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.
Andrew Romans is General Partner and co-founder of Rubicon Venture Capital.
Romans is also the Founder and former President of The Global TeleExchange, as well as former Managing Partner at Georgetown Venture Partners and Georgetown Angels, a global angel investment group he co-founded. He's also the former General Partner of The Founders Club.
He was Managing Director of EMEA at Sentito Networks, and managed enterprise software sales at Motive Communications.
Romans has a BA from the University of Vermont and MBA in finance from Georgetown University.
VatorNews: What is your investment philosophy or methodology?
Andrew Romans: We typically invest in late-stage seed, Series A or Series B for the first time that we make a new investment into a startup. So that means you've already got pre-seed, seed and demo day stage funding. There’s variance on this, but typically we'll invest in a startup when it’s the round that happens after demo day round. There are times when we're connected to the entrepreneur, or one of portfolio CEOs turns us onto an entrepreneur, and we invest a bit earlier than that, and we might be in a pre-seed. From time to time we land into a later stage deal where we have some magical value add, but it's typically late-stage, A and B the first time we come in.
A few years ago, before the average Sand Hill road VC fund size got so big, what's being called a last-stage seed, would have been called a Series A. So, in my thinking being someone who’s been in the VC community since 1997, we're kind of a Series A focused VC firm for the first investment. We typically get into about 25 companies in a single portfolio, and we leverage our own network and our LP base to help these companies be successful with a LOT of contact and interaction with each of our portfolio companies.
So, our real outlook or philosophy is to be the venture capitalist that's adding value to the startup, and that responds to whatever their problems are and tries to fix those problems and be helpful. I think a lot of VC funds raise money from institutional investors, like a pension fund, and those pension funds don't have any interest in sitting down and meeting a startup, or taking a board seat or trying to help the startup. They just put their $25 million into that big VC fund and want to see the baby with a big return.
With us, we've raised money from a mix of angel investors, with a lot of variance in geography, age, sector, experience, all kinds of things, and then a wide group of corporations. So actual corporations that are investing are looking not only for a financial return, but looking for strategic partnerships with disruptive, high-tech startups, to make their large corporation more hip and up to date and diversify their products and services.
A lot of family offices have invested in our fund, and they often own a few companies of their own, or there's one company that's built the fortune, and now they own lots of assets. They're often looking for strategic partnerships between those companies, and assets, that the family owns and our high-tech companies.
The result is rather than just the employees of Rubicon and myself trying to do everything ourselves, we have a lot of interaction among our limited partner investors and our startups. We're able to achieve success and try to really fix problems by having a larger group of people and even companies trying to help these startups not die and be successful.
Another thing we do that's a bit different is when an investor becomes an LP and they invest in our fund they gain the right to co-invest with our fund via a special purpose vehicle, which is basically like a VC fund to make just one investment. It's only the LPs in our fund that may invest in our SPVs. So we might invest in a company in a late-stage seed or a Series A and then we send out, with the permission of the CEO, what we call a "sidecar memo" and we email all the investors in our fund. "Hey, our fund has just wired money and made an investment in this company and if you'd like we've got room for another $1 million or $3 million. You can invest a small amount or a medium amount or a big amount into that, and we'll aggregate that into the SVP and wire that money to the startup."
For the startup, they get one wire transfer from Rubicon, and then a second wire transfer from Rubicon with the sidecar cash. So a subset of our investors are investing in their company. Now you've got angels, family offices and corporations that have a financial incentive for that company to be successful. Because, beyond their exposure to that investment through the fund, they have exposure to that investment from their personal capital or directly investing off the balance sheet. The startup gets more network around the company to help it be successful.
Some of these LPs are venture capitalists and corporations from Japan, and corporations and individual people from China, there are VCs, angels and corps from London and Zurich and around the world backing our fund. So there's a bit of a global network of support that we bring beyond just five general partners working together out of their single office in New York or Silicon Valley with limited partners that are rather passive. We're not the only ones that do SPVs, but for us we leverage the network of investors for different stages of the process - from deal flow to due diligence and vetting of the investment opportunities. We usually have a subject matter expert within our network that vet a deal and deliver value post-investment. That's delivering value to the startups after the investment has been made. A lot of times, I'll tell a CEO, "Let me introduce you to three different friends of ours. These two are LPs, and this one is just a friend, meaning not an LP, and they're experts in what your startup does. Even if we don't invest, you can thank me for having introduced you to the CTO of that company or whatever." So, usually, the CEO is happy to have been introduced to these guys even if we don’t invest.
We typically invest in 25 deals and we will continue to support 100 percent of our funds in one fund portfolio. We tend to double down, and write larger checks into the future investment opportunities after we've gotten to know the company better. If we're introducing the CEO to a lot of potential customers and they continue to not succeed in getting any of those customers, whereas another one is closing them all and turning that into revenue, we're more likely to put more money into the future financings of the second company.
