Invest Like the Best with Patrick O'Shaughnessy - Josh Kopelman - The Past, Present, And Future Of Seed Investing - [Invest Like the Best, EP.170]

Episode Date: April 28, 2020

My guest today is Josh Kopelman, the founder of famed venture capital firm First Round Capital. Prior to starting First Round, which has invested at the earliest stages in companies like Square, Uber, and Roblox, Josh was a three-time entrepreneur, so our conversation spans early-stage investing, business building, and entrepreneurship. I’ll not sure forget his analogy distinguishing between navigators and cartographers, nor the rest of the interesting ideas he shared after seeing and investing in so many great businesses. We also discuss how First Round has bucked the trend to build what I’d call a platform adjacent to the core investing business which does a lot for their entrepreneurs and is a model for other professional investing firms, both in venture and elsewhere. Please enjoy my conversation with Josh Kopelman.  This episode is brought to by Koyfin. For more episodes go to InvestorFieldGuide.com/podcast. Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub. Follow Patrick on Twitter at @patrick_oshag   Show Notes (2:05) – (First question) – How pandemic has impacted their investing strategies (3:54) – How this stressful environment impacts founders (6:23) – His early career as a founder and how startup culture has changed (10:15) – Most important lessons from his entrepreneurial career and building from just an idea (11:50) – How to analyze a founder (14:05) – Common disagreements when it comes to deciding on an investment (15:33) – How many opportunities they evaluate in a meeting (16:16) – The curvy road to their investment in Roadblox (17:52) – Whether the concept for a platform is overused (19:36) – Founders asking what google search they should build on (20:46) – Solving existing or forecasted problems (25:39) – How the startup scene is impacted by the huge legacy tech companies (30:28) – What makes a great early stage investor (32:19) – Do they focus on founders or themes (33:19) – Where will valuations and returns come back to after the pandemic (36:30) – How are business models evolving in technology entrepreneurship             (36:31) – Matt Clifford Podcast Episode (39:40) – The Dorm Room Fund (43:02) – Whether investment funds should have their own platform (47:31) – Product mistakes in software building (51:52) – What he’s most excited about for the future (54:05) – The kindest thing anyone has done for him  Learn More For more episodes go to InvestorFieldGuide.com/podcast.  Sign up for the book club, where you’ll get a full investor curriculum and then 3-4 suggestions every month at InvestorFieldGuide.com/bookclub Follow Patrick on Twitter at @patrick_oshag

This episode is brought to you by Coifin. I've become very interested in the best software tools in investing. And when I asked Twitter for the best Bloomberg alternative, the overwhelming winner was an excellent new product called Coifan. It's a web-based platform that lets you analyze stocks, ETFs, mutual funds, and other asset classes in one place. I've been using it every day to track what's going on in the market, and I think if you try it, you will too.

Coifin has a ton of high-quality data, powerful functionality, and a clean interface. The best part is that it's free. You can sign up at www.coiffin.com. A-O-Y-F-I-N.com. Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best. This show is an open-ended exploration of markets, ideas, methods, stories, and of strategies that will help you better invest both your time and your money.

You can learn more and stay up to date at investorfield guide.com. Patrick O'Shaughnessy is the CEO of O'Shaunicee Asset Management. All opinions expressed by Patrick and podcast guests are solely their own opinions and do not reflect the opinion of O'Shaunsi asset management. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of O'Shaughnessy asset management may maintain positions and the securities discussed in this podcast. My guest today is Josh Koppelman, the founder of famed venture capital firm First Round Capital. Prior to starting first round, which has invested in the earliest stages in companies like Square, Uber, and Roblox,

Josh was a three-time entrepreneur, so our conversation spans early stage investing, business building and entrepreneurship. I'll not soon forget his analogy distinguishing between navigators and cartographers, nor the rest of the interesting ideas he shared after seeing and investing in so many businesses. We also discuss how first round has bucked the trend to build what I'd call a platform adjacent to the core investing business, which does a lot for their entrepreneurs and is a model for other professional investing firms, both in venture and elsewhere. Please enjoy my conversation with Josh Cappellman. Josh, thanks so much for doing this with me. I've yet to talk to a really,

early stage seed investor about kind of the post COVID-19 investing environment. We're going to spend a lot of our time on just Evergreen investing principles. But I sort of feel obligated to start with a couple questions on just how the environment has changed very quickly. Had we had this conversation when we first scheduled it in January, you and I would have probably talked about very different things. It's amazing how quickly the world has changed. And I would love to just begin by hearing your take on how what has happened in the world affects your part of the investing ecosystem, really at the earliest seed stage? Sure.

So I think that the job of a CEO is to predict the future or invent the future. And oftentimes you're trying to deal with an uncertain world. And your aperture is set to a certain range. Right now, just given the period of uncertainty that we're going through, the aperture is so broad. If I was to differentiate, I think there's two different challenges. The first is companies that have already been funded. So companies that raise their seed funding in the last, sometime in the last 18 months, they raised a certain amount of money and they have a job to do with that money, whether it's to build a product, to generate product market fit, to get to market.

