysts to do their work. It's a team that spun out of the data science team at Yammer, which was a very strong team, and they spun out to build a product they thought they needed to do their work. It had done well, and it's another company I've invested in three times, at angel, at seed and again at Series A. I'm very optimistic.
Some of the more recent investments are really exciting. Willing, which is a legal will creation service, and end of life planning solution. It's just doing fantastically well. It's a strong founder out of Miami who, using my approach, identified and tracked down and started conversations with him. He's done very, very well.
Another one is Skyfit, which is a workout app. It has a large base of runners that has it, and has grown in popularity really rapidly. It's sort of coaching for exercises as you go. It's had a lot of momentum around it.
I also have a bunch of companies that have unannounced rounds that are doing extremely well.
VN: What do you look for in companies that you put money in? What are the most important qualities?
PA: Around the founders, there's a lot of specific backgrounds that are the initial filter. Folks that worked at certain companies and had certain jobs, and so forth, that we saw was really predictive of folks being likely to build a successful company in the future. We saw that across our data, which was 11,000 companies, and we built that data over about six months. So there are a lot of insights around that.
Then, beyond that, you into what any other VC would probably do as well, which is really digging in and understanding the product, and feeling like it resonates and solves a real problem that you feel and understand. And that there's a market opportunity for something reasonably large, at least, to be built.
VN: What kind of traction do you look for in your startups? And can you be specific? Are you looking for a number of customers or order volume?
PA: I do tend to invest in post-traction companies. It's not an iron-clad rule, but the large majority of my companies are post revenue and growing quickly on a month-to-month revenue basis. It's the sweet spot that I feel comfortable coming in on the company. Usually these are $1 million to $2 million seed rounds, where I'm writing a check alongside a handful of other seed funds as well. That's the most typical type of deal that I'm doing.
I've invested companies as early as pre-launch, and I've invested in companies quite a bit later, Series A, as my initial entry point, but I'd say by far the most common entry point is a seed stage company. They might be three or six months in market, very often making annualized revenue in the six digits with strong core metrics around monthly growth, retention, conceivably strong unit economics, things like that. It's usually the companies that have broken that six-figure annual revenue barrier, and the best ones have taken too much time to get there.
VN: How long does it take before you meet a startup and make an investment and how do you conduct your due diligence?
PA: It's so all over the map. Probably the shortest has been about a week, and the longest has been about a year and half. If a round's really coming together, sometimes that happens in a two week period or so, but at least as common is someone is really early, they get in touch with me, or are introduced to me, very early on, and they're just leaving their jobs, or something, and I get to know them over the course of a year. They really show they're building a serious company that I can get behind.
So, it can vary quite a lot, depending on what point I meet the founder, and how close they really are to justify a serious round. So, as short as a week, and as long as you can know somebody.
VN: Given that these days a Seed round is yesterday's Series A, meaning today a company raises a $3M Seed and no one blinks. But 10 years ago, $3M was a Series A. So what are the attributes to get that Seed round? Since it's a "Seed" does it imply that a company doesn't have to be that far along?
PA: It's funny, that is certainly true. It's just that the bogies have shifted back for everything, so Series A investors come in companies with dramatically more revenue than they used to have. In the 90s, they came in on companies per-revenue very, very commonly, now that's very uncommon. The average seed stage investment is a post market company that has traction or revenue or user base that's meaningful. With that you have the emergence now of pre-seed funds, who are really taking role of being pre-market investors. So, the whole thing is a bit of shifting landscape and sometimes that's confusing for entrepreneurs, but that's certainly going on.
Often a company needs to bootstrap or even raise a pre-seed type of found, whether that's from a pre-seed fund or whether that's kind of an angel type of round of modest size, maybe a few hundred thousand dollars. They have to really prove some kind of initial traction. Whatever it takes for them to keep the doors open to build a product, get into market and prove that there's strong market receptivity to it. That usually needs to be done before most seed investors are looking to come in.