So it's a bit of at the early stage invest in 25 and you've adjusted the risk. Push 50%+ of the fund dollars into the real winners and you've lowered the risk for your investors a second time. And you put yourself in a position to be able to take risks investing in risky startups while still having a high probability of making a really good return and we expect to massively outperform the S&P 500 Index.
The other key thing is that the fund invests in late-seed, A and B, and we allow our investors to co-invest as frequently as possible, which is probably only 60 percent of the time and the other 40 percent it's oversubscribed or it's moving too fast or whatever reason we don't do the sidecar. We do continue to invest in our portfolio companies all the way through Series C, D, E, growth stage, pre-IPO financings. But we only do that from sidecars. So we'll support a company from cradle to grave. The diversified fund that invests in 25 different startups moving most of the fund into the clear winners stops investing when we believe a 10X return is no longer plausible. If we are in a late stage deal like an Uber and we have direct access we might make a sidecar available for our LPs to invest more capital into a very late stage opportunity where the risk of losing capital looks low with a senior liquidation preference and the upside looks like a solid 2-4x return. That would hurt our fund which always seeks a minimum 10x return, but makes sense for one of our angels to put in $250k with a strong likelihood of making $500k or $1m within 1 to 3 years and downside risk protection. Again, that would hurt the performance of our fund so we do the late stage from sidecars only keeping the fund dollars focused on the 10x returns.
VN: What do you like to invest in? What are your categories of interest?
AR: Broadly speaking, we invest in Internet, software, and connected hardware type companies. We invest in both enterprise and consumer.
The fact that we are a relatively small and earlier stage in our franchise of funds, we've got to be careful of investing in companies that are too capital intensive, or have a high risk or total binary failure, or are guaranteed to have incredibly long time horizons to exit. Or even if it goes well there's no potential for liquidity on the secondary market. Because if you're a VC fund that's been around for 30 years and you invest in some hugely capital-intensive company that has no chance for an exit for at least six years, if you want to raise a fund every two to three years, it's hard to go back to your existing LP investors and say, "It will looks great on paper now. Please invest in my next fund." It's better to go back and say, "We've invested in 25 deals. A lot of them look like they're on a good path. Some may have died, but we've already returned the whole fund from these two wonderful exits."
We like to invest in companies that have the characteristics of potentially getting to profitability without raising total trainloads and truckloads of funding. We like to invest in companies that are somewhat past the point of risk of total binary failure, although we do take on real risk. We avoid companies that have the characteristics of a biotech company, where you're going to have to go through phase 1, phase 2, phrase 3 clinical trials. It's going to be guaranteed to raise $1 billion, and not a penny less. There's no way this thing would exit any sooner than 4 to 7 years, and there's a risk of total binary failure.
We stay away from biotech for these reasons, and we stay away from tech companies that have those built-in characteristics. So we end up investing primarily in Internet, software and connected hardware we can get behind to growth the business very fast. I like a business that can generate a lot of revenue and get to profitability very fast. And there's really been a Renaissance of hardware companies and you can pre-sell things. We're quite smart on manufacturing and we've done well with that and we've got LPs from China to help plus the right kind of connections here. So we're doing more of that despite the historical reasons to avoid hardware. They call it hardware cuz it’s hard!
VN: What would you say are the top investments you have been a part of? What stood out about those investments in particular?
AR: Right now, there's a number we've invested in that when we looked at how much we invested, what the valuation was, what we think the exit would be, there's a few of them that, individually, could return the entire fund. Or, if they were to return half the fund, there's quite a few of them now. It's hard to know when they’ll exit, but we have a high degree of confidence that we're already in a position to return the fund from a few and deliver big profits to our LPs from the rest as gravy. I expect too that the one that is struggling now just might be the bit hit of the portfolio. You need to be comfortable to deal with problems, torpedoes hitting your portfolio and remain cool, positive and supportive. I’ve seen some VCs get coercive on the entrepreneur when bad news surfaces and that does not help. We want to know bad news as quickly as we can from our portfolio co’s and try to help and mobilize our network quickly. It never helps to loose your cool. We feel confident that our current portfolio has crossed the chasm and the we just want to see how profitable the fund will be when a few winners returned all of the paid in capital. We can now afford to be cool and calm, but one needs to enter the room feeling that way based on your certainty of your portfolio construction and investment strategy.
You asked me to name names. One of the high profile companies we invested in was TodayTix when it was pre-revenue.