And those companies are all now quickly recalibrating how much capital they have and how much runway they have to accomplish their job. For new companies, I think they're trying to deal with the fact that VCs say they're open for business and VCs say we're still. writing checks. That's exactly what they said in 2008 and 2009. And the first quarter of 2009, the venture funding was less than 50% of where it was in first quarter, 2008. So we have yet to see it sort of play out in terms of the new funding environment. I'm curious how you think the type of founder that is kind of pulled to start a new company into this environment affects how you think about what you fund. Do you find that this sort of stressful environment attracts a different sort of founder that's looking for their first check now, maybe that's just beginning to start their business

than three months ago? So I think right now you have yet to see the change in the market. Anyone who's out fundraising now was pretty much working on their idea before COVID-19 hit. What I can say is looking back after the dot-com crash in 2001 and looking after the great recession of 2008, what tends to happen is that the tourists go home. As the economy has boomed or as startups have access to capital, that capital, to some degree, the constraints on that capital reduces. It gets easier and easier for people to raise capital. And more and more people are willing to start companies and take that risk.

I think what tends to happen now is you get more of the true believers, more people who are willing to embrace a true amount of risk, given the fact that you're just dealing with the massive uncertainty regarding a fundraising environment. There's just so many scenarios that people do. don't know. Some people still think we're expecting a V-shaped recovery. I think most people are expecting a much longer recovery. And therefore, the people that are starting companies today or that are thinking about starting companies in the next few months are going to be the true believers, the true entrepreneurs, and the tourist symposers will have gone home.

Do you think that that tourist idea extends to the seed stage of venture investing as well? One of the things I've noticed from the cheap seats is, I don't know what the number is, hundreds of solo GPC venture capital funds, $25, $50 million, $10 million, whatever. It seemed like just an insane proliferation of these sorts of funds, often from very young. Maybe these are people that would have been founders in a normal environment have become VCs. Is that tourists too? Do you think that part of the ecosystem on the investing side gets washed out? I wouldn't say washed out, but I do believe that you're going to see a rationalization.

I think that the vast majority of those funds were funded by individuals and family offices who have exposure to public and as well as private asset classes. And I think that you're going to see the capital get a lot tighter for those folks. I think you're even going to see it get tighter for funds that have been backed by traditional institutional endowments, pension fund type LPs as well. But yes, I do think you're going to see sort of all of this ripple through. I'd love to go all the way back to the beginning. I was so interested when doing a little bit of research ahead of this conversation to read about your rapid succession of entrepreneurship. First round's been around for a while. But it was just,

maybe the fourth or fifth iteration, I think, of an entrepreneurial bug that you have. I'd love you to describe just the early couple of companies that you built in the 90s, sort of what they did, and use that as a way to explain to listeners how the nature of forming a company has changed from when you were doing it, sort of the cost of starting a new company, the time to first product. Tell that story about arc, because I just think it's so fascinating. I got my first start while I was an undergraduate at Penn. I co-founded a company called Infanautics back in 1991. We built a product called Homework Helper, which was the first product on CompuServe,

Prodigy and America Online that offered sort of educational resources to students. And we were fortunate enough to go public in 1996. After that, I started a company called Half.com. And Half.com quickly became a top 10 e-commerce site. It was a person-to-person marketplace that enabled people to buy and sell, used books, music, and movies. It was a precursor to what is now the Amazon marketplace where individuals can list items as well. And eBay quickly acquired that one in June of 2000.

I think I kind of shut the door on the dot-com boom, rather be lucky than smart. And then the third company I helped to found was a company called Turntide, which was an anti-spam router that Symantec quickly acquired. What was interesting is that even in that short period of time from 1991 to 2003, you just saw a tremendous decrease in the cost to start a company. For Infanautics, for homework helper, that first company, we had to build our own data center. We built a halon fire suppression system. We had a diesel generator out back. We bought expensive tandem hardware.

And it took us over $5 million to get the first product chip. The second company, Haft.com, we were in. able to rent a cage, but we had to stock it with our own Sun hardware, and it took us about two to two and a half million dollars to get to first product chip. We could leverage Linux, other open source tools. The third company, Turntide, took less than about $500,000 to get the first product chip. And so you saw an order of magnitude drop. And at the same time, what was interesting is that venture funds during that same 13-year period or so had tripled in size, and the average initial investment had tripled in size. So that was like a 30x swing. And

when you combine a 10x increase in capital efficiency and a 3x increase in venture fund size, that's a 30x gap. And that was kind of what led to the insight to start first round in 2004. Do you think that that trend has slowed considerably in recent years? Because my subjective interpretation is switching onto AWS now isn't even necessarily cheaper. It's definitely better than physical infrastructure, more flexible, but it doesn't seem to be a cost saving. So I'm wondering if that kind of curve has reached its diminishing point. So I'd say that AWS is still cheaper in that when you sit down and look, if you're a startup company and you need to actually go out and buy that hardware yourself, there's just a certain base cost that

you're going to have to spend. So I think AWS can allow a company to get started for a couple hundred bucks on their credit card, which just is much cheaper. I think part of the challenge is access to talent has gotten a lot more expensive. You're now building for multiple platforms. you're needing to build for native web, for Android, for iPhone. And so you're sort of duplicating costs. So I do think that the cost curve, the decreases, have pretty much flatlined. And I don't see it's sort of continuing to get 10x cheaper over the next 10 years to start a company. Given that first round is investing at the earliest stage, seed, pre-seed,

I would love to hear how often one of these would be founders already has a product or it's just a slide deck. I love this concept of the very early days of a new idea or a new product. I would love to ask a bunch of questions about your experience, watching so many founders kind of go through this idea stage. So first, what do you think are the most important lessons that you take from your own entrepreneur days of that sort of product seed fire, the core idea and how to iterate on that idea versus have some stroke of Eureka genius that you have the plan and you just go build it?

