What if Startup Investing was like ETFs + Credit Default Swaps?

The JOBS Act was supposed to let the everyday person invest in startups. Years later, this is not a reality. Pretend they could though, the non-accredited investor would face the same challenges as any angel: it’s difficult to build a portfolio of companies and generate a positive investment return. Here’s an idea on how to invest cheaply, diversify, and make startup investing more liquid too. It’s called Startup Indexes.

Inspiration Part 1: ETFs & the Ability to Track Broad Market Performance

Exchange-Traded Funds (ETFs) are shares representing baskets of securities. For example, SPY is the SPDR S&P 500 ETF. It’s comprised of every stock in the S&P 500. As those stocks move up and down, the S&P 500 increases or decreases in value. Without products like ETFs, an investor would have to buy each component of the S&P 500 to mimic that exposure. With SPY, you can get the same exposure at a greatly decreased cost.

From this, Startup Indexes takes the concept of broad exposure to a market at low cost. However, one thing that doesn’t work is the constant nature of indexes like the S&P. Stocks get added or kicked out sometimes, but the index can’t withstand mass change. That doesn’t work with startups, where 70% of them can eventually go bust.

Inspiration Prat 2: CDS & the Vintage Years

Credit Default Swaps (CDS) are known as greedy Wall Street inventions that brought about the Great Recession. They’re actually rather ingenious financial products. At the most basic, an investor might own a lot of debt in one company. There is a risk that company doesn’t pay back its debts and the debt-holder loses big time. In CDS, the debt-holder (or a third party) can buy insurance on those defaults from an insurer.

But maybe you don’t want to insure against a single company. Maybe you have broad exposure to mortgages you want to hedge. Or maybe you own too much European debt. You have the ability to buy insurance on an index of companies. The indexes list each debt issuer and which specific debt is included. No two indexes will be the same. An index released in 2007 will look and perform differently from one in 2014, even if its the same general market. This is due to the different pieces of debt and companies that are included or excluded.

Startup Indexes steals the “Vintage” idea. I theorize that Series A is the right risk/return profile that could perhaps scale into my Index concept below. However, companies only go through Series A once, therefore it needs to be a moment-in-time snapshot like CDS Index Vintages. Beyond the vintage concept, Startup Indexes shares little to nothing with CDS.

Startup Index Definition

A management team goes out and does a large number of A-round deals each year. They invest a few million into each one, pool the investments together, and sell that portfolio’s future cash flow rights via Startup Indexes. A Startup Index owner would not have any control rights. The index value fluctuates with future financing events. When an exit occurs within the index, investors are paid out on a pro-rata basis. The management company charges an annual management fee and potentially carry. To capture a vintage effect, a new Index is sold every 12-24 months.

An Example: From Funding, Index Valuation, to Cash Payments

Over 12 months, the Management Company invests in 50 companies at $3 million each. Original “cost value” of the fund is $150 million. Management company decides to break it up into 10 million shares, cost valued at $15 each. The majority is sold via IPO and privately agreed upon transactions. Management retains some percentage to align interests.

Price changes are determined by the market. However, the actual cost value is changed by future financings. 5 companies raise another $50 million. 10 companies declare bankruptcy (initial investment of $3 million per, total loss of $30 million). Net value of the index increases $20 million, updated share cost value is $17. Share price will differ based on future expectations of financings.

Investment retain liquidity since shares can be actively traded. However, the underlying investments are still illiquid. Like venture capital, money is mostly made via exit. If Startup Indexes owns 25% of a company’s shares and that company is acquired, Startup Index gets 25% of the proceeds and allocates it to investors based on how much a person owns of the index. If a company IPOs, there needs to be a decision on whether those shares are sold or distributed back to the investors (likely sold). Allocations are again based on how much someone owns of the index.

The Obvious Problems

The management team needs to do ton of deals every 12-24 months to populate each vintage. Does that negatively impact selection? Once invested, can management truly remain active across so many investments? There are regulatory issues (though I believe this is do-able without any further action on the JOBS Act). But what level of disclosures is management required to make? There’s confidentiality issues for the underlying investments. There’s a size issue. This product may not be large enough to attract institutional attention for your 401K or pension. There’s the funding issue. Does management have to front the investment and hope people purchase it shares from them? If so, they have to do it for each vintage! But this is likely the tip of the iceberg.

Conclusion…

Besides looking at those financial products as inspiration, Startup Indexes isn’t very different from something like Y Combinator or TechStars. Investors put money in and get a small amount of equity in return. That just doesn’t scale or help non-accredited investors. I don’t know if startup investing can successfully scale, but this is one potential way.

Startup Indexes has issues. I still think it injects liquidity into the system and allows cost-effective diversification into startups as an asset class. At a minimum, it was a fun thought experiment, right?

Glory Days Again

In 30 minutes, I’m presenting to college students at Loyola College (nay, University) Maryland. Here’s the presentation. I spent a lot of time searching for appropriate pictures. Check it out if you’d like. I’m talking with some 21 year olds, so I hope I don’t get booed off the stage or yawned to my face. It’s Friday afternoon though. Fingers crossed.