In New York City you can get theater tickets by standing in the middle of Times Square whether it's snowing or raining with tourists from Ohio and get a discount on your theater tickets, comedy club or ballet tix. So you get your ticket to the Nutcracker for your kids at Christmas at $200 instead of $500. The founders of TodayTix thought, "It’s stupid to stand in the snow and any self-respecting New Yorker should just download the app," and they had 100% of Broadway, at the time they launched it, and they've now got almost all of off-Broadway. It's a beautiful app that you can look through all the plays and theaters that’s on and you're guaranteed to get the same price that they're selling at TKTS. It was just a no brainer. You can buy from the back of your cab, in your kitchen, in the back of your limousine and know you're getting the same prices as those fools that are standing in line. And if you want to pay an extra $5 you can pick up your tickets from an attractive, unemployed actor or actress on roller skates wearing a big TodayTix t-shirt, standing in front of every single theater every single night. So anyone who goes to the theater in New York sees these TodayTix guys and girls giving out the tickets with an iPad, with a big button that says, "Ask me what TodayTix is." It grew virally really fast and they're beginning to sell a big percentage of all the theater tickets in New York. They launched in London, which we helped them with, they launched in San Francisco and 8 cities as of now and they're adding new cities every month. Their revenue is amazing and a true hockey stick and it’s the kind of company that just when you like the revenue and you’re looking at an acquisition offer we can juice the revenues more.
We actually kind of mentored the company from early days. We even introduced them to the lawyer who incorporated the company. We've been very hands on with these guys. We invested in the company when they were zero revenue; two and a half years later, they've come pretty close to an annual revenue run rate of roughly $100 million. If you look at 4 to 5x multiples, with potential for bigger multiples, you can gauge what the company would be sold for today. We introduced them to the investors that invested in the company after us and we co-invested again and again with each round. Introducing our portfolio companies to investors is a big part of how we spend our time. We spend a lot of our time working with founders on getting the right terms and pricing and valuation to other VCs that we like, and really running an investment banking process to help introduce them to future sources of financing and get some competition to invest and still get the right investors in at the right valuation.
Another company that we're extremely excited about, which is just shipping now, is Navdy. That's a local, San Francisco company that makes a head up display that you can buy and stick on the dashboard of your car connected to your smartphone. If your phone rings or you get an SMS or if you get a Tweet, WeChat or whatever is happening on your smartphone that you want to happen on Navdy, if your mother calls you, without having to touch your phone, or look at your phone, it projects an image in front of you so you can keep your eyes on the road. You can answer your phone using either voice recognition, or touchless gesture. It's kind of like "Minority Report." It becomes the hub of the connected car. If nothing else, Navdy is simply the best and coolest navigation system for a car on the market right now. They are positioned to become a massive business on that alone. When you start to add in the other apps that run on a phone into the mix and then even look at their development roadmap you’ll come to understand that this is a total game changer transformational company.
The company is largely in stealth secretive mode of what’s really going on at Navdy, but this is a company that will become a household name. Navigation is the tip of the iceberg. This is a rocking team changing the connected car space for real. I cannot divulge numbers, but they have a viral video, and if you own a car you'll probably end up buying the device. Stop reading this article and go to www.navdy.com and I’d be surprised if you don’t buy one. I have one in my car and my car looks sweet when I park it leaving the HUD on the dash. There's an expanding universe of large corporations that would like to buy them and I think this is a potential IPO company as well. That's an extremely cool company and we're really psyched to be a small investor in a powerful syndicate that's backing that company. They've raised quite a bit of funding at this stage now. We were a small investor in their initial outside funding round. We introduced them to Formation 8 who invested in subsequent financings and we and feel privileged to be investors in Navdy. I know you asked for specifics, but with Navdy we don’t divulge numbers or anything publicly.
A third one is from Rahul Vohra. He's the founder of Rapportive, which was this awesome plug-in for Gmail that gives you all kinds of information about the person you're sending or receiving email. With one click you can connect to that person on LinkedIn with an invite, see their Tweets, all kinds of data that they're grabbing. When you enter an e-mail address, Rapportive shows you that you typed it in correctly. So if you're typing in a difficult Japanese email address, it tells you if its correct or not.
Rahul sold that company to LinkedIn and his investors made a lot of money. One of our portfolio companies, Partender, is a cousin of Rahul's and convinced Rahul, "Don't just take money from your 15 previous investors. Let one new investor in." So his existing investors backed him, because they made a lot of money with him before, and we got in on a pre-seed investment. We invested in that company again in the next financing. The company is called Superhuman. There are a lot of companies that have addressed e-mail, making it more efficient and we’ve looked at a lot of them at Rubicon. We all spend a lot of time on e-mail, and his company will help make each of us a superhuman and be more productive.