Do you think that the best founders are, it's more about their personality? more about the original idea? Oh, I think it's far more about the founder's personality than the original idea. And there really is no original idea. I think an idea evolves over time. So I think a founder is just pulling this thread. They're trying to sort of discover some insight and something where they believe they're right in the market, either believes they're wrong or hasn't realized it yet. So I think that most of the best founders are really good at sort of weaving that tapestry as they pull that thread and the idea evolved. So even when you look at most of the companies that we've back by the time that they're successful, oftentimes it looks very different than where it first

started. So for us, sort of do we look at the product that when someone pitches us, if they have a prototype? Of course we do. But for us, the product is more of a lens to understand how a founder makes decisions, what a founder prioritizes and how they process signal and separate signal from noise in terms of collecting data from the market. What have you learned about methods for evaluating that aptitude in a founder over the many years of looking at seed stage businesses. Are there major ways that you are models that you use for investing today that you wouldn't have used in the early days of first round? Look, being a founder is hard. You're just dealing with massive amounts of risk of unknown and of uncertainty. But more importantly, you're going against the

grain of everything that is taught. When we raise kids today, our educational system is such that We've built a product that values conformity. When kids go through school, we built an education system that's designed to raise the greatest number of people up and increase their standard of living. And we do that by conformity. And so everything a kid is taught is about how to follow the rules. Like when you show up your first day of class at a college and they give you the syllabus, what is that?

That is a roadmap for your class. You don't have to guess what to read. The professor will tell you what to read. You don't have to guess when to read it. They'll tell you when to read it. They'll tell you when the quizzes are and what the tests are. They'll give you the study guides. And in fact, they'll give you the cheat codes for the class by telling you what class participation is 15%.

And these assessments are this. And they tell you what winning looks like. Yet when you start a company, no one tells you what to read and what not to read. No one tells you when to do something. And no one tells you what winning looks like. And so it's really hard. you're kind of like stepping off this conveyor belt of conformity and just going the other way. So one of the things that we really look for are what are experiences in that founders past,

where they have gotten off that conveyor belt, where they have been nonconformist. And it doesn't have to be entrepreneurial. It could be, did they choose a major in college or did they create their own major? Do they join a club or nonprofit to help? Or did they start a club or nonprofit? Do they read books or magazine articles or write them? What are the things that they do that show that they're comfortable going off map? Because so many people, we raise a society of navigators, of map followers.

But most of the best entrepreneurs are cartographers and know how to create their own map. What are the things I know that the voting structure for investment at your firm is a two-thirds majority among the partners, or historically has been, correct me if I'm wrong, what have been the most common arguments you've had when something is flirting around that two-thirds, third's barrier as a partnership? So it still is two-thirds. It tends to be far more of a conversation than a vote. And I think for us, the biggest sources of disagreement are on relative weighting of risks or

opportunities. So we might meet with a founder that's building some hardware. And one partner would say, I think the founder is completely off on their timing or their cost of complexity of actually building this piece of hardware. And I think a different partner might say, I agree, the founder is off, but that's a risk I am willing to take, whereas one partner would say, no, I am not willing to take that risk. So for us, it oftentimes it's not a disagreement in fact. Oftentimes we acknowledge the same fact pattern, but we just prioritize or wait the risk on that differently. And I think that's the surface area of a lot of our conversations inside the partner meeting. It's trying to make sure, trying to isolate. the facts, see if we agree on the facts. If we disagree on the facts, then we need to go back and actually do more work. But if we agree on the facts, then it's a question of explaining what are the reasons for either the high weight or the low weight on that decision. I'm sure that these partner

meetings are both very fun, invigorating and also mentally taxing. I'm curious, what number of opportunities you are willing to or typically evaluate in a given meeting? So I'd say it's anywhere from zero to two. It's hard to do more than two in any given meeting. And one of the things we've done just historically given the pace of seat stage is that we've actually moved to two partner meetings a week rather than one. So we have meetings on Monday and Thursday to sort of increase the access to our ability to get to a decision, just given the competitive environment. So for us, if we're having partner meetings twice a week, it's hard for me to see us inviting more than two founders into a partner. Do you have a specific meeting or discussion around a company that stands out as the most

he did or took the longest for the partnership to deliberate on looking back? Yeah. I could look at our investment in a company called Roblox, which is a gaming company. And my partner, Chris Freilich, brought it in. And we passed the first time. So we said no. And then Chris persevered and sort of went out and collected a lot more data and brought it back. And thankfully, thankfully we agree with him. But there have been times where we've said no to an initial investment and then four, six months later, been able to reassess it, either with new information or a different lens to evaluate it. For those that aren't familiar with that company, can you briefly describe what Roblox is? Sure. Roblox is a virtual world gaming company. So it's a

company that's targeted at kids. If you know someone who's age 7 to 13, there's a 60 to 70% chance, they are an active Roblox player. The coolest part about this world, that all of these games and all of these experiences are created by the community members. So when Fortnite became a thing, Roblox users created their own version of Fortnite in Roblox. It's a world where there are just millions of games, and those kids are actually getting paid to be developers based on other people using their games. You're talking about tens of millions of active users, and especially now, just given the quarantine, every day is Saturday for Roblox. I'm curious to hear your thoughts on this word platform. It's a word that I would certainly consider Roblox to be a platform, something that

enables sort of the open creativity of its users. What do you think about that word? Is it overused? in Seed Stage investing? Is it something that you look for in companies the potential for them to be a platform for others? Yes. So the answer is yes and yes. It is extremely overused. And I think for the most part, most platforms get their start. They have a killer app that's already innate in the product. Before Facebook became a platform, they were a very strong social network in and of itself. Most people don't remember. But when the iPhone launched, it wasn't an open platform. Every single app when you bought the iPhone was developed by Apple. And then they built the App Store and enabled other people to build on this.