VN: What are the attributes of a company getting a Series A?
PA: A typical company needs to do 5x to 10x, usually more like 10x, than numbers I'm investing at. So if they're coming to me at $200,000 annual revenue, I usually see their next round is when they're at $1 million or $2 million revenue. So they need to make that journey there over the 18 months or so that a seed round lasts.
I tend to think the progress needed to be demonstrated between rounds is pretty large. I'm looking for companies that I think can really do that. I've had the fortune of having an extremely high follow-on rate, which is well over double industry average for my companies going to Series A. I tend to have pretty high expectations for when they can pull it off. I try to be helpful to the founders by helping them understand that because the worst thing is if they don't understand how high the expectations are at the outset. It's sort of unfortunate if they have the wrong expectations going in about what they need to accomplish.
In the early stages there needs to be pretty impressive growth to get the attention of the Series A investors. There are always exceptions but, as a rule of thumb, it's better to be safe by growing pretty aggressively.
VN: Given all the money moving into the private sector, I believe there's more money going into late-stage deals in 2015 than there was during the heyday, back in 2000, do you think we're in a bubble?
PA: I would say that a year and a half ago it was worse than right now. I don't know if I'd call it a bubble, or exactly what you'd call it. One reasons is maybe because it wasn't as big as what people called bubbles before. The other reason is I'm not clear if it was set up to pop, as much as just to slowly cool down.
What was definitely clear is the markets were hot a year and a half ago, and they were hotter than should have been. That wasn't a venture problem, either. Another reason I hesitate to call it a bubble is because bubbles tend to be associated with a single asset class, like the tech stocks of the late 90s, or the real estate crisis of 2008, or the Dutch Tulip bubble of the 17th century. But what was happening a year and half ago was every single asset class was overpriced. And they were all overpriced, frankly, kind of evenly. So, venture was overpriced and there was too much in money in venture, maybe there was even extra too much in the late stages, you could argue, but you too much in public equities, where you had PE ratios of publicly traded stocks were too high. You had the yields on bonds were far too low, so there was far too much money in the bond markets. Real estate prices were above historical norms. Commodity prices were largely above historical norms. So, it was actually every single asset class was too hot and venture was just one of them. People in the venture world were talking about it a lot, but it was actually this global macroeconomic phenomenon of having a long period of good time with low inflation rates from global banks.
So that's how I looked at it. I never looked at it as a tech problem, and I never really was too worried that it was going to pop, but I also was really cautious and thought that everything was overpriced. That was the balance of how I thought about it. I still think about it but it has cooled off some.
VN: If we're in a bubble, how does that affect your investing?
PA: I think about valuations, and valuations do matter to me. I've certainly turned down deals where I think the valuation isn't appropriate. That, for me, is the most important part. Valuations at the seed stage have gotten a little more reasonable. Often founders come in with too high expectations, and sometimes we have a conversation about that. Often we come to terms, and its something that we're both happy with, and occasionally we don't, and then it might be something I would pass on.
If you think the market's overly hot, you have to pay attention to the prices you’re paying, so you don't get carried away and lost and pay for all the damage later.
I do think that venture is an interesting market. Maybe most markets are like this, if you think it's high, you can't just stop participating. You just put your money in cash and sit on the sidelines for a few years, because you lose your effectiveness as a venture investor if you're not active, if you're not engaged in the networks and communities, if you're not continuing to make the deals and stay up on the trends, and have a brand and reputation that's active and ongoing. For me, it's largely about staying engaged but trying to be price intelligent.
It would be great if you had the flexibility to put more capital to work. In the public markets, that's kind of the class scenario, if you're smart enough to time markets you would do that. The same is true in venture. People don't often have that luxury of having extra money when times are tough, because their limited partners are giving them grief, on one hand because they're often making steady investments for the reasons I mentioned before. So, even if the markets are down, they often keep a similar pace, and if they speed up they're worried they might not be able to raise the next fund, because their LPs are all feeling hurt at the time. In an ideal world, you would invest more in the down time, in practice it's maybe harder to do.