It’s my third time on campus since I graduated and great to be back here. Hammerman Hall, built in the Brutalist architecture style, still looks brutal. Otherwise, some things change, most remain the same. I’m happy to walk around the campus in none-teen temperatures. But I snapped some great photos for my photography class while I’m here. Besides HH and LOLButler, it’s a beautiful campus.

Thanks to the school for having me and to the Financial Management Association for lunch. Alonzos/Loco Hombre, still delish.

Four Ways to Make Life Hackable

3D printing plastic prototypes, 3D printing electronic boards, Arduinos, and Raspberry Pi. Founders for all these companies, plus an expert on hardware supply chain and manufacturing, got me excited enough to run home and put a few hundred bucks in my Amazon wish list last night. Consider this post a summation of the evening and a brief primer for a some hardware technologies.

Matt Turck of FirstMark Capital hosted the 3rd Hardwired NYC meetup at kbs+ Ventures last night. It’s my first Hardwired meetup. The groundswell of support plus the quality of presenters was impressive. With just organic word of mouth growth, over 800 people joined the group and 265 registered to attend. The place was filled, tickets were free, and they gave away pizza and beer.

My previous post was about how meetups don’t engender great relationships. This post is about how Hardwired got me geekily excited to keep coming back for more. Like Web 2.0 or the Sharing Economy, the Internet of Things is a big buzz word in tech. It means a lot and nothing at the same time. It’s the intersection of hardware, manufacturing, software, and engineering. And while the title inventor applies to software technologists and others, these founders most closely resemble the inventors of our past.

Jeff McAlvay runs Tempo Automation. He has a 3D printing solution. 3D printing is where a device takes a 3D software/graphical representation and renders it, typically in plastic. Watch a Makerbot Replicator create Yoda in this timelaspse video:

Besides Yoda, people are making ornaments, iPhone cases, spare parts. People have 3D printed using other materials, Here’s NASA trying to figure out how to print pizza in space. I mean, FOOD PRINTING. It enables rapid prototyping for manufacturers and small batch manufacturing runs (when traditionally you’d rent out machines in a larger factory with burdensome costs unless you ran large batches).

I had never heard of 3D printing electronic circuit boards until Jeff started talking. It’s the same principle. Using software, a design is created. His robot takes a blank electronic board and assembles it with resistors or whatever other components the design calls for. Instead of waiting weeks to iterate your boards, you print in hours. It’s in a prototype phase and they’re working towards crowdfunding.

Sam Cervantes presented a more classic plastics printing approach with Solidoodle. Like MakerBot and other competitors, you’re prototyping small plastic objects and wireframes. Sam built the first 20 printers in his tiny Brooklyn kitchen and expanded from there. When pressed about competition and the MakerBot acquisition, Sam demurred. He doesn’t believe Solidoodle targets the same user due to their price points and convenience of us. Unrelated anecdote ahead. One time he had a customer print a full Aston Martin made of 6 inch 3D printed parts.  Now, one 3D printing sticking point is software (this is second hand, I’ve never gone from design to print). I’d have liked to hear more on that from both Sam and Jeff.

Massimo Banzi, co-founder of Arduino, sat down with Matt to talk about where Arduino has been and where it’s going. Arduino is open source hardware and software (firmware too). There are many different components and peripherals that combine to do very different things. You can build a remote and change a neighbor’s TV from across the street. Get an LED light to flash every time you get an email. Create a pressure sensor. It can  be connected to bluetooth low energy devices to route information online. At WeWork, we met with someone creating an Arduino sensor to measure when the keg’s empty. It is truly depressing when you get to the 4th floor only to discover a plastic cup resting on the tap.

Arduino was created by academics, engineers, and others to promote low cost electrical engineering and testing. The company is open source, so someone creates a component that lives up to Arduino specifications, pays them a licensing fee, and sells on their own. Adafruit is a popular US-based Arduino provider. A starter kit runs $130-140 and comes with 15 different projects and directions. I should also note while I’d love to play with these things, so do kids. Both this and the Raspberry Pi are interesting ways to get children interested in STEM subjects.

Scott Miller heads up Dragon Innovation, which helps companies all along the hardware planning and manufacturing spectrum. Scott spent a long time on the actual cost of goods, and how hidden costs are underestimated and lost along the way. It was detailed in nature, so I don’t want to revisit this in depth. What I will repeat though was this caveat: cost of goods miscalculations explains why many crowdfunding projects can fail. If you don’t take into account the cost of machine time, cut the fat out of manufacturing overhead, think about packaging costs, or properly estimate transport costs, you’ll aim for the wrong crowdfunding target and be screwed from the get go.

Last up was Matt and Eben Upton, founder of the Raspberry Pi. It’s essentially an ARM based microcomputer or controller that can be connected to a variety of peripherals. It’s a Linux based system coded in Python (which explains the Pi name but not spelling). Eben was a student and teacher at the Cambridge engineering school. When he arrived, people spent their youth tooling around on Atari and Commodore 64. Over time, Eben believes Nintendo, Playstation, and the like have replaced the hacking-gaming systems and made people end users instead of system collaborators. This resulted in fewer applications to Cambridge engineering and a weaker knowledge base on entrance. Raspberry Pi is their answer to get kids playing again.