Salesforce, far before becoming a B2B platform with Force.com, was a very compelling CRM tool. So when we're evaluating platforms, what we're trying to understand is it's really hard to see someone instantiating a platform day one without a really compelling use case in terms of an owned and operated manner, in terms of sort of that operator building something that has hooks and it could be really sticky. And only then, only then do you earn the opportunity to expand from a very compelling product to a compelling platform. So it sounds more like the platform strategy is a great way to scale a business, not so much the best way to start a new business. It's really hard to see platforms that start day one as a platform.

In almost all cases, they start off with a very compelling sort of single user or just initial value proposition and then expand. Speaking of that notion of value proposition, I loved that idea you had that companies should ask themselves what Google search they'd want to appear first on. Can you expand on that idea a little bit? Yeah. Oftentimes, you have a founder who has a very clear understanding of what they're trying to build, but a less clear understanding of the need they're trying to solve in the market. And so the first question I would ask a founder in those cases is if I could give you the number one position on any Google search, if I knew Larry and Sergey and said, guess what, you're going to be the number one organic answer to search X.

Like, what is that search? And then the second question is, is that a search that people are searching for today? Or is that a prediction that you have as to that people will be searching for that in the future? And if so, why? So are you solving an existing pain point that people understand and are actively seeking a solution for? Or have you found something that you think will be a pain point but people don't even know it yet? And just like that very simple, having to lay out a Google query forces a level of transparency to sort of understand exactly what problem you're solving. Do you think that the better investment opportunities come from the existing problem or the forecasted problem? The hard part with a forecasted problem is now you're having to deal with the risk of time. You have to deal with the question of when will this be a problem.

Not only are they right, but are they right in a period of time that's soon enough? As a seed stage investor, typically, it's rare to see companies have more than 24 months of runway. So if a company has 24 months a runway and they want to raise their next round maybe in 18 months, and they're going to take six to nine months building whatever they have, you have a very tight window to actually be able to validate or demonstrate traction. When I founded first round, my co-founder was Howard Morgan, and he says he's made a lot of money funding things early and lost a lot of money funding things way too early.

So part of the challenge is not only understanding the bet, but you're also making a very specific time bet. we'd like to sort of at least fund something where you at least have an early thread on the fact that people are asking that question. Now, it might be a very small group of people. It might be a group of early influences or early adopters. So if you assume that tens of millions of people are going to be asking this query in three years from now, but today there are 30,000 people who are really focused on this, like, that's totally fine. But if it's a question that no one is asking right now, it becomes really hard to sort of see how you're in a typical venture funding landscape and

time frame that you'll actually be able to validate it. It sort of dovetails with this present problem versus forecasted problem is this idea of existing behavior versus behavior change. I've seen you say elsewhere that it's typically much easier to build something that lines up with an existing behavior of the user versus trying to change the way that they behave. So I think that makes sense. Have you ever seen an example, though, of a company that did successfully change? change behavior? Oh, sure. I guess it depends what you're talking about, the extent of a behavior change, right?

The level of transparency that you see people posting on social networks is a new and novel behavior in the last 15 years. Yet people did write letters and they did share information and they did send photos to people previously. On the one hand, you could say, is social networks and novel behavior change? Yeah. The fact that people are constantly chronicling their lives on Instagram, on Snapchat, on Facebook. Of course, that's a behavior change. But there was some common thread that they pulled on in terms of the human behavior belonging to a community, sharing their life with people and keeping people informed. But when you look at most tools that you use today, whether it's the iPhone or the apps on the iPhone, there were phones and used to take

taxis before you took Uber. So from my perspective, I think that it's very hard to sort of say, I see this new view and I'm going to do something completely different that no one has ever done before and no one even knows they need to do. But finding a way to do something that has been done before in a new, inventive, creative way, doing it faster, better, cheaper, those are the opportunities that tend to attract me. Because at that point, the biggest risk that you have as a seed stage investor is the so what risk. If you build it, will the consumers actually engage? And if you're able to tell a story that says people have done X for a long period of time, but doing Y is 10X better, that's a very easy to understand bet as an

investor. You can have clarity on the bet you're being estimated. In addition to the Google query question, are there other devices or questions like that that you often use to suss out whether or not a founder has a good grasp on the problem they're solving or their idea? I think oftentimes when a founder is pitching a VC, he or she believes that, their job is to have all the answers. So you ask a question and they just, they tell you the answer. You say, what's your sales cycle? They'll tell you 65 days or what's your cack and they'll tell you 800. I think instead, one of the things that we really look for are founders who are able to articulate what they don't know. Because the difference between a startup and a company is pretty

much like a startup's job is to learn and a company's job is to grow. A startup, what you're trying to do is maximize the learning per dollar spent. You want to learn as fast as you can and as cheaply as you can. So in my case, most of the best founders have a real grasp on what they know and what they don't know and are able to sort of intelligently talk about the unknowns and their path to figuring them out. And so for me, if a founder gets stumped by asking what don't you know rather than what do you know, that's a warning sign. I love that. What do you think of the environment that we sit in today where there's incredible dominance by large incumbent technology companies, which just reading the tea leaves in the early, early days of COVID, if anything,

it appears that that may strengthen that Amazon or the usage rates for some of these huge tech companies has gone up during this early stage of the pandemic. I'm curious how you think about the dominance and the role that those big incumbent players, the role that they play in how you think about funding new companies. My friend Josh Wolf calls this. the megas and the minnows. I love that little concept. Do you think that the minnows are facing a harder battle because of the dominance of these big technology companies today? Yes, 100% yes. And even because when those minnows begin to grow, I think what all of these large platforms have seen is the cost of missing a platform shift. AOL missed the platform shift from dial-up to cable modem