VN: Tell me a bit about your background. Where did you go to school? What led you to the venture capital world?
PA: I worked for small startup before went to law school, and we served private equity and venture capital clients, actually, and that's when I became aware of the industry and started to get the hunch it was something I was strongly interested in. I went to law school, and realized I had no interest in that whatsoever and knew that, instead, I wanted to come to Silicon Valley, to get involved with startups and venture.
When I came to Silicon Valley I actually took job with McKinsey as a management consultant, in the Silicon Valley office, and I spent about four years there. It was a great place to spend some years. It's great training ground, I learned a lot, I worked with great, smart people. I had the opportunity, after a period of time, to join a startup I was pretty excited about called AppDirect, which was a young company, fresh off of its Series A round. I was brought into that company of 20 people to manage the business side of the company. It's had the fortune of doing really well; today it's a 700 person company, it's in the unicorn club, it's had about $200 million from some pretty intelligent investors. It's a sterling success story, and we went through a dramatic amount of scaling while there. I've seen what it takes to grow a company from 20 people to several hundred and the many challenges involved with that. It was an exciting time to be there, and to be leading all those teams.
I was thinking about how I wanted to place myself in venture and what I realized at AppDirect was that I very envious of the founders themselves, and I realized that when I was going to do venture that I had a strong interest in building my own fund from the ground up.
I've been making investments since 2013. In 2014 I launched a venture fund, which, at the time I called Arnold Capital. As I went on to raising a larger fund, and realized I was going to do this for a long period of time, I wanted the brand to be less about just my name, and so I branded it in January as Switch, though the majority of investments are older than that.
VN: What do you like best about being a VC? What makes you excited?
PA: I thought about starting my own company and there's no easy answer as to why I didn't. I think everybody has own choice. There's certainly things I miss about being an operator in a larger company, there's no question about it.
But there are things I like about being a VC. I like working across a variety of founders, and using a more analytics and strategic way of looking at their problems than just the get it done mentality you have when you're inside a company every day. I also like coming in early and helping them get going and I enjoy the flexibility of building my own fund the way I would like to build it.
It's kind of pros and cons. I did definitely think about starting a company, and went down that path, and almost kicked it off, but ultimately venture felt like the right balance of things for me.
VN: What is your investment range?
PA: Initial checks are usually $300,000, and follow-on checks are often double that.
VN: Is there a typical percent that you want of a round? For instance, do you need to get 20% or 30% of a round?
PA: No, I really don't think about it that way. A lot of funds do; it's a great debate I've had with a lot of VCs, about whether ownership percentages matter. They certainly matter if you have a very large fund. If you have a micro VC fund, like almost every seed stage investor is, except for a handful of the really large ones, like First Round, I really don't think you need to pay attention to ownership percentages. You need to pay attention to how much money you're putting to work, and how much upside there is in the company.
You don't need to work backwards from ownership percentages, so I don't worry about that.
VN: What percentage of your fund is set aside for follow-on capital?
PA: I set aside 40 percent
VN: What series do you typically invest in? Are they typically Seed or Post Seed or Series A?
PA: I'm trying to stay much more focused and the seed and A. Seed is where almost all initial investments are made, where the majority of the fund dollars go. Then's reserve money, mostly for Series A. I have done Series B. In the future I'll probably do Series B outside of the fund, by raising a special purpose vehicle, and things like that.
VN: In a typical year how many startups do you invest in?
PA: About eight to 10 a year, and about 30 out of the fund total.
VN: Is there anything else you think I should know about you or the firm?
PA: I write occasional blog postings, which I enjoy doing. They help keep me smart. I'd like to write more than I do. Some of those are interesting, if anybody’s interested to check them out. A couple of them I'm proud of. Gospel of Growth, that's my most recent post and I think it's pretty good.