And kids definitely play with it. It’s a mini computer at a cost of $25. Yes, $25. Here’s an 11-year old’s website dedicated to his adventures with Pi. In fact, there’s an entire article about how kids and Raspberry Pi stole PyCon 2013’s show. Adults are inspired by it too. Here’s someone who hacked their own microwave.

Last night was great. I saw founders of companies I’ve followed for a long time. They talked about things that ten years wouldn’t have been possible. But thanks to a confluence of advances in hardware/software/engineering/manufacturing, hardware has become a real space. As all the different things it’s enabled? It’s incredible. Life is now hackable, in a good way. And that’s exciting.

Loyola Venture Community

Tonight marks the first meeting of the Loyola Venture Community (join here). LVC is a community of Loyola students, alumni, and staff that are interested in entrepreneurship. You don’t need to work at a startup to join. You can be a startup accountant, lawyer, or investor. You can be someone who has worked at Big Corporate for years and just wants to explore what’s happening in the startup space. To become a community member, the only pre-requisite is that somehow you have ties to a Loyola school.

LVC’s goal is to facilitate communication, provide resources to its members, and build community. Does that sound familiar? I borrowed the idea and model from Mark Peter Davis of Columbia Venture Community after interviewing him in early 2012.

I feel there is a clear need for LVC. There was no easy way for me to identify the proper people and resources who could assist me from the Loyola network. I relied on my personal networking skills to surface them on my own. It was effective, but it shouldn’t be that difficult. The alumni board has startup focused events. They’re great, but they aren’t consistent enough. I even wrote about them here on my blog. The school is  working on startup initiatives but they don’t yet have a community that can connect all the different constituents. At this point I should note: LVC is unaffiliated with any specific Loyola university.

I’m not aiming to duplicate anyone else’s efforts. There are two components, digital and in-real-life. Digital first. You need to identify PR people, lawyers, investors, industry contacts? All the information is there for our members in the Group Directory. Similarly, you want to fill or find an internship, locate a mentor, hire a full-time marketer, run a crowdfunding campaign, gain access to a specific event, develop social media strategy, or simply browse or share relevant books and articles? Utilize our Google Group to broadcast to all members. It’s our listserv. It’s where the online conversation happens.

Now for the in-person side. Tonight is the first meeting, 6:30 at Pop Pub (University Ave between 11th and 12th St). All subsequent meetings will be the 3rd Wednesday of each month. Check it out on the calendar. Tonight’s agenda is simple. Informal networking. Crowd introductions. 2-person foosball tournament. Crowd introductions are comprised of everyone introducing themselves, explaining whatever projects they’re working on, and stating explicitly what help and resources they need and what help or resources they can provide. This point is to cut through the BS and get to the core of what people really need. This is the real meat of the offering, the value I want LVC to bring. And for the foosball tournament, pick a partner you haven’t met before. Get to know each other.

The events are New York-based. I’m here, so I’m biased. We have constituents outside New York. My hope is that we can connect everyone digitally until perhaps something develops in other locales. And of course, I hope to have people at the schools get more involved as well, whether it’s through guest speaking opportunities or workshops on campus.

I’ve illustrated why I believe there’s a need. I’ve described my approach. This is my minimum viable product. I don’t know what direction this group will go. I’ll listen to what the crowd likes and doesn’t like and move from there. And so you know, here’s the hypothesis I’m operating from:

My colleagues from Patriot or Ivy League schools have an incredible network to tap into on demand for resources and introductions. The Loyola schools have a large network of successful students, alumni, and staff. I posit that a major difference between Loyola and these more touted schools is the ability for these people to easily connect on their own. I believe our people, if presented the opportunity, would gladly match their efforts and collectively pull ourselves forward.

Anyways, that’s just what I think. Let’s see if the market agrees.

Creative Entrepreneurship

My Updating Reading List just got a new addition that actually accomplishes a lot of what I want the updating reading list to do. kbs+ Ventures is the investment arm of kbs+, a creative, advertising, and marketing agency. Last week, Charlie O’Donnell had a note in his weekly newsletter about their new book, Creative Entrepreneurship.

The folks at kbs scoured the web for the top articles  dealing with different topics on entrepreneurship, including history & context,  finance advice, how to be a VC or entrepreneur, how to fundraise, and more. They figured, instead of digesting it from their own personal experiences, interviews, or research, why not take it directly from the sources? So, for each topic they’ve found about 4-6 essays or blog posts written by people from Mark Suster and Fred Wilson to Blake Masters and his Thiel-Stanford lecture notes. The first ten people to email kbs about the book also received a free copy (I’m happy to say I’m one of them).

For anyone else who’s interested, follow the link above. It’s a free download for your Kindle, iBooks, or whatever eReader you’re using.

Enjoy.

Venture Capital for Dummies

Earlier this year, I got asked to join a new venture capital firm called Pilot Mountain Ventures. I’m thrilled and lucky to be involved. I’ve told some friends and family about it, and more often than not they smile and nod and don’t have any idea what that means. Largely due to prominent bloggers like Mark Suster, Brad Feld, and Fred Wilson, people in the startup industry know more about VC now than ever before. Still, it’s not a well understood subject by everyone else. It’s gotten more press lately since Mitt Romney secured the Republican nomination. More press, but regrettably not an informed press. So, I thought I’d put together a basic primer on how venture capital works. Got questions? Ask in the comments section and let’s have a discussion.