and died. Yahoo missed the platform shift for search and mobile and died. became footnotes. And what's happened is all of the large incumbents have learned this lesson. So when you do see something that looks like it might even be getting escape velocity, whether it be Oculus or whether it be Instagram, they're grabbing them up. Not only are you seeing that these companies are far more competitive and far more willing to clone features that they see in other smaller companies, but they're also far more inquisitive, which is limiting the upside of some of these smaller minnow companies, as you referred to them. Now, I would say that there are areas where you still can innovate around them,

and oftentimes a lot of that has to do with risky symmetry. So after I sold haf.com to eBay, I was involved with some of the early discussions because eBay was trying to compete with PayPal at the time. And PayPal was a small startup, venture back, that was dominant on eBay's auction listing. So when you bought something on eBay, you were closing that transaction or consummating the payment via PayPal. eBay said we got to launch a competitor. And so they said, we're going to build this thing called BillPoint. And eBay formed a joint venture with Wells Fargo.

So here you had the number one auction platform and the number one bank building this platform to compete with PayPal. Why shouldn't Billpoint close the payments for all their auctions? Yet what happened was obviously PayPal won. And everyone might say it was, well, PayPal had a much better product, which they did. And they said, well, eBay just doesn't know how to build products. actually wasn't the case. What was interesting, at least what I saw, was that in the product planning meetings at eBay, you had almost as many lawyers as you had product managers. Because at that time, if you go back and look at PayPal's S-1, I think you'll see that they were under investigation by over

20 different states, attorney generals. They were in violation of the MasterCard and Visa Merchant Processing Agreement, federal issues investigating use of pay PayPal for pornography and for drugs and for gambling. And so now, if you were eBay and Wells Fargo and you had tens of billions of dollars in market cap at the time, and you had a choice and you had to say, all right, the laws really weren't written to deal with this digital payment movement of money. So we have three choices. We could say, here's the law that is lily white. That's 100% clean. Here's the law that's your black letter. The law says you can't do that. But the vast majority of the rules were gray. In many states, there were two conflicting laws, or you could interpret one

differently. And what I saw was that PayPal embraced the gray and said, if we're successful, the laws that are ambiguous will get cleaned up. And the larger companies couldn't afford to take the regulatory risk of not being in compliance. There's no way Wells Fargo was going to risk their bank charter on this small feature on top of eBay. And I think that's a large part of the reason why PayPal ended up winning. And you see that all the time. You see that Uber is a prime example of some cases where they were clearly in the gray. Maybe some cases they went a little too black.

But I actually think that there are plenty of examples where to some cases, the large platform size and scale creates a risk adversity, a risk arbitrage that meaningfully creates opportunity for startups. Have you worked with many founders as effective, I'll say, as Travis Kalanick, at just being a bulldog and creating this opportunity in what we'll call the sort of the gray zone? No. To be fair, my partner, Rob, was the one that led our investment in Uber. But Travis wasn't incredibly, I'd started three companies, but there's no way I could have done what he did, both in terms of his aggressiveness and his conviction. He did something that very few

founders could have done. You mentioned your partner, Rob. I've met a few of your other partners, and it just seems like this incredible group. I'm curious what you've learned about what makes a great early stage venture investor, whether it's from the partners you've worked with or from the community in which you've been involved. What do you think that we've talked a lot about the key features of a founder? Are they similar for what makes a great investor or very different? I think one of the things that we look for, the first thing we look for is empathy. It is really hard to sit in that founder's chair. You're having to make dozens of decisions daily with imperfect information. And so unless you could empathize with the job that a founder has to do

and understand that the founder is collecting thousands of data points to make these decisions and that you as an investor after you've invested, you see such a fraction of what they see. So job number one that we look for is empathy because we think it's really hard to be a founder And it's important to realize that as a VC, there's that whole story when the chicken and pig get together to make breakfast. The chicken is involved in making the eggs, but the pig is fully committed to making the bacon. And I think we recognize the best VCs are chickens. The founders are far more involved than the VC. So I think it's important. What I've seen is that the best investors are the ones oftentimes who ask the best questions of founders rather than give the right answers.

two founders because your job as an investor is to help bring out the best in the founder, not to replace that founder's judgment with your own. So I think that's a lot of what we look for is an understanding of difficulty and challenge that it comes with starting companies. And so I've really been fortunate to work with some partners that I think that shared that mindset and that philosophy. Are there areas of the kind of industry taxonomy or ecosystem that, them that you think are especially interesting to look at today? Or is your approach much more bottom up? Ideas come from the founders. You're more interested in the founders than the areas in which they're operating. So we've tried, there have been times where we've done, we've tried to come up with

themes or areas or topics that we wanted to focus on. But for the most part, I would say what we've learned is by the time something becomes obvious enough for us as a seed stage firm to say this is an area that we want to deploy a lot of capital into, it's too obvious. Most of the time, the best companies we funded have been ones where the founder has come to us with something that we had not thought of before. And what's cool is that we also have found that very few people had thought of that before. So for us, we tend to avoid being thematic investors and just sort of try to be open to rapidly learning. What do you think will happen in back to kind of where we started this new environment as it pertains to valuations and therefore to the prospective returns of an early stage VC fund?