I remember Rahul came into my office and I already knew a lot about him and the company, but I could see within seconds of meeting Rahul that I was in. I do not buy into the vision of every other e-mail company I've looked at, and I've looked at many. Rahul’s so intoxicating, that this guy, I know can recruit recruit people the Silicon Valley talent war. He clearly had the ability to raise capital. So if he can recruit the talent to turn is vision into reality, raise the capital to pay them and I buy into the vision – what can I say? I’m in! I knew he could recruit, inspire and retain people. He definitely seduced me within, like, 30 seconds to want to invest in the company. So I bought into the vision, I believed this guy can recruit people to work at his company and stay there, even when they get torpedoed, and every company gets torpedoed. He has the ability to continue to raise funding. The key thing is to make sure that we just do that pensively, and we spent a lot of time with Rahul on each funding round. He's, right now, extremely well capitalized. He raised funding from great investors. At higher valuations he got more money. He’s really incredibly well supplied, with the right people and the right cash, to execute on a vision, and he's very close to being launched.
Those are just a few examples of companies that we're incredibly excited about. It shows you the breadth of Internet software and connected hardware. I could keep going with other ones, but let’s move on.
VN: What do you look for in companies that you put money in? What are the most important qualities?
AR: In the early days of my career, I was very focused on the technology and the product, and through experience, as I've gotten older, I have to say that what I'm most focused on is the market they're going after, and to make sure that this is the right team for this mission. And then to make sure they do have some underlying technology that gives them the ability to have a high growth miracle take place, and something they can protect in a sensible manner to bring that to market. It's management first, market second, and I kind of need to see those two, and then there's gotta be technology.
So we need to check all three of those boxes. The market they're going for, that this management team is suited for that market, because sometimes this guy was born to disrupt that industry, but he was not born to disrupt another industry. Most companies, if you're investing early stage, are going to pivot. If you listen to a guy who got into the winner's circle with an amazing IPO or M&A exit, tell his story in a fireside chat, you'll hear that he was the opposite of pigheaded or stubborn, he was very versatile. Versatility is an important characteristic in the managers and the founders to be able to deal with rapid change in a high tech world. They have to run experiences and find out that they don't all work.
If they're the right team going after the right market, and they pivot, what you're left with in a world of pivots is the management team and the market. So that's where we try to focus.
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?
AR: The truth is, what's driving us, which is maybe a little different as a metric from other guys, is that we want to see a minimum of an 18 month runway at time that we invest. With all the syndicated capital of the financial round in which we participate, and the operating financial plan of the company, we want to see is that this financing round, where we invest for the first time, would be enough for this company.
In a worse case scenario, if the sales pipeline does not come into anything, the funding would last for 18 months. That means we should be able to make some progress over the first 12 months, and now we've got six months to raise capital, while hopefully milestones are still coming in, before the company runs out of cash. Running out of cash is the number one cause of death for a startup. If you come in first with an 18 month runway, there's a good change that you will have something go right, and something good will happen.
Sometimes, as far as what traction is, there might be zero traction, but we've got a killer management team, going after a killer market with an amazing track record of previous achievement. With our ability to add value, we know what we can do to help them reach milestones. So, I like to see 18 months of direct line of sight of what that milestone is, and how much I believe they can achieve that milestone.
A lot of the companies, when they're really early, they're not willing to take so much dilution that they're going to give themselves an 18 month operating runway with the way they're running the business. Once we have a company in our portfolio, we try to stick to the rule of "don't make a follow-on investment into a company that is raising financing with less than a 12 month operating runway." I think companies should give themselves a minimum of four months to raise a financing round, and it's not crazy to give yourself six months, if you want to play it safe. The problem is the entrepreneurs don't want to sell too much of their stock while the valuation is low, compared to where they think it's going to be in the future. We have to spend time with our founders to convince them of that. Then, sometimes, if they want to play it tough, and raise a bridge round that just keeps the company going for another three months, they can do it, but we're not as likely to put money into those.
A lot of founders, I jokingly say they're born coming out of their mamas screaming about dilution. Meaning that, it's innate, and they're born with an understanding that the more they get diluted, the less that they will own of the company at the time of exit. So it's bad to get diluted. Thus, they should try to raise money at the highest possible valuation every time, and nothing else matters.
I think it's important for entrepreneurs to raise money at a valuation, not based on what was possible, not on investors from Los Angeles that came in on AngelList and showed up to the YC demo day, or some guy from Moscow, or a Chinese investor. They should raise money at a valuation that gives them operational runway to make some milestones. Direct line of sight to a milestone that will enable you to raise money at a higher valuation. Then, at a minimum, you can raise more money at a flat valuation, and even if things go wrong, and when you're early stage you should be prepared for things to wrong, you can get something done. You say, "Look, I went to work every day for six months, this is the progress we've made, we think we raised at a valuation of $5 million, now we're raising at $8 million. Or we're raising money at $10 million." The unsophisticated investor from L.A. says, "I threw in $100,000, and that's now worth $200,000, In literally six months I've doubled my money." So then he's encouraged to put another $200,000 in." That's stupid, but it's real.