On Venture Capital and other stuff: Chris Yeh

Image via CrunchBase

Chris Yeh is many things, among them a General Partner at Wasabi Ventures, Vice President of marketing at PBworks, father, and blogger. Chris is neither a Droid or Apple guy, but very much requires a physical keyboard on his phone. He hopes someone buys RIMM’s patents, and soon. Chris and I talked about how Wasabi Ventures works, a recently created accelerator at Loyola University Maryland, and some other questions about the industry. You can read much more from Chris directly at his blog Adventures in Capitalism and his personal website, or you follow him on Twitter at @chrisyeh. Here we go…

Image by Eastwick Communications via CrunchBase

From my understanding, Wasabi Ventures doesn’t operate like other venture capital firms. Can you talk about your operating model?

We like to think of Wasabi Ventures as kind of a throwback to the old days of VC. In the old days, venture capitalists didn’t invest as much money as they do now, but they did a lot more hands on work. Over the years, the industry has become much bigger and the amounts of money invested have gotten larger, despite the fact it’s cheaper than ever to start a company. We’re trying to return to a traditional means of venture capital. We invest small amounts of money but we also invest our own time and expertise to provide that kind of nurturing startups need.

Wasabi Ventures recently launched an accelerator program at Loyola University Maryland. What motivated that?

The new accelerator we launched at Loyola is a joint venture with the university that tries to serve what we view as an underserved market. The wonderful thing about the internet is you build these products and companies through distribution channels that are now global, like social media or the various app stores. It seemed like a place like Silicon Valley had a monopoly on innovation because they have so many resources. It’s not because they have more smart people, though there certainly are plenty of those. Silicon Valley has an ecosystem: attorneys who will work with you, experienced executives who can provide mentorship, former entrepreneurs who are now investors, VCs who are used to putting in money. We feel like we can bring some of those things to the Baltimore area and fix the situation there. The good news about Baltimore is it has strong support from the state of Maryland. There are a lot of very smart people and good universities in the area. It just needs some catalysts, and starting an accelerator at Loyola is one of them.

You recently wrote a post on Adventures with Capitalism called “Is There A Social Media Bubble?” That’s very topical right now. Can you talk a little bit more about why you think the startup scene is overheated?

Ultimately, overheating in markets is where the valuations get away from what can actually be supported. I’m an old school guy. I believe you can value any company or opportunity. You do that through the old-school method of a discounted cash flow analysis. You add together all the future cash flows and discount them back to the present day using the appropriate discount rate to arrive at the present value. What I see is similar, but not to the same extent, of what I saw during the dot com era. Then, if you did a discounted cash flow analysis on eBay, it was clear the valuation of the company was based on it maintaining a 100% annual growth rate for two decades, which just simply isn’t possible. No company can grow at a rapid pace forever. Even an enormous company like Apple can’t grow forever; otherwise it’s larger than the world economy. Everything has to slow down eventually and everything has a finite value. In the dot com era, there was no way you really calculate a scenario under which they’d be worth the amount of money they were worth in the public market.

The same thing could happen today. I’m going to invest in a company, a seed stage startup, with a ten million valuation. Here’s the problem. What are the chances that a startup that gets funded eventually exits at a good value? Let’s walk through a scenario. You seed that company. Let’s say there’s a 1-in-3 chance you get venture funded and from there it’s a 1-in-10 chance it becomes a big success. You now have a 1-in 30 chance of a success. So what does a big success look like? Probably on average, it’s two hundred million dollars. You’d feel pretty good selling a company for two hundred million dollars. But if you have only a 1-in-30 chance one of your companies is worth that amount, and you had to make thirty investments at ten million each, effectively you’ve paid three hundred million for a two hundred million return. The math just doesn’t work out; you have to pay a lower price. Or you have to see much higher exit values. The reason why we get bubbles is people see exits like Instragram. Zero revenue, one billion dollars. Well gee, if my average exit becomes a billion dollars, then even if I make thirty investments at ten million each, that is, pay three hundred million present value and get a billion back, you’d do it seven days to Sunday. The problem is those kinds of public market valuations or acquisitions aren’t sustainable. We saw it happen during the dot com era and during 2007, and we’ll no doubt see it happen again in the near future. We just haven’t reached that point yet.

What’s an example of one mistake or failure you’ve had and what did you learn from it?

I won’t use the company’s name because I don’t like to talk bad about any entrepreneurs, but I’ve certainly made mistakes in investments before. You try to learn from every mistake. But if you lose a bunch of your money as an investor, you really tend to remember the lesson. One company, for example, was in a space that I thought would be very strong, and people still haven’t cracked it yet but it could potentially be huge. The entrepreneur was a friend of a friend. He’d been very successful and had led a publicly traded company. He was a very credible figure tackling a problem area that I felt was very strong and attractive. The issue was that he hadn’t gotten the product to the marketplace yet though. As it turns out they were never able to get the product to market and I lost all my money. In fact, I was unwise enough to be the only investor in that particular venture. So, the lesson was don’t invest in companies before the product is there, no matter how great the entrepreneur or market seems to be. It’s very difficult to know the product will be there.