I'm curious what a high end expectation. Everyone always talks about like a 3x return or something like this as a target. Do you think that that has materially changed in recent months looking forward? And is that mostly because of any changes in valuations? So I think the real answer is it's hard to know. Right now, you really seem very little impact in private investing because public companies trade daily and private companies trade by appointment. And when you trade by appointment, you typically trade as a founder. You typically sell your shares at the point of maximum leverage, at the point of maximum validation. You have your curves going in the right direction.

Now, what changes that oftentimes is if you're forced to go out in fundraise because you need the capital. So there are going to be some companies that are going to be going out in the next quarter or two that thought they were going to be going out in one environment and are now going to be going out in a different. And that will be the first time we get some sense as to what's going to be happening with valuations. As I said earlier, I think DCs, even though they say they're still writing checks, it's very hard to sort of have a growth mindset or an optimistic mindset when you're sitting hunkering down at home. When you're sitting down trying to make sure that your coworkers, your friends, your family are all safe, it just brings up a very defensive mindset. And I think you're going to see that from venture investors as well. I think that when it comes to returns, I think you're going to see, at least what I saw during the dot-com boom and then bust, was that the funds that struggled the most were the funds that changed their strategy aggressively during the boom times. So you had many funds that raised $400 million venture funds every three years, $400 million, every three years.

And in 1998, 1999, they shrunk from a three-year fundraise to 18 months down to nine months and went from $400 million to $1.2 billion. And those who changed their strategy or operating cadence at the peak or as we approached the peak, I think those were the funds that were hurt the most, that weren't able to reemerge. Now, I think the opposite is also true. there are plenty of funds that kind of just left the market in 2008 and 2009 and stopped investing. And if you're an early stage investor, like some of the companies in 2009 and 2010 were some epic companies. And so I think that at least the lesson that I've drawn from the past booms and busts has been to really try to stay true to an operating cadence or an operating strategy that works for you, a fund size, check size, fundraising cadence. So it's one of the reasons why first round, for example, today our fund is still, we're investing out of fund seven. It's about a $200 million fund. Our first institutional fund was $135 million. So we haven't, in the course of 15 years, we haven't even grown. We haven't two X.

And obviously you've seen most venture funds during the last 15 years grow by five X. There was a great line in a prior episode with a guy named Matt Clifford who talks about the history ambition and sort of the domicester. and sort of the dominant technology of ambition. So the thing that the most talented people go do to seek the most leverage. And he's identified technology entrepreneurship as that today. Maybe it was finance. 50 years ago today, it's technology entrepreneurship. I'm curious how you see business models evolving within technology entrepreneurship.

So some of the dominant players of the last cycle, they didn't have revenue for a very long time. It was more about eyeballs or distribution or audience size. Do you think that that has changed or will materially change? and we'll see more early revenue, clear value proposition charging for services within the bucket of technology entrepreneurs? So I think the answer is yes. There are two things I'd say.

The first is during a downturn, VCs, even when they're investing, oftentimes, there's always this balance of trust me or show me. Okay, so when a founder's telling you his or her story, how much of it is trust that they'll do it versus proof that they've done it. So I think that you're going to see far more emphasis on show me in the next two years than you might have seen in the prior to. I think you're going to see less of a trust me and more of a show me. I think the second thing that's become very obvious is you have a generation of VCs. For the most part, when people were building a software business, software by its very nature had incredible margins. So by default, if you had a successful software company, you had a very value. tech company and that company would be able to get highly valued. I think over the last 10 years, you have a lot of VCs who really never had to learn how to value a company. And so they applied, they just assumed that software margins applied towards every business, whether it's retail,

whether it's real estate, whatever it might be. And so I think you're also going to see sort of a real shift back towards people trying to understand how companies are valued or will be valued. Because as investors have funded companies, I think during times, boom times, money gets easier. And money flows a little more. And I think a number of funds, and I think we've made this mistake a few times, a number of funds have funded companies that their underlying margin structure, their underlying cost structure, just don't match the typical, quote, software tech multiples that were. applied to those companies. One of the things that I'm so interested in is little software companies that can charge very quickly. Just as someone joked on Twitter, that profitability is the new product market fit,

which has not been product market fit, classically defined. I just think it's so neat to watch some of these little tiny companies charging very quickly. Absolutely. We were fortunate enough to be the seed investor in a company called Notion. Oh, yeah, sure. And Notion is just a perfect proof point of that. There's really no marketing budget.

there's really no sales budget. You just get on board. You use their free product and very quickly, you're paying them for it. And when a company can sort of unlock that type of magic, that's really, really compelling. Can you talk a little bit about the dorm room fund? I thought this was such a fascinating idea, specifically where the idea came from. I think it was maybe seven or eight years old, something like that, and then sort of how it's evolved. I saw an interview with you, I think soon after it launched that you said it's going to be an amazing outcome. We just don't know if it's going to be amazingly good or amazingly bad. I love ideas like that. So what is the dorm room fund? So I co-founded my first company when I was a sophomore in college. And then three years after

I graduated, that company went public. That was a marginal success. But so many epic companies were started by kids in college, whether you're talking about Facebook or you're talking about Google or you're talking about FedEx, Microsoft, just you're looking at just billions or even trillions of dollars worth of market cap have been created if you go all the way back while they were in school. Yet, if you look at the sources of funding for students, some students have such conviction in their ideas that they're going to drop out and then they'll go raise money from a venture capital. But a lot of folks aren't going to drop out. And there really is no good source of capital. If you're a sophomore in your dorm room working on an idea and you need $50,000 to get started,

