6 ms·

A Seed VC’s Decision Tree

72 points by ghosh 13y ago

drakaal 13y ago
Most Seed VC's are investing in a Team and an Idea. "Founder" as a singular rarely get investments. No man is an island, and you don't want your investment to get hit by a bus.
- enko 13y ago
  > you don't want your investment to get hit by a bus So take out life insurance on the founder. And if two founders are essential for a successful startup, then there is actually twice as much chance of it failing by one of them being hit by a bus.
  - drakaal 13y ago
    A typical pair is a business guy and an IP guy. You don't have twice the risk because it is assumed that they talk to each other, and you could replace either based on what the other could fill in. You can only insure for the amount of your investment, that offsets the risk but doesn't cover your gains. Also since the cost to do so is 1/10th of your investment over 3 years, you would typically not opt for the coverage. I don't know of an investor who does. There is also a belief that no one guy is "that smart" that anything 1 person can build has any competitive advantage.
- cynusx 13y ago
  The only genuine reason I see for not investing in single founders is that startups are a lot of work and it's unreasonable to expect that a single founder can focus on all the different bits that need to align for a business to take off. However, taking this as a given doesn't strike me as right as founders can definitely get to some sort of market traction on their own and hire people to fill in their deficiencies. It also strikes me as odd that while Dropbox is one of YC's biggest hits they still hang on to this 2-founders doctrine. I can't help but think that not investing in single founders is caused by the social signalling involved of single individuals. The reasoning would be "If you can't convince somebody else to join you, why would I invest my money in you?". Another genuine concern would be that this individual would have to have mastered a broad set of skills to run a successful business independently and such people are unicorns.
rgrieselhuber 13y ago
It's interesting to see this mapped out so clearly, but each step along the way is still entirely subjective. Most investors, IMO, are not great evaluators of founders (e.g., are easily fooled by elite credentials), markets (they tend to chase shiny things), or founder / market fit (this takes a lot of operational expertise to realistically evaluate).
- zmitri 13y ago
  Agree with you. I'm actually unclear what exactly this is a decision tree for because its steps are so subjective. Definitely isn't the decision tree from first contact to investment - that would be much deeper. It would also have to factor in how much heat there is behind the deal already - which for most seed firms is probably the most important signal! Seems accurate as a decision tree to take a meeting with someone though. As an exercise, try running some of their portfolio companies through that decision tree and see what kind of results you get.
  - Dartanion7 13y ago
    I'm also curious what inputs they use to evaluate the founder. Surely there's some objectivity to that element of the decision tree beyond "great guy, articulate, firm handshake" --- I'm thinking probably quality of undergraduate / graduate schools, past exits, years in industry, etc.
    - ig1 13y ago
      From my experience it's much more individual than that "what makes this person exceptional ?" - which tends to be a combination of track record (what have they achieved previously) and individual traits (are they super-smart, charismatic, etc).
    - seiji 13y ago
      "great guy, articulate, firm handshake" You can tell a lot by the first five seconds with a person. That's why so many founders today are the cool kid/hot guy variety and not the Bill Gates/slovenly nerd variety. VCs won't take seriously a guy who shuffles-when-walks with zero eye contact and stares-at-floor-constantly habits unless they come with someone vouching for them. VCs will take seriously someone who can project all the right social signals, act strong, and not let anyone see into their weakness.
gizzlon 13y ago
What is an awesome founder? Or maybe, what does an awesome founder look like? This is a serious question. It actually looks easier to gauge the marked than the people..
- xivzgrev 13y ago
  Completely agree - first question that came to my mind too. As others alluded to, much of investing is intuition. No one can predict the future, otherwise they'd be billionaires hand over fist. So they use their intuition and available data to get as confident as they can about an investment. I feel for them - what data do you have on a founder, especially a first timer? Maybe pedigree, relevant experience, or a portfolio of past projects for a hacker, but outside of that, seems to be a fuzzy haze of gut feeling...confident, had "good" answers to questions, etc.
- ganeumann 13y ago
  There's been some interesting research on what characteristics successful founders have (actually, the research was on what successful VCs look for in founders, so maybe the extrapolation is unwarranted, but... research!) Here's Geoff Smart's Phd thesis (Management Assessment Methods in Venture Capital: Toward a Theory of Human Capital Valuation): http://www.ghsmart.com/media/press/methods_in_venture_capital.pdf http://www.ghsmart.com/media/press/methods_in_venture_capita... And a simpler overview [pdf]: http://www.ghsmart.com/media/press/human_capital.pdf http://www.ghsmart.com/media/press/human_capital.pdf And, he wrote a book called "Who", but he generalized the research to hiring anybody. Still a good book. TL;DR: VCs who hire people that have successful experience doing what they plan to do end up getting the best ROI. VCs who hire people based on their gut ("I like the cut of your jib!" keeps popping into my head as I write this) do worst. The simpler overview is interesting reading.
- peloton 13y ago
  It's a good question but I think Rob was trying to leave that out of scope and focus on a process that probably fits what other seed/early stage funds have either proactively created or reactively evolved. What's implied is that everything is moot unless they meet founders that they deem investable. Only then, does he spend more time researching the other stuff.
lpolovets 13y ago
Seems in line with a few published results that I've run into recently: - For one VC, market size was the main predictor of whether a company would get a term sheet. (http://iterativepath.wordpress.com/2013/02/11/how-vcs-decide-to-invest-in-your-startup/ http://iterativepath.wordpress.com/2013/02/11/how-vcs-decide...) - A survey showed that angels and VCs care about the management team more than anything, although market characteristics and the product rank highly, too. (http://www.go4funding.com/Articles/Angel-Investors/Angel-Investor-Decision-Making.aspx http://www.go4funding.com/Articles/Angel-Investors/Angel-Inv...)
- xivzgrev 13y ago
  Reminds me of Marc's post from 2007, asserting market is biggest factor. http://www.stanford.edu/class/ee204/ProductMarketFit.html http://www.stanford.edu/class/ee204/ProductMarketFit.html
ekianjo 13y ago
What's the point of making a "rational decision tree" when your first decision point is based on awesomeness level of the founder. That's a useless tree if I ever saw one.
- seiji 13y ago
  How else can you take credit for picking the winner? Otherwise you're just following something any dumb programmer could put together. You're not a dumb programmer. You're an awesome VC who controls the lives of dumb programmers. The rules of logic, society, and sanity don't apply here.
  - syntern 13y ago
    Not surprisingly, the same argument can be applied to: - investment decisions, - hiring/contract decisions, - travel agencies, - and probably countless other services too. We only need some service provider that automates all these functions...
LambdaAlmighty 13y ago
TLDR: Primarily looks for a good market. Without a market, fund only if founder top 0.01% (whatever that is). An insightful, actionable blog post. A true gem in the HN treasury.
graycat 13y ago
"Always look for the hidden agenda." Okay: (1) Get publicity for the VC firm and, thus, more deal flow. We can conclude that they are not getting much deal flow. (2) Have criteria that look good to the LPs, that is, easy to understand and like nearly all other VCs. Then forget about the 20% and live on the 2%.