Still, there are exceptions to every rule. I recently did an investment in a company with two very strong entrepreneurs that hadn’t yet decided what they wanted to do. These folks had a proven track record of building and selling products and were themselves coders. The previous entrepreneur, however, was a business founder and had to rely on others to build the product.

Roger Ehrenberg of IA Ventures and Dave McClure of 500 Startups recently wrote separate posts on whether or not venture capital is scalable. Do you think so? Why or why not?

Venture capital as we know it is not a scalable model. The reason is simple, it’s math. Venture capital depends on three things. The first is having a ready supply of capital to deploy. That’s not the limiting factor on scalability. You could always raise larger and larger pools of capital. Warren Buffett has clearly done it with Berkshire Hathaway and has proven you can scale up investments. The second piece of the puzzle is number of available exits. Ultimately, as a VC, you have customers: the public markets and public companies that buy your investments. The total amount of money paid back into the ecosystem is limited to the total number of acquisitions and IPOs. Historically there are not that many monster IPOs or acquisitions. In a typical year, the number of hundred million-plus transactions can easily be counted in the low double digits. There aren’t enough buyers to support increasing capital by 10x. This is why individual venture firms tend not to scale up beyond a certain point. And third, an individual human being can only serve an active role on so many company boards. So let’s say each company you invest in has a board meeting every month. You sit on ten boards, and then you’ve got your own work. As a VC, you’ve got Monday, which is taken up with partner meetings. That’s you and the rest of the partners deciding which investments to make. So Monday’s shot. You’ve got ten companies, so about every other day you have a board meeting. You have to do prep work and follow-ups after, that consumes time. Then, you’ve got to meet new companies and try to assess investment opportunity. It simply isn’t possible to add that many more investments. What I’m sure Dave McClure is doing is arguing that his approach is different and scalable. If you assemble a collection of people to do the mentoring and whatnot, and you make investments rapidly, and invest in companies that can exit for small amounts, that has greater scalability. But that’s not venture capital.

Who are your biggest personal and professional influencers?

I’m a little unusual in that I draw from a wide range of influences from outside the startup world. For example, a big influence on me, from an intellectual standpoint, is Martin Seligman. He’s the former head of the American Association of Psychiatrists who started the positive psychology movement. I’m very interested in issues of popular psychology and behavioral economics. I think those things impact my professional career more than random investor this, random entrepreneur that. That being said, there are definitely people in the community who I know and don’t know personally who I admire a great deal. In terms of investors, there’s Jeff Clavier. I’ve been very impressed with his ability to find good deals and do traditional venture capital stuff. He’s been extremely successful. From a business influence, I really admire certain aspects of what certain famous entrepreneurs have done. Clearly, like many people I’ve tried to learn lessons from Steve Jobs and Jeff Bezos. Both have been enormously successful despite being heavily criticized at various points of their careers. Finally, I’d say in terms of people who’ve made a big impact in the startup ecosystem, it’s hard to match what Paul Graham has done at Y-Combinator, both in terms of producing some pretty amazing companies as well as changing the ways startups and entrepreneurs think.

Do you have an investment thesis that really excites you right now? What is it and why?

Let’s go with two. One’s a traditional investor answer and the other one is not. The traditional investor answer is I think there’s a ton of upside in touch screen computing for the enterprise. A lot of people call it mobile but I prefer to call it touch screen because tablets aren’t necessarily mobile in how I think of mobile. But it’s absolutely huge, because for the first time the devices are adapting to the human interface instead of the human adapting to the computer interface. That has opened up the market enormously. When you have applications that babies and cats can use, then you’ve really broadened the market. There’s no way a baby or cat could pound on the keys of an Apple II and do anything.

For the second one, I feel like there’s a tremendous opportunity in Silicon Valley to drive value with a greater emphasis on startup management. I think most companies and entrepreneurs don’t really think about how to manage or build a great culture. They pay lip service to treating their people well. I think it’s very valuable especially in the kind of environment we’re in, where jobs are highly available for the talented. I think companies and entrepreneurs who really focus on building a great company will have a serious advantage.

What’s the neatest startup you know that you’re not invested in?

As a relatively established startup that I continue to be impressed by, I’d say Square. They’ve taken on an enormously valuable and powerful industry, credit card processing and payments, in a way that PayPal had taken them on about a generation ago. They’ve done it with an incredible amount of style and attention to design. I doubt the food truck industry would exist without Square, because people want to be able to pay by credit card. They swung for the fences and really connected, and I admire that.

Actually, that brings up a related question. Near Field Communication (NFC) technology has been frequently touted as the next big thing. Why do you think someone like Square hasn’t gotten involved with it?

Square’s issue with NFC technology is they’ve already achieved a very strong position and it’s unlikely merchants will stop using Square’s products. I think they can afford to ignore NFC because of that. The reason probably is because NFC is going to require additions to their product, which takes resources to support it and to figure out all the different flavors and phones. Now that Square’s already a little established, until NFC becomes a clear winner, they can afford to wait on making the investment. Meanwhile, I’ll bet Amazon is investing heavily in NFC because they have the financial wherewithal to flesh it out early, much like they did with the Kindle. I think NFC could potentially be huge, but it takes someone like Amazon to invest the money and be patient, and a series of startups that are willing to gamble their existence on it, to really exploit it.