What's worse is that they raised money at a $25 million round valuation, when they were a bright and shiny object at demo day. Then, reality sets in and nothing is going to plan. Now they're trying to raise money literally at $8 million to keep lights on. That fails, and now they're looking at acqui-hire, and other bad options.
It's not all about dilution, which they knew at the time of their birth. It's about planning for up rounds even if things do not go according to plan. Sometimes things go better than you planned, but they usually do not go to plan. Entrepreneurs should prepare for that. Also, if things are going well, you're dealing with an increasingly sophisticated type of investor, who's got more dealflow to choose from, and that's a big issue.
VN: How long does it take before you meet a startup and make an investment and how do you conduct your due diligence?
AR: It's different with every single deal. I would say that, compared to some other VC funds, we benefit from a lot of active LPs, not to mention other people in our network, that we reach out to.
Even if I meet a startup, and I don’t want to invest in its current round, I'm happy to do a little due diligence, and help them out, and do some favors, so they kind of owe me. Then, when the next financing round comes, and some other, greedy, big VC wants to take the whole round, they'll remember the favors that we did for them, make some room for us as a thank you and get our commitment to help on a continuous basis.
It's kind of a triple-sided coin. We do due diligence with subject matter experts, and, in a way, that's helpful. We introduce them to awesome people that can help their company, as opposed to just distracting them from running their business because they're raising capital. We're actually helping the CEO, while getting the information from the startup. We're positioning ourselves to get our LP potentially active and excited and inspired, to maybe take a board seat or become an adviser to that company. We're also beginning to have direct contact from our LP to get excited about investing in that company, and be ready to commit additional capital to a sidecar fund, to put money into that company. Other times, we do due diligence by introducing a startup to a large corporation that's either an investor in our company, or who we have a strong relationship with.
So, due diligence, for us, if you were to say it in few words, is that we leverage our network to do due diligence. I also try to be very respectful to make our due diligence as behind the scenes, back channeling, as I can. Or even helpful to the entrepreneur.
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?
AR: It used to be that you did one or more angel rounds, and then you'd do a financing round that was too big for angels. And it used to be that there weren't that many angels; there wasn't the democratization of AngelList and the demo day dynamic. The good entrepreneurs did not go to incubators or accelerators. So, by the time you got to $2 million or $3 million, that was really considered a Series A, regardless of what stage the company was at.
Now, our investment in Navdy was a $6.5 million financing round, and I kind of thought, "$6.5 million, that's pretty chunky, that's an A." I was talking to the CEO and he said, "Andrew, so when do you think we should we raise our Series A." I said, "Wasn't that a Series A we just did? That was $6.5 million." So he goes, "Well, we haven't shipped the product yet, so we're pre-sales and pre-revenue."
I think that, a lot of times, companies that are per-revenue, regardless of the size of the round, are calling it seed. I think you've got pre-seed, which is funding at the formation of the company, the first money in. You've got seed financing, which might be right before and during the accelerator, and then what I call :demo day seed,” when it's the demo day, because that has its own special set of dynamics. Then there’s what I call late-stage seed, though some people call it seed extension.
There might be repeats of seed, then there's late-seed or seed extension, and there might be repeats of that, and there are more and more repeats as the Series A and those funds get bigger. Some of those big funds are participating in seed, or late-seed or demo day, and then the Series A, last time I looked, was trending at $10 million.
That's pretty big, and that's not the $2 million to $5 million A you used to have. And then you'd go for $10 million or $15 million B, and then a $15 million to $35 million C. That was the old normal. Now, you've got a lot of seed stuff to get you to the metrics, or the good relationship, that gets you the $10 million elusive Series A. By the time you're doing a $10 million financing, or an even larger Series B, I would say 90 percent of the most important decisions for that company have already been made. So if the big VCs were not involved before, they're not really having much of an impact on the company, other than pure capital.
VN: What are the attributes of a company getting a Series A?
AR: I look at every single company as unique and different from all other companies. I say, "What are the key metrics for this company? Is it the revenue? Are we looking at proving positive unit economics? That this company can be profitable and we're going to go into loss making for growth, but we can tip it into profibtability any time?"
I know this startup that has partnerships with mobile apps, and, through those partnerships, they can tell where people are. One key metric for that company is what percentage of the population, in any city, town or region, can they track? Have they got enough apps that are partnered with them that they have 90 percent of the population of Boulder? For a Series A for them, if they could say they've got 70 percent of the U.S. population covered, that's a more important metric than revenue. For them to be able to shove big data to sell to retailers, showing where their customers go before and after they're in the store, how often they come back, stuff like that. Revenue is not as important as what percentage of the population they've got covered, and certain demographics.
