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Hear how the general partner makes Series A investments in "consumer-like" startups
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, however, 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.
In this edition of "Meet the VC," we interview Howard Hartenbaum, General Partner at August Capital.
Howard Hartenbaum joined August Capital in 2008. Prior to joining, he served as a General Partner at Draper Richards LP where he was the founding investor in Skype and a former member of the board of directors where his achievement resulted in his joining the Forbes Midas List of top venture capitalists.
Before entering the venture capital field, Howard was at Hughes Electronics, where he was responsible for supporting business development, marketing and sales of satellite, information security and automotive technologies developed by HRL Laboratories. He also worked in engineering positions in ergonomics and user experience at Honda Motor Company and manufacturing at Teledyne Relays. Howard has worked overseas for a total of ten years in Luxembourg and Japan.
VatorNews: Tell us a bit about your background. What led you to the venture capital world?
Howard Hartenbaum: I went to MIT and got a degree in mechanical engineering. I worked as an engineer at a few companies and then worked in business development in technology licensing. I was at a startup company where they battlefield-promoted me to CEO, and in the process of raising money I met Bill Draper. And Bill, though he didn’t want to fund the company, asked me if I wanted to become an investor. So I joined him and that’s how I got into investment world.
VN: What do you like to invest in? What are your categories of interest?
HH: I like to invest in unusual companies that are addressing a very near problem even though the market isn’t always completely obvious. I don’t like investing in companies that are a small tweak on another company and are trying to be #2 or #3 in the market. That’s just not my style.
I tend to like companies that have a product either directed at consumers or used in a consumer-like fashion. For example, I’m on the board of EAT Club, which sells lunches to the enterprise with customers like Netflix, Atlassian, and Kaiser Permanente. But every day thousands and thousands of people open an app and select a lunch. And then logistics kick in and it’s delivered to them at work, but it’s paid for by the company. So it’s not really a consumer product but it looks and acts like a consumer product.
VN: What do you look for in companies that you put money in? What kind of traction do you look for?
HH: It’s always more comfortable to invest in companies that have traction and engagement, but generally I’m betting on the people, the value proposition, and that the problem they’re solving is really important enough to get people to want to use the product.
VN: What would you say are the top investments you have been a part of? What stood out about those investments in particular?
HH: I invested in a company called RelayRides, which has changed its name to Turo. I invested in them because the argument was cars are only used 7-9 percent of the time and the rest of the time they’re sitting idle. They’re a depreciating asset. If you could find out how to make money from them while you’re not using them, that makes a lot of sense. And there’s already a historical car rental market so maybe we could do it peer to peer. I just liked the idea of having a very capital-efficient business where you can add a lot of value to a marketplace on both sides.
I also invested in a company called Samba TV, which puts technology into internet-capable TVs through partnerships with the manufacturers. It understands what you’re watching and can do various things with that data. For example, it determines which ads are effective, which shows people are clicking into and out of, etc. They know in real time what people are watching without having to do a panel.
VN: 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 of a seed round vs a Series A round?
HH: Series A used to be when institutional investors—professional investors investing other people’s money—did the investment. Now we have seed funds, which are basically doing exactly that.
What you call a round is somewhat immaterial. You could do a $4 million seed followed by a $10 million Series A, followed by a $20 million Series B. And if you went back 10 years that would’ve been called Series A, Series B, and Series C. What you call it doesn’t really matter. It’s easier to define a Series A by the traction the company has, how big the round is in terms of size and valuation, and I would say a significant portion (30-50 percent) of Series A deals today look more like Series B deals did 10 or 15 years ago.
VN: In 2015, there was a lot more money going into late-stage deals than during the heyday back in 2000. So do you think we're in a bubble or is this the new normal?
HH: The challenge in the late-stage, high-price deals is that it’s all driven by a very small number of inexperienced investors who inappropriately believe that venture is all about being in the one or two deals of the decade. Therefore, paying any price doesn’t matter, but that’s a recipe for potential disaster in losing LP money. You could run a great venture fund having a few deals that are worth a few billion dollars, where you’re the Series A and return many multiples on the fund.
I heard one interesting comment from one of our LPs about three years ago that there was a firm out there whose average going in price was higher than the average exit price. And of course that can’t work. Those investors are all smart folks, but they’re inexperienced and don’t grasp that it really isn’t about being in one or two. And they’re so convinced they’re going to be in the one or two that they’re betting their entire firm on that. The great majority of venture firms are not going to bet their entire firm on being in the deal of the decade.