There is no good source of capital. Like VCs aren't in the business of A, writing $50,000 checks or $20,000 checks. And B, they typically don't do it to people who aren't pursuing their idea full time. And so we said, wouldn't it be neat if we created a fund that would fund these student entrepreneurs, but obviously we're not best equipped to evaluate them. So who could? And then we said, well, if these students are smart enough to create these epic companies when they're in school, why aren't students smart enough to invest in these epic companies

while they're in schools. So we now have dorm room fund in four cities in Philadelphia, San Francisco, Boston, and New York. And in each of those cities, we have anywhere from 10 to 12 students, whether it's Harvard, MIT, Northeastern up in Boston, or Columbia, NYU, in New York. And those students are the partners. And they're writing $20,000 checks into student-founded companies. And over the last eight years, they funded over 200 companies. And a number of those companies have gone on to raise a lot of venture capital. So when you look at the leverage of the $20,000, translating into hundreds of millions of dollars that have followed, that's pretty cool. And I think for us, there have been two interesting learnings. The first is we were originally focusing on the student entrepreneurs as that the most

engaged community. What we found candidly is that this community of investors is also really interesting. So every year you have multiple, quote, dorm room fund partners that are graduating from college. And now over 25% of them have taken a job in venture capital after they graduated. So I think dorm room fund is now the largest pipeline into venture, much larger than like Hoffman Fellows in terms of sort of the number of people that were graduating. What's also really cool is that the dorm room fund partnerships, the goal for us is that the demographics of the partnerships represent the demographics of the universities. So we're actually finding far more underrepresented female folks getting into venture

because Dorm Room Fund gives them the experience to actually write checks and perform that craft before they're being hired to do it. So for us, that was a really interesting way. I'm also really intrigued. I've spent a good amount of time talking to your partner, Brett, about the platform that you've built, again, to use that cliched term. I think this is something that not nearly enough investment firms, not just venture firms, but investment firms, more generally speaking, think about as part of their business.

And I know you think about it as maybe a separate function or feature of first round than the investment decisions as sort of the core product. So talk me through your thinking there. How did that evolve? And would you recommend that other investment firms adopt this sort of side platform thinking? What's interesting is if you look at the type of company, most VCs like to back or say they like to back, they will tell you they like to back software-based, non-neutral. human services, scalable network effect-based companies. Yet if you look at the firms that most venture

capitals build, it is not software-based, it's human capital-based, and it's anti-network effect. And what I mean by anti-network effect is if value delivery occurs in a human capital way, so I'm a partner and I attend a board meeting and I'm going to deliver value to these companies, if I'm point on five companies, I could spend one day a week helping my companies. But as you had new nodes to the network, if I'm now point on 10 companies, I can spend one day every other week. So with each new node you add to the network, each new company you add to your portfolio, you're reducing the value prop for every other player. It's the definition of anti-network effect. So we kind of stumbled into this, which is back in 2006, 2007, we created a Yahoo group for our

founders, just a simple mailing list. And we quickly saw that they were able to, able to help each other far more than we could. When Aaron Patser, who founded Mint, won the TechCrunch Disrupt Conference and he won the prize and his servers crashed because he had a MySQL, MySQL got overloaded. He asked my partner Rob and myself, hey, do you know how to scale MySQL? The answer was no. Could you help? And it was a Friday and we started calling people we do. But then he posted it to the CEO for him. And one of those folks introduced him to Martin Micos, the founder of MySQL, who was able to help him solve that. And like, you begin to realize that there are these ways, what we've done is we've now tried to productize that, where whenever a company joins the first round community, they get access

to a set of online tools, an online network, not just for them, but for their entire company. So their head of data science could share best practices with the head of data science at all of our companies. If you're in SEO at one of our consumer companies, you're never going to really interact with your VC board member. So your ability to get value at, and by the way, most VC board members don't know how to deliver value on SEO to your head of SEO. But if we have 20 or 30 people that do that at our companies, the ability to connect them is really cool. Because then what happens is each time you add a new company to the network, you're actually increasing the value for everyone else. So we've invested pretty heavily in software engineers

to build an online network that not only connects the executive teams, but try to to connect every employee at all of our companies. So we have thousands of people at all first round companies connecting online. And we also extend that offline because we think that a lot of trust and respect comes from actually getting to know people in multiple formats. So for us, that was a big advantage because I got to tell you, I used to a company would launch and they would say, hey, could you recommend, they would always just call me as a partner and say,

could you recommend a good PR firm? Could you recommend what do you think on incentive comp for sales reps? And sure, I might have a point of view, but the ability to find that out from people who are practicing now, look, when I ran a top 10 ecommerce site, half.com, there was no mobile, there was no social, and there was no paid search. So if you're an e-commerce company today, asking me about customer acquisition, the half-life of my knowledge as an operator is very short. So if I'm going to deliver any knowledge to a company today, what am I doing? I'm typically sharing what I've learned from what I've seen that other founders and other companies do. And if I'm sharing what I've seen other founders do, well, then why not just take me out of the loop and have the other founders share that? If you're a mobile marketing manager and you want to figure out, how do I get featured as the Apple App Store of the day? Maybe you could ask me, but wouldn't it be cool to ask the mobile marketing manager of Uber, Hotel Tonight, Square, and other companies that have already done it because they probably can help you far more than I can.

As somebody that is actively building software, really for the first time and loving it, but sort of feeling like a title wave of learning that's hard to face down. I'd love to talk a bit about product mistakes in software specifically. You mentioned earlier this great feature of good founders of knowing what they don't know and being in sort of hyper learning mode. How does that manifest on the other side of the ledger and mistakes? So what are the most common early product software mistakes that you've seen, maybe that selfishly I can avoid or others out there listening building software could avoid?