72 points by ghosh 13y ago

Most Seed VC's are investing in a Team and an Idea. "Founder" as a singular rarely get investments. No man is an island, and you don't want your investment to get hit by a bus.

enko 13y ago
> you don't want your investment to get hit by a bus So take out life insurance on the founder. And if two founders are essential for a successful startup, then there is actually twice as much chance of it failing by one of them being hit by a bus.
- drakaal 13y ago
  A typical pair is a business guy and an IP guy. You don't have twice the risk because it is assumed that they talk to each other, and you could replace either based on what the other could fill in. You can only insure for the amount of your investment, that offsets the risk but doesn't cover your gains. Also since the cost to do so is 1/10th of your investment over 3 years, you would typically not opt for the coverage. I don't know of an investor who does. There is also a belief that no one guy is "that smart" that anything 1 person can build has any competitive advantage.
cynusx 13y ago
The only genuine reason I see for not investing in single founders is that startups are a lot of work and it's unreasonable to expect that a single founder can focus on all the different bits that need to align for a business to take off. However, taking this as a given doesn't strike me as right as founders can definitely get to some sort of market traction on their own and hire people to fill in their deficiencies. It also strikes me as odd that while Dropbox is one of YC's biggest hits they still hang on to this 2-founders doctrine. I can't help but think that not investing in single founders is caused by the social signalling involved of single individuals. The reasoning would be "If you can't convince somebody else to join you, why would I invest my money in you?". Another genuine concern would be that this individual would have to have mastered a broad set of skills to run a successful business independently and such people are unicorns.