Each startup, I try to get an understanding of what are the key metrics that show success, failure, progress, or a step backward. What do we think we need to do to raise funding on the next round at a higher valuation?
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?
AR: 2014 was all, "go, go, go," and a lot of funding of loss-making unicorns. Forget IPOing, valuations were just going up, and companies were staying private longer. The first half of 2015 was like that, then in August market data came out of China showing that their factories were empty. That sent a chill into the sophisticated, large pools of money. The endowments and pension funds and hedge funds and big investors that invest in the venture capital funds started saying to the VC funds, "Hey guys, we want to see you get your companies to profitability and IPO. The party's over on this 'stay longer private, keep raising money, at enormous valuations.' So go get your companies profitable, stop the nonsense of having your startups spend a dollar to get 85 cents of revenue back from their customers, just burning like crazy for growth."
The memo didn't quite hit the seed stage financing. The seed investors, like some Googler with money from stock options, he doesn’t have any LPs telling him anything. He's only three or four years into his investing experience, and still excitedly investing in companies and doesn't understand how illiquid these companies are, or which ones are going to fail or survive.
We went through a period where there was a gap in the mindset of what the valuations should be from VCs that see a market correction, and the entrepreneurs. The entrepreneurs are reading the blogs of Brad Feld saying there's a market downturn, but they think that their startup are all, "go, go, go," and their unsophisticated angels are still all, "go, go, go." So they're thinking they’ll get a $40 million valuation on a company with no revenue. Whereas, if they try to get a sophisticated investor in there, they're saying, "Geez, the valuation of your last round was really $40 million? I wouldn't value this more than $8 million. I'd invest $2 million on a pre-money of $4 million or $5 million." Now you've got a major gap of what the buyer thinks the valuation should be, buyer being the VC, and what the seller, meaning the entrepreneurs and his existing investors, think they should be selling equity at.
The first half of 2016 was a very rough time, with the gap between what the valuation should be from the VC, with the angry or pessimistic LPs, and these entrepreneurs with all their optimism. As they failed to get rounds done, or succeeded at getting rounds done at lower valuations, the view of where the market should be percolating and the gap is closing again. There's more of a consensus on what a valuation should be for any company at whatever specific stage it's at.
VN: If we're in a bubble, how does that affect your investing?
AR: I worry more about what the next valuation will look like when I'm trying to agree on the current valuation. If I see someone saying, "The valuation right now $40 million," and I don't believe the next financing, even with the progress I think they'll achieve, is highly probably to be higher than $40 million, then that's going to make me not want to invest.
Another thing is, when our fund invests, we're an early stage, late-seed, A and B fund, so we tend to want to see potential for a 10x return. If the company got a $40 million valuation, to make 10X we've got to sell that company for $400 million. That starts looking like a pretty big valuation, and it might be hard to imagine that company ever getting to a $400 million valuation. We've got M&A bankers that are LPs in our fund. That' all they do is sell VC-backed Silicon Valley companies for a living, and when I say, "Do you think there's any chance this company would sell for 10x any time soon?" They say, "This thing would be lucky to sell for $90 million." I'm not going to take all this risk for a 2x return or less on that business.
I worry about can I make a 10X return? And I worry about do I have a high degree of confidence to get to an up round on the next financing round? This is helping the entrepreneur understand what the VC thinks.
Unfortunately, a lot of entrepreneurs hang out with other entrepreneurs that have red-hot startups with investors fighting to get into them. Sometimes, one of the guys is a mentor to this other CEO who’s like his little brother, and, all of the sudden, the younger brother’s doing better than the mentor. The mentor's like, "Damn, I've been around longer than him, he's at $40 million, what's this bullshit of valuing my company at $8 million? I should be at least as good as him." They're distorting reality from false comparables.
VN: Tell me a bit about your background. Where did you go to school? What led you to the venture capital world?
AR: I went to a bilingual high school in Paris, so the last years of high school were kind of international. Then I did undergrad at the University of Vermont, and then I got an MBA at Georgetown University. I did that on scholarship, with a stipend working for the dean. I had little startups and businesses that didn't require investors, starting from my freshman year of high school, and then I got into more businesses later in high school. I had a big t-shirt business that was political. It donated money to charity but it made me a lot of money in college, since it franchised to lots of universities. So, it's always been in me to start companies and execute on an idea, not just think of an idea.
By the time I was 26 years old, I had raised $43 million in venture capital funding. As an entrepreneur, I've raised over $100 million for my own ventures that I founded. I then became an adviser to other companies out of Europe and Israel and the U.S., helping companies raise venture capital funding. That further developed my network with VCs. I decided, long-term, that's what I would like to do.