Startup Harbor chats with Brad Svrluga

Brad Svrluga is a co-founder and General Partner at High Peaks Venture Partners, a firm that invests in seed and early stage software, internet, and digital media companies, with a focus on New York City. Just recently, High Peaks had a big win by selling TxVia to Google. TxVia is a mobile payments technology company they seeded over four and a half years. Anyways, Brad and I got on the phone together and covered a lot of ground. Want more from Brad directly? You can follow him on Twitter at @bradsvrluga and at his blog, appropriately named Can I Buy a Vowel?

Image via CrunchBase

You personally manage an exciting portfolio that includes WhoSay, Savored, Kohort, Flat World Knowledge, and Ticketfly amongst others. What’s the biggest challenge facing one of your portfolio companies right now?

I’ll make a general statement first. The challenge we talk about a lot across the portfolio as a whole is for the last year or two, we’ve been the beneficiaries of a really frothy early stage capital market. Good companies, even moderately good companies, haven’t had trouble raising cash. Whenever that’s the case, we always err a little on the side of paranoia and wonder when it’s going to end. Many of the companies in our portfolio will need to raise capital again before they get themselves to profitability. Our question becomes what are the price and terms for that financing? If this market turns at the wrong time, that could present a challenge. Fortunately, I think the vast majority of our companies are solid and should be able to raise money. It’s just a question of optimizing pricing and terms. We worry about that a lot and for the past year we’ve been encouraging all of our companies to take capital now while it’s available just to make sure they don’t get caught in the crossfire if the markets do turn.

On the individual company level, there are a handful of specific challenges. One common to a couple of them, WhoSay and Savored in particular, is that both of those companies have done a fantastic job in the early days building up very valuable networks. In the case of WhoSay, it’s really an unparalleled aggregated network of celebrity talent who are using the WhoSay platform as the starting point for all of their social networking interactions. That’s an incredibly unique and valuable thing. In Savored’s case, they’ve built a fantastic network both of restaurants and consumers. But the real asset is on the restaurant side, and the restaurants are big fans of the service that Savored provides them. The big challenge and opportunity for both of those companies is, how do they optimize their business model to maintain the strength of their network while also building the most valuable enterprise they can. In each case, it’s not one of those “Boy, we can’t think of any good ideas for how to monetize this network.” It’s more that we have a lot of different opportunities. For each company there are at least 3-4 “obvious” opportunities or solutions, but when you’re in the early stages of a company, you can’t run several at a time. You have to take one or two and execute relentlessly against them. So the choices those guys make as to how they winnow down the opportunities and make smart bets on the very best will be key to determining how successful they will be.

On the other hand, what do you think is the biggest opportunity one of your portfolio companies has right now?

The single biggest opportunity is the flipside of WhoSay’s challenge. That business has an incredible amount of potential and we really think it could completely reinvent the celebrity media content business. Certainly when you have authentic, personally produced content coming straight from these people and their lives, it’s a lot more appealing to the average consumer than a grainy paparazzi picture. I think there’s a multi-billion dollar potential media opportunity with their business. It’s hard to imagine anybody else replicating the network they’ve built.

What’s your thoughts on investing in me-too companies?

The easy answer is we don’t do it. But at the same time, that doesn’t mean that if company X is leading a market doing a particular thing that you should stay away from anything remotely similar. It’s not always the first guy in who wins; it’s frequently the fastest followers. However if there are two, three, four, or five companies, and sometimes now it’s fifteen or twenty-five, going after the same opportunity, and maybe with different geographical slices on it or slight tweaks to the model, I think that’s a bad idea.

You need to be careful though, because sometimes the baby gets thrown out with the bathwater. People focused on avoiding me-too’s tend to stay away from companies that may appear at a glance to be copycats, but are in fact something different.  The real key is to think about when there has been large macro level paradigm shifts in the way markets operate driven by market leaders. That creates the opportunity for other businesses to leverage those trends and disrupt those markets or other sections.

As an example, I got asked by a bunch of people when we invested in Savored, does the world need another daily deals business, a restaurant oriented deals business? But that’s not what Savored is, it’s a yield optimization platform for the restaurant industry. It’s far more like Hotels.com (a large and very profitable business) than it is like Groupon. But importantly, Savored’s success has been in no small way a result of the work that Groupon and Living Social have done in educating the marketplace about the value of small local businesses doing direct marketing to consumers for discounts and other special promotions. While Living Social and Groupon proved to restaurants that you could reach consumers and drive a lot of traffic, they also proved that their particular model didn’t work very well for fine dining. Savored came along and said hey, we’ve got a better answer. It’s something that solves your problem every day of the week, instead of every six months with a Groupon deal, and we can give you far more control and flexibility on how that platform works. Both the restaurant and consumer side of Savored’s business took advantage of some macro-level tailwinds that Groupon created in the marketplace. Savored has worked out by disrupting an industry as a derivative of their work, but it’s obviously not the same thing.

What typical characteristics do your portfolio companies display and what do you look for?