rgrieselhuber 13y ago

It's interesting to see this mapped out so clearly, but each step along the way is still entirely subjective. Most investors, IMO, are not great evaluators of founders (e.g., are easily fooled by elite credentials), markets (they tend to chase shiny things), or founder / market fit (this takes a lot of operational expertise to realistically evaluate).

zmitri 13y ago
Agree with you. I'm actually unclear what exactly this is a decision tree for because its steps are so subjective. Definitely isn't the decision tree from first contact to investment - that would be much deeper. It would also have to factor in how much heat there is behind the deal already - which for most seed firms is probably the most important signal! Seems accurate as a decision tree to take a meeting with someone though. As an exercise, try running some of their portfolio companies through that decision tree and see what kind of results you get.
- Dartanion7 13y ago
  I'm also curious what inputs they use to evaluate the founder. Surely there's some objectivity to that element of the decision tree beyond "great guy, articulate, firm handshake" --- I'm thinking probably quality of undergraduate / graduate schools, past exits, years in industry, etc.
  - ig1 13y ago
    From my experience it's much more individual than that "what makes this person exceptional ?" - which tends to be a combination of track record (what have they achieved previously) and individual traits (are they super-smart, charismatic, etc).
  - seiji 13y ago
    "great guy, articulate, firm handshake" You can tell a lot by the first five seconds with a person. That's why so many founders today are the cool kid/hot guy variety and not the Bill Gates/slovenly nerd variety. VCs won't take seriously a guy who shuffles-when-walks with zero eye contact and stares-at-floor-constantly habits unless they come with someone vouching for them. VCs will take seriously someone who can project all the right social signals, act strong, and not let anyone see into their weakness.

gizzlon 13y ago

What is an awesome founder? Or maybe, what does an awesome founder look like? This is a serious question. It actually looks easier to gauge the marked than the people..

xivzgrev 13y ago
Completely agree - first question that came to my mind too. As others alluded to, much of investing is intuition. No one can predict the future, otherwise they'd be billionaires hand over fist. So they use their intuition and available data to get as confident as they can about an investment. I feel for them - what data do you have on a founder, especially a first timer? Maybe pedigree, relevant experience, or a portfolio of past projects for a hacker, but outside of that, seems to be a fuzzy haze of gut feeling...confident, had "good" answers to questions, etc.
ganeumann 13y ago
There's been some interesting research on what characteristics successful founders have (actually, the research was on what successful VCs look for in founders, so maybe the extrapolation is unwarranted, but... research!) Here's Geoff Smart's Phd thesis (Management Assessment Methods in Venture Capital: Toward a Theory of Human Capital Valuation): http://www.ghsmart.com/media/press/methods_in_venture_capital.pdf http://www.ghsmart.com/media/press/methods_in_venture_capita... And a simpler overview [pdf]: http://www.ghsmart.com/media/press/human_capital.pdf http://www.ghsmart.com/media/press/human_capital.pdf And, he wrote a book called "Who", but he generalized the research to hiring anybody. Still a good book. TL;DR: VCs who hire people that have successful experience doing what they plan to do end up getting the best ROI. VCs who hire people based on their gut ("I like the cut of your jib!" keeps popping into my head as I write this) do worst. The simpler overview is interesting reading.
peloton 13y ago
It's a good question but I think Rob was trying to leave that out of scope and focus on a process that probably fits what other seed/early stage funds have either proactively created or reactively evolved. What's implied is that everything is moot unless they meet founders that they deem investable. Only then, does he spend more time researching the other stuff.

lpolovets 13y ago

Seems in line with a few published results that I've run into recently: - For one VC, market size was the main predictor of whether a company would get a term sheet. (http://iterativepath.wordpress.com/2013/02/11/how-vcs-decide-to-invest-in-your-startup/ http://iterativepath.wordpress.com/2013/02/11/how-vcs-decide...) - A survey showed that angels and VCs care about the management team more than anything, although market characteristics and the product rank highly, too. (http://www.go4funding.com/Articles/Angel-Investors/Angel-Investor-Decision-Making.aspx http://www.go4funding.com/Articles/Angel-Investors/Angel-Inv...)

xivzgrev 13y ago
Reminds me of Marc's post from 2007, asserting market is biggest factor. http://www.stanford.edu/class/ee204/ProductMarketFit.html http://www.stanford.edu/class