So I think if the goal is if you're trying to learn something, you're still trying to learn something through your software. You're trying to say, is this feature going to be valuable or not? All too often, I'll tell you about a product that we built that didn't really get traction. We said, oh, you know, when everyone goes down and raises their follow-on rounds, they always create this new Google Doc of all the venture funds they're talking to, and they kind of build their own CRM at the same time for fundraising. So why don't we build that for them? Because we know how a good fundraise should happen. We will build it exactly as it should happen. So we'll build this fundraising tool to help them track which funds to talk to,

where are they, manage their fundraise. And it really never got that traction. What we learned is we would have been much better off hacking something together, putting it out there, instead of spending six months building the feature perfectly, get something out there to get in front of the customer very quickly, even if it's not scalable, even if it's sort of vaporware. just collect that data. And I think sort of when I see companies that are making, some of the biggest

mistake is when they code something so perfectly in software with the expectation that they're right. I remember there was an idealab company called CarsDirect.com, which would help you buy cars directly from dealers. And when they first started, Bill Gross had the great idea of saying, all right, let's just put up a form. What type of car do you want to buy? I want to buy a Honda CRV. I want to buy X or Y. And rather than build all the software to connect all the car dealers, inventories, and understand where things were. When you said, I want to buy a Honda CRV, all that happened was an email, went to an operator or an associate's inbox, and they said, all right, Patrick wants to buy in whatever year, whatever color, Honda CRV. And all that person then did would call three local

auto dealers to ask them if they had in stock and negotiate the best price. And then they would just type in the price and it would get in a form and it would just get automatically sent to that dealer. But there was no software in the beginning that actually connected to all those dealers. And only after they realized this is the cadence, this is the workflow, this is how it works, these are how many dealers we need to connect to, and this is the price that we need to be able to offer. Only then did they actually instantiate all of that ended up connecting to the inventory and the dealer software systems so they could programmatically do that. That's like a perfect example of sort of starting off with your goal is to learn very quickly,

but it actually is expensive to instantiate process, to instantiate something into a product. So oftentimes the best products are ones that start off super lightweight and then grow when they found that hook, when they know that they kind of struck a court. I love that idea. It reminds me of game paths or something. Very often they're in counterintuitive or strange places. But if you just look versus trying to guess and forecast and build for six months like you did with your product, you might be far better off, even though it doesn't feel like the right thing to do. I feel that's been my observation is it feels right to make it more complete so that you're not embarrassed by it when the first clients see it. But maybe that's

exactly the wrong thing to do. Have there been people that have said, this is what the product is going to be and gotten it right? Of course there are. But oftentimes what you're trying to do is get something in front of people. And I think when I look at Nat and Zach, the founders of Flatiron Health and what they did there as well as invite media, They were exceptional at this. They would sort of put together almost like screen mocks of a product. Just get it in front of people. It didn't work.

They would just try to understand. They would take their insight, put it into screenmocks, go out and have meetings, come back and edit. They only built after they had 50 conversations where they were able to show product and they had real confidence in what they were building. What are you most excited about? You've done a lot. You've built a lot.

You've been a successful investor for, a long time now. What keeps you going when you wake up each morning, whether it's within first round, other things you're pursuing, looking to the next 10 years? What are you most jazzed about? So I think I have the best job in the world. I wake up and my job is to hear people's dreams. They come in and they're at the earliest of stages and it's really just the difference between sort of what is a game changing company and what's a novelty or toy. It's so hard to differentiate at the stage that we funded at. I just get real energy by hearing people talk and share what they want to build and what they think the world needs. And so for me, that's the most fun part

of my job. The hard part is obviously saying no to 99% of them and doing it in a way that doesn't get you very jaded. This is an industry where you could very quickly get jaded. And forcing yourself to maintain that open perspective is hard. YouTube was tried so many times before YouTube launched. You had real player. There were just so many people that had pitched that. And Dropbox, there were things called like Carbonite. And there were like tons of backup in the cloud type plays. And so the hardest part of the job, and it's one of the most fun parts is not totally pattern matching to the point where you're closed that you've seen something 10 times before. It doesn't mean that the 11th time isn't going to be the different one. It's almost as if you get to spend all your time in that learning phase. You get to adopt the period of mega learning that each of the founders gets to experience over and over again. What a cool concept. Yeah, the first 18 months are just a magical period.

The founder is they're figuring out their go-to-market, they're positioning, they're hiring their core team, they're baking their culture, they're figuring out pricing and product. All so much of the company gets baked in the first 18 months. And so sort of selfishly, I kind of designed a firm that just enables me to focus and my partners to focus on that stage. So, Josh, my closing question for everybody is to ask for the kindest thing that anyone's ever done for you. When I was starting half.com, my wife was a successful attorney. and I think she really chose to sacrifice her career to support my dreams. And that was a level of unselfishness and kindness that I don't know if I would have been

able to have made the same decision that she made. Fantastic. What a beautiful answer. I've learned so much today. And what I've learned as much as many of the ideas is like your excitement, visible excitement, we're doing this on Zoom. so not everyone will be able to see, but they'll be able to hear it. I just think that as a litmus test for what you should be doing, you should have your kind of excitement.

So I really appreciate what you've taught me today and the way in which you've done it. Thank you for your time. Thanks for having me. It was a lot of fun. Hey, everyone. Patrick here again. To find more episodes of Invest like the best, go to investorfieldguide.com forward slash podcast. If you're a book lover, you can also sign up for my book club at investorfieldguide.com forward slash book club.

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