It’s going to sound simple. At the end of the day, it’s about great people and teams solving very real problems. For the most part in our work, it means doing that at the application level not at the infrastructure level. We’re also not trying to say we’re going able to look around the corner and spot the next Twitter or Tumblr twenty miles away. So while we love companies that build large networks of connected users or customers, we don’t tend to make big, completely speculative bets on businesses that aren’t attacking an existing, understandable market opportunity. For that reason, I’ll unfortunately probably never have a Twitter or an Instagram in my portfolio. But that’s OK. I want to talk to entrepreneurs who are looking at real pain in the market place and addressing that directly by showing a nuanced understanding of the market and customer dynamics. At the end of the day, it’s really about the people. That’s a lesson I’ve had to learn and relearn again and again in this business.

What are the most common mistakes entrepreneurs make when they pitch ideas to you?

I consistently find entrepreneurs diving into the weeds too quickly on exactly what their product is and how it works and, as a result, skipping the opportunity to talk about the most important thing. I think every pitch should start with the back story on the business, where the idea came from, why the team is excited about it, and why they were compelled to quit their prior gigs because they had a burning need to build this business. I want to hear what I call the genesis story. Great entrepreneurs always have good genesis stories, and I always learn a ton of valuable context from hearing them.

One of the things about today’s frothy market is, unfortunately, there are too many people kicking around ideas just for the sake of starting something. Those businesses don’t tend to be as powerful or important, because they didn’t evolve from people’s organic understanding of a market problem that needs a solution. They evolved from four guys sitting around throwing an idea against the wall and then finally finding something that seems good enough to give it a shot. That’s not a great back story. The great back story is I was working in this market and I saw customers consistently feeling pain and I knew we could make money if we went out and built something to address that pain. That’s the kind of story you hear behind great companies like Dropbox and AirBnB, or in our portfolio, behind Ticketfly or TxVia.

What do you do if an investment in a portfolio company starts going bad, what actions do you take?

Well, we do roll up our sleeves and jump in and try very hard to be helpful. One way is that we force management to take dispassionate and honest looks at the data in a business. When things feel like they’re going off the rails, it’s not uncommon, when you dig in and really understand the data, to find out you’ve been chasing the wrong path. If you look differently at the data your business is generating, you can often see there’s a better way.

What’s the hardest lesson you’ve learned in venture capital?

It relates to the last question. It’s the challenge of balancing a desire to really dig in and be helpful with the realization that ultimately, portfolio returns are driven almost entirely by the degree of success of your best companies, not the degrees of relative success or failure for your underperforming ones. So when you have struggling companies, every fiber of my instinct says I should help these guys as much as I can. But you have to understand that you’re playing a zero sum portfolio management game, and so an hour spent helping a struggling company is an hour spent not helping a flourishing one. Your ultimate returns are going to be driven more by, can you help your winners turn from 6x deals to 8x or 12x deals, not if you can help your struggling companies change their outcomes from fifty cents on the dollar to eighty. It’s a really hard reality and it’s a tough thing to internalize. To be clear, that doesn’t mean just abandoning tough situations – but it does mean being careful not to get sucked too far into them. It’s an essential part of decision-making on a day-to-day and hour-to-hour basis, and if you lose sight of that, you’re not doing a good job of managing your portfolio.

What’s the best advice you’ve received in the industry?

Again, related to the last point, very early in my career a real veteran of the business said, “It’s important to remember that you can never lose more than 1x your money.” We talk about deal outcomes in multiples and the point is you can make five, ten, or twenty times your money. I mean Accel’s probably going to make a thousand times their money on their Facebook investment, and Andreessen Horowitz just made like 250x on Instagram. But you can never lose more than 1x. If you don’t put another dollar into a bad situation, you won’t lose it. If you invest a million dollars in a company, the worst that can happen is you can lose a million. So how do you balance your energies? Helping a company that’s doing well, and where you invested a million, do things that will make your million worth fifteen million instead of ten is probably a better use of time. It’s “don’t put good money after bad,” but also don’t spend your time and energy in the wrong places. If you fail to help a struggling company, the situation won’t necessarily get a lot worse. If you fail to lean into your winners, you’ll almost certainly leave money on the table.

What do you think an entrepreneur should be looking for in an investor?

There are a couple of things, some of which are obvious ones that everyone points to and some are ones that people don’t. The obvious ones are what’s the direct experience of the investor in my industry or what companies do they work with that are like mine, and what are the networks or relationships that investor might bring to my business? Those are valuable, for sure, but one that is under emphasized is what’s my true fit with this investor? What’s the cultural style of the person? How genuinely helpful do I feel these people will be? Will their style and approach mesh well with mine and can I learn from it? I’m always amazed at the willingness of entrepreneurs to take money from investors without doing diligence, without calling other portfolio companies and finding out if the investors put their money where their mouth is. What were they like to work with? Did they deliver on relationships? Were they responsive and consistently trying to be helpful? Did they help you when times got tough? You’ve got to get that, you’ve got to develop a holistic picture of what working with these people is going to be like. Those relationships are going to be as important as any senior management hire you can make. You’re going to be in bed with these people for a long time. Don’t make a decision based on the firm brand and partner’s bio alone, make it based on fit.

We’re almost home, what’s the best or most exciting startup you know besides your own companies?