VN: How long is your due diligence period when choosing to invest in a startup?
HH: It is all over the map. On the short end, meeting to term sheet could be less than a week, provided there’s enough time to do a bunch of reference checking on the person and time for the entrepreneur to get to know me as well. You would never meet someone on the street in Vegas and marry them in three days; that’s a recipe for disaster. In many cases, it’s an entrepreneur we’ve known for a few years or months and the timing is just right. They started new company or changed what their company is doing. The parties know each other and there’s not really a need to reference because you got to know them over time.
Sometimes fast, sometimes slow. Entrepreneurs who are focused on speed to funding often get in a relationship where it can be very broken a few years later, where they didn’t know each other and didn’t agree on the business. I think it’s very immature for an entrepreneur to take money from a venture investor they haven’t gotten to know because there’s no way to get away, except if the entrepreneur gets thrown out. If I were an entrepreneur, I would rather invest in someone I know, I trust, and I understand as opposed to somebody I just met who’s a great salesperson and can quickly give me a term sheet. That can work great, but that’s also asking for trouble.
VN: How do you conduct your due diligence?
HH: If a company is pretty early, there aren’t a lot of numbers to look at. If there’s technology, you want to make sure it’s technically feasible what they can do.
All VCs know a lot of people. If somebody comes to me and say, “I’m going to sell a SaaS solution to chief marketing officers at large companies,” I call three buddies of mine who are CMOs at big public companies and spend a billion dollars a year on marketing budget. And they tell me, “That doesn’t make sense,” “It’s crowded,” “It won’t work,” “I won’t buy it,” “The price point will be low,” or they’ll say, “This is awesome,” “It’s been hard to do,” “No one else has been able to do it,” “If they can do it I’ll pay a lot of money for it.” I let the economic buyers (that I trust) tell me.
The company that has customers, I call some of their existing customers and then I call people who are potential customers that they’ve never talked with. And I try to find someone they’ve talked to who said “no.” If you just call the customers they recommend, you’ll hear exactly what they want you to hear—that’s not all that useful. Then I get to know the person. Nobody’s perfect, I’m not perfect. I will call people they used to work for and find out their strengths and weaknesses. Most importantly, “Would you work with them again? Would you hire them again?” When people say, “I’d never work with that guy again” or “I wouldn’t hire that guy again,” that’s a big red flag. Or if they say “That guy’s awesome, if he was doing something new I would quit my job and work for him for no salary,” that’s a good indication as well.
VN: What is the size of your current fund? And where is the firm currently in the investing cycle?
HH: $450 million. We’re about halfway through making new investments in that fund, so we’ll probably raise another fund in another year and a half or so.
VN: What is the investment range? How much do you put into each startup?
HH: Low-end: a few million bucks, maybe as low as $1 million. High-end for an early-stage company: probably $10 million. Our sweet spot is somewhere in between.
VN: Is there a typical percent that you want of a round? For instance, do you need to get 20 percent or 30 percent of a round?
HH: Like most venture firms, we’re trying to get enough of the company that if they’re a big hit we make a lot of money. We do make our money from the hit. We’re usually targeting between 15 and 25 percent of the company.
VN: What percentage of your fund is set aside for follow-on capital?
HH: Roughly 60 percent is new investment and 40 percent is follow-on.
VN: What series do you typically invest in? Are they typically Seed or Post Seed or Series A?
HH: 80 percent Series A, 15 percent seed, 5 percent other.
VN: In a typical year how many startups do you invest in?
VN: What do you like best about being a VC?
HH: It’s sort of like going to graduate school. Every day, really smart market experts in something new and intriguing tell you how exciting the opportunity is. Even if it’s not a space I would invest in personally but my partner is the one looking at, I learn something really interesting every single day. No meeting is a waste of time unless the guy’s a bullshit artist.
VN: Is there anything else you think I should know about you or the firm?
HH: If you’re doing something that’s differentiated and not completely clear what the market’s going to be but think you're solving a real problem, we’d be interested to talk. But if you think you’re going to be #3 in the market and sell to #1, that’s generally not what we’re looking for. We want to back companies that become freestanding and don’t sell.
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Joined Vator onFounded in 1995, August Capital is a leading venture capital firm actively investing in entrepreneurial teams throughout the information technology market spectrum.
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