I accidentally got called by Accel and they asked me to raise money for a portfolio company of theirs, since I was kind of a telecomm expert. Then, other VCs started asking me to be a private placement investment banker for their portfolio companies, so I was taking board seats, and raising money for companies. It became my job, but I was only as good as my next deal, so I would spend a lot of time running around at networking events trying to find the best deal. I would then have to get the company, to convince them to make me their adviser, and a board member, to help them raise money and pay me on that. A lot of the really hot ones don't want to do that. I also wanted to move back to California from Europe, especially because it's not that popular to use advisers there.
I also figured it's better to raise a fund and invest directly in the companies than be an adviser. At the end of the day, you can get to better dealflow, build a better network, and probably financially come out doing better. It will even feel better. A lot of times when I would successfully get a round done, and I'd make a half a million fee on that, but everyone viewed my payment as leaking out of the deal, as opposed to being put to work for the startup to hire more people. People weren't even happy about me being successful, so that didn't feel good.
After being an adviser, I founded the Founders Club, which was an equity exchange fund. VC-backed CEOs who own founder's stock in their company, they can put up to 10 percent of their common shares into a limited partnership, managed by me. I would give them LP ownership units in that limited partnership, which would aggregate 25 startups. I'd get stock from both founders, and some of the angels, in one startup, into this equity exchange fund. Then you might get like 25 venture-backed startups in there. Whenever there's an exit, everybody gets paid 80 percent of that cash, and 20 percent goes to me. It was creating, like, a fight club of entrepreneurs that all support each other.
That was interesting model, and I thought it made a lot of sense, but I discovered in practice that the most confident CEOs didn't join. I came close to getting the whole category of streaming music: Spotify, Pandora and Last.fm, when they were all private. In the end, Daniel Elk says, "I think I'm going to do better than Pandora, or these other guys." It was kind of an adverse selection; the really good companies don't hire a banker, and the really good companies don't want to exchange their shares for other shares.
The reason Elk wanted to get into Founder Club was not even for the diversification, but just to get into the network. Like a YPO of all these CEOs, with the financial incentive to help each other. So I said, "Let's do something like that but with real money, because if you're offering money and network and support, then that will work."
I came together with Joshua Siegel, who’s one of my best friends. I met him in 1998, on the first day of MBA at Georgetown, so we've known each other for a long time. We've done a lot of work together, a lot of angel investing together. He told me that he was selling off his entire real estate portfolio, and was going to full time angel investor in New York. He wanted to be the kind of New York, the most prolific angel investor. I said, "That sounds pretty stupid to me. If you're going to do that you should join an angel group, and here's all the reason why you should join. And here's all the things the angel group do wrong.”
With all the seed funds, the angel groups should be dying at this point. They should actually have a fund that they can move fast with, so they can get the meetings. Telling a hot deal that Peter Thiel just invested in to come our next angel group meeting, and we can only take six companies so come back in a month, that hot deal's not going to wait around for that. They're just going to go to a micro VC and get the deal done. So I said to Josh, "Join an angel group, but try to get them to do this and this and this." Angel groups that charge the startups, that affects dealflow. Not only does that feel wrong, but they're going to alienate themselves from the good deals. If 90 percent of the returns come from 10 percent of the startups, and you've alienated all the good ones, that's stupid.
Rubicon came together through me and Josh, with me trying to help Josh and convince him that this was a better path than the Founders Club. We decided to stop taking new companies into the Founders Club, pay everybody out when the exits come, and everything we do now is cash investing, and then trying to help with the network. We founded the company, so it's our, and we raise the money and its ours and now we're trying to grow it.
VN: What do you like best about being a VC? What makes you excited?
AR: Probably within three to five months of raising money from VCs, I started looking around at these guys and said, "Their business model is quite interesting. They get to basically be like a junior co-founder of a whole bunch of companies, and if any one of them fails it's not the end of the world. And if one of them hits they don't make as money as Jack Dorsey, but you'd do well to be in Jack Dorsey's deals. And it looks like they kind of get to live in the future by seeing intelligent, bright people explain what they're working on."
I get to see what Navdy is going to do in three or four years from now. I learned a lot about the connect car world, and the automated world, and I get to hang out with the corporate venture arms of all the automotive companies, telling me what the future of the car looks like. It's kind of fun to live in the future a little bit. Then the dots begin to connect between everything from transportation to how we do things.
I enjoy not being tied to one company for 10 or 15 years, but being able to be involved in lots of companies. I enjoy being helpful to my portfolio, my LPs, and my friends, with a well established network of people. You get good karma when you do favors for people, and then they help you back. So when I need something I like the fact that I can usually get it pretty quickly. willing to help me back. That's the enjoyable side of the business.
VN: What is the size of your current fund?
