What works better, selectivity or spray and pray?

Angel investors talk strategy and Dave McClure characteristically drops a lot of F-bombs

At last night's VentureShift at Cafe Du Nord in San Francisco, investing strategies was the topic of discussion among a panel of angel investors including AngelPad's Thomas Korte, Dave McClure of 500 Startups, Manu Kumar from K9 Ventures, Jed Katz from Javelin Ventures, and moderated by Mike Kim from Cendana Capital. And then Kim asked about Dave's strategy and Dave got all fired up.

Here are some notes from the panel, with some opening remarks from Mike Kim.

Mike: Fundamentally, venture capital is like a pubic hair on a mouse nut.  Last year the total raised by venture funds was $12 billion. But there’s $2 trillion in hedge funds.  The average ten year return is -4%. Seed is the back-to-basics capital.  Bigger funds are writing bigger checks, so it makes it harder to invest in seed funds.  So let’s do some introductions.

Dave McClure: Professional asshole, talking head, I believe in the quick-flip.

Jed Katz: we just closed a fund over $100m. We mostly do series A, and we mostly do seed investments when we’re pretty sure we’re going to invest in their Series A. We don’t want to do a seed round for someone if we don’t think we’ll do their Series A, because we don’t want the company to go up for their Series A and look bad because their seed investors aren’t following them into their Series A.

Manu: I’m probably the smallest of the small micro VC funds out there…like a nano VC fund. The focus of my fund is core technology and new markets. I only do four or five investments a year. I start in the seed stage and do Series A and Series B as well.

Thomas: I do incubation so I give the least amount of money.

Dave: Are we bragging about being the smallest of the smallest VCs? Like, I have the smallest penis, take money from me!

Mike: How do you guys build your portfolio? Dave, why do you want to invest in 500 companies a year?

Dave: I’m so fuckin’ tired of being characterized as a spray-and-pray VC.  Why do we invest in a whole bunch of companies?  For the same reason that dogs lick their balls: because we can.  We all agree product development is down substantially.  What people aren’t focusing on is that customer acquisition costs are down.  At the high level, product development costs and customer acquisition costs are now much smaller.  So you should be able to do a large number of deals with the same amount of capital.  Board seats are also not that impactful on a company’s success.  I know that’s sacrilege for people who think their time is so fucking precious, but that’s the case.  Most things fail—all of you founders out there (casting arms over the audience), half of you are going to fail.  It’s higher than 50%.  So we want to make a lot of investments with the assumption that most things fail, and then go in for a second round and spend more time on those that succeed.  That’s not spray-and-pray, that’s diversification.  I just don’t want people shitting all over my strategy because I put a lot of thought into it.

(Woman behind me says, “Aw…”)

Jed: I disagree with everything Dave says. (Laughs) We do about six deals a year.  We’ll invest as little as a couple hundred grand to two and a half million.  Starting a business is hard.  And the extent to which I can use my time and energy to help companies not fail, scale, and become a success, that’s what I think is important.

Manu: Most companies don’t succeed because of their investors, but despite their investors.  In terms of different strategies, Dave and I are at opposite ends of the spectrum.  I respect what he’s doing, but I have a very different strategy.  I want every single one of my companies to succeed.  I don’t want a high failure rate in my companies.  I have four or five companies in my portfolio right now and I want every one of them to succeed. That’s why I’m very selective on who I invest in. there are different strategies at the seed level. It doesn’t mean one is wrong and one is right, they just work at different levels.

Thomas: I’m between Dave and Manu.  We invest in about 40 companies a year.  We do everything a VC does, but in a more scaled way.  The company itself is very structured, we spend three months with them, they’re in the same office as us…and we have an artificial “demo day” where startups get two minutes to say what they do.  And then we give them options from there.  Today, you see fewer angel investors involved in high-cap investing.

Mike: Dave, how do you feel about a syndicate in the spaces that you look at?

Dave: Even at incubation stage, we work with every size and shape of investor.  The stage we focus most on is seed, and it helps us to think about the size of the check that other investors are writing.  It’s hard to fit two $500k checks in a round.  You have to think about one investor leading the round.

Thomas: Most founders take the money they get offered. The first checks you get, you take. They tend to be small.  But if the round picks up speed, it gets more competitive in later rounds.  Very few founders look at investors and say they can take me all the way through B and C.  If you get seed funding, you can probably find money somewhere else later.

Jed: Sometimes we do a hybrid where we follow the entrepreneur’s desires, like say raising $1 million. We do $1 million all the time, but sometimes there are angels that the entrepreneur really likes, and we’ll work with them and split the round in half. We lead the vast majority of the deals we do, probably 80%. Having been entrepreneurs, we like to work quickly, we don’t want to get into a much longer cycle with other firms.  With smaller investors, we can do it quicker. But with larger rounds, we’ll put bigger and bigger syndicates together.

Manu: I’m syndicate agnostic.  In general, I like to lead deals, as opposed to following in on a round, but I do that often because my check size is fairly small--$100k to $200K. I tell entrepreneurs, ‘you have to figure out who you want to bring into the round.’  I just screen companies down a lot more and I expect to have a much higher success rate. I don’t do a lot of high valuation deals.  I don’t touch high cap notes. I’m looking for deals that are appropriately priced—I don’t do high-priced deals. I wouldn’t touch anything that’s five or four.  Anything at five or higher, I’m not touching it.

Dave: It’s not that our portfolio has a higher death rate, it’s just that there’s a higher death rate out there. We try to align ourselves more with the founder and acquirer than the downstream investor. As an investor, I want to be aligned with an investor and acquirers. I want to see if a company has scalable impact, and if so, I want to buy it as soon as possible.

Manu: I agree with Dave, but I want to be perfectly aligned with the founders.  If it’s a good deal for the founders, even if I’m just getting my money back, then I’ll do that.

Mike: Thomas, what do you think of this ecosystem?  You work with all these companies, give them advice, so it seems like a good time to be an entrepreneur.  Are seed funds here to stay?

Thomas: I think it’s a quite healthy ecosystem right now. You have a lot more angels out there now, and I think that’s a good thing. Three or four years ago, we didn’t have seed rounds in the million dollar range. Most of the micro VCs have established themselves at true value to the founders. There’s usually one or two people who call the shots and get things done fast, rather than VCs who take a lot longer to make decisions.

Mike: Dave, you come across a lot of entrepreneurs, and they want to work with the big VCs first…

Dave: I think people want to work with the biggest names in the valley. Funds like first round and Y-Combinator are very well respected in their own right.

Jed: We see a lot of entrepreneurs who want to avoid the larger funds—it limits their exit options and they feel like they’re going to lose control of their company