Probably my favorite venture backed company right now, as a consumer for sure and I suspect as an investor as well, is Uber. They’re a brilliantly executed mobile-driven black car service. They’ve created a network of black car operators and a simple consumer service where you go into an app, and it shows you on a map where all the cars in the network are. Go play around with it, it’s a freaking brilliantly designed service. It’s a market that’s desperately been in need of disruption and some improvements on the distribution end. I had looked pretty hard at a business in the black car industry that was trying to consolidate it about four years ago, but I didn’t think they had the model quite right, and they certainly didn’t have the distribution piece well executed. Uber has made it happen. It’s consolidated that industry incredibly effectively with a consumer service that I think is unmatched by anybody in the web or mobile app world. It’s so simple to use and elegantly designed, it’s such a beautiful experience. Literally every time I use it, I’m like, “was that really that easy?” It almost makes my heart skip a beat. I’d love to find businesses that make my heart skip a beat like that as a user.

Two more… so what’s your advice for people who want to become Venture Capitalists?

Work at a successful startup, make it as successful as you can, get to know the venture backers, and when you come out the other end of that success story, work those relationships and try to find a gig. It’s a hard business to get into and it’s getting harder because it’s shrinking, not growing. I think you need to find ways to get in front of VCs and get to know them professionally rather than hope you get lucky. It will take luck no matter how good you are to rise to the top of the list of the dozens of Harvard, Wharton, Stanford and other MBA grads who are trying to apply through the front door.

Ok, last question. How do you pronounce you last name?

Spelled phonetically, it’s SVER-LOO-GA.

Q&A with Mark Davis

I recently did a Q&A with former VC-turned-entrepreneur Mark Davis. Mark is the CEO & Co-Founder of Kohort, as well as the founder of both the Columbia Venture Community and New York Venture Community. You can keep up with Mark on Twitter at @mpd and at his blog, mpd.me. Enjoy.

Image via CrunchBase

In your blog’s “Getting the VC Job” series, you coined the phrase “venture mullet,” which is a jeans-and-blazer style dress code for job-related meetings. You said “just as its hair-do counterpart is really about business in front and party in back, the venture mullet is about business up top and casual down below.” I actually don’t have any questions about it; I just wanted to repeat your excellent analogy.

Thanks man.  Turns out that’s primarily the *NY* VC dress code.

How’s beta testing for Kohort coming along?

It’s going great. We’ve spent the past few months with tons of groups pounding away on the platform which has helped us learn.  We’re very fired up about the upcoming public beta launch.

At the TechCrunch Disrupt conference last May, you mentioned that Kohort, with American Express Open Forum, and Cooley were getting together to “unify the entire entrepreneurial ecosystem and export entrepreneurship globally by taking the model we developed at the Columbia Venture Community to every major university in the States and beyond.” Can you talk about what the Columbia Venture Community model is?

I believe that entrepreneurship is that path to a better world.  Startups create jobs, increase the standard of living and can help to solve many of our social problems.  They are the path to the promise land.  I founded the Columbia Venture Community (CVC) believing that it could help to further this cause.

The Columbia Venture Community has a simple mission to support every student, alumni or entrepreneur from any school at Columbia University to support one another in pursuit of entrepreneurship.  CVC achieves this not only by providing members with a trusted group of like-minded advisors and resources, but also by creating a community that bridges would-be entrepreneurs to the broader NY ecosystem.  Through a roster of educational and social events CVC is the gateway for many students and alumni to the entrepreneurial path.   The organization has grown virally to thousands of members and is actively led by twenty VCs and entrepreneurs affiliated with the university.

There’s a lot of demand for the CVC model – over 50 inspired students and alumni have raised their hands to bring this model to their university.  They do this because they want entrepreneurs at their schools to have an easier path to startupland than they had.  They’re trailblazers who want to pave their tracks with a smooth asphalt road.  Everyday more volunteers contact me, offering to lead their university forward.

We are also applying the same model to regions.  I founded the New York Venture Community, a 10,000 person group in NY, with the same mission.  Leaders are already stepping forward to start regional venture communities around the world.

If you’re reading this and you want to bring the movement to your university or region, contact me via my blog mpd.me.

How would you describe the current New York startup scene?

In 5 words:  Smart, Fast, Passionate, Warm, Supportive.

Besides Kohort, what’s the most interesting startup you’ve heard about lately?

There are a lot of really cool startups running around town.  I’m really excited about what the guys at Tripl, Savored, Zipmark and others are doing.

 What’s your general operating philosophy?

Build companies that solve real problems and will improve the world (one brick or one house at a time).  Build a team of the best-to-be-around and brightest.  Work harder and smarter…but never feel like I’m working.

 Who do you look up to most in this industry and why?

I’ve looked up to a lot of people in my life.  They’ve all shared a common characteristic – a transcendence of the social norms, process and order which enabled them to search for and create a better world.  These visionaries climbed to the top of the trees, enabling them to see more than the forest…they see the horizon.

What’s the toughest decision you’ve ever made?

One of the hardest professional decisions was to leave my cushy VC job to be a CEO.  It was the right choice, I’ve grown as a person as a result of it and I’ve never looked back. (Author’s note: I highly recommend reading Mark’s own post on that decision here)

 If you had to give one single piece of advice to a young entrepreneur, what would it be?

Ask everyone you speak to what you could be doing better.  You’ll be surprised by how good some of the advice will be.