AR: We're targeting a small fund size, but our LPs get to invest a lot more, via the sidecar. The fund itself is targeted at $20 million, and its our expectation is that, over the life of investing in some of these companies, it would exceed $100 million. The target size, where the fund would be oversubscribed, is $20 million.
This gives us the ability to have the flexibility of a small fund, with the deep pocket of a bigger fund. If a $500 million fund invests in a startup, then a year later the founders get an offer to sell the company while they still own 70 percent of the share capital, it gives a nice return, but the $500 million fund was hoping that this $5 million financing round would be followed by a $15 and a $30 and a $60 million funding round, and they could start to make a dent and move some of that fund. They don't like the idea of the company being sold for a 5x or 10x, because their fund is very big and it doesn't move the needle. It's actually bad news for their LPs. They might even want to block the sale of the company, bring in their own CEO and then do a big $25 million round, on the back of turning down a $150 million sale. That's where it can be dangerous to take money from the big funds.
With us, if we're investing out of a $20 million fund, and we make a 5x or 10x on a small investment, that could make a nice dent in returning the fund, and it does move the needle on a small fund. We can be financially aligned to to be supportive of that small sale. At the same time, if the company goes on to raise a huge financing round, maybe that big VC fund does block it, but we might be able to raise money from corporates that are partnering with that company, or family offices, institutional LPs, and a bunch of little guys, to write some big checks, potentially even leading a financing round down the line when the company's really on its hair.
To be perfectly honest, though, I wouldn't mind having a bigger fund, and I think Fund III will be substantially bigger than Fund II.
VN: What is the investment range?
AR: We have a rule that says, no matter how we excited you get, don't put more than than 10 percent of the fund into one startup. If we do end Fund II at $20 million, that would mean that $2 million is the total amount of capital we would invest in any single company. Yet, we've got this model of investing in 25 deals, and if we went all chips in on five companies, that would mean 50 percent of the fund dollars are going to into those five companies. We've done all chips in a couple of times, but we also do a lot of follow on investing along the way. Partially because we want to to, and partially because we want to show support, and get other guys to follow with us.
These days we don't want to write a check from the fund of less than $100,000, and we like to have at least 2x that in the sidecar fund at the same time. We can do $100,000 and not do a sidecar, but we'd rather do $100,000 from the fund in the first round, and then look at what's available and see what the appetite is from our sidecar. Bigger is better on the sidecar from our perspective, and it's usually good for the company.
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?
AR: A lot of guys with a small fund would say, "My fund is small, $20 million, and I'm trying to get into 25 deals, therefore I should invest in very early stage. And those early stage have a high risk of failure, and will take a long time to exit, depending on the sector."
For us, we're saying, "My fund may be small, but I'm actually getting into A rounds and B rounds. We put small amounts into seed, and big amounts into A and B, yet our percentages are going to be small." So our percentages are going to be small and we don't give a shit. That make us very different from those other guys.
VN: Where is the firm currently in the investing cycle of its current fund?
AR: We've now got room for another four to six investments into new companies out of Fund I and we've already had numerous rolling closes of Fund II. We're in the process of raising additional capital for Fund II right now, but we timed things to make sure that we never became a zombie, which is a VCs fund who no longer has dry powder. All of their money is either in portfolio companies, or they flat out invested all of it and have no money. I never wanted the dealflow to stop from other VCs, angels and entrepreneur. We actually had our first closing earlier this year and I think we're ready to start investing now out of Fund II. So there will be a little bit of overlap.
VN: What percentage of your fund is set aside for follow-on capital?
AR: More than 50 percent of the fund is set for follow-on.
VN: What series do you typically invest in? Are they typically Seed or Post Seed or Series A?
AR: More than half the fund dollars go into A to B, and most of our first-time investments are late-seed, but not all of them.
VN: Anything else I should know?
AR: I just finished my second book, and it's called "Masters of Corporate Venture Capital." I interviewed over 100 corporate VC firms, and VC-backed CEOs like Brad Feld, Tim Draper, getting their perspective on guys like Intel Capital, Salesforce Ventures, IBM Ventures, and how they do it.
The truth is, we're all about adding value to the startup, and if you raise money from a corporate VC, you may have sold your company. It can be a dangerous game. They might cancel the CVC program, the guy who led the investment might quit or move around. There's a lot of negative things, but when you get it right, it can be amazing. If you can get Huawei from China to put your mobile app on 10,000 handsets in a trial, and then a month later put it on 50 million handsets, and then two months later put it on 300 million handsets in 100 countries, that's the most amazing thing for that app. To hell with Sequoia, that's adding value. If you can leverage a corporate to do business with a startup, that's a huge thing. Yet, it's so complicated and filled with flaws.
I really wrote the book for entrepreneurs to avoid the problems, and be successful, raising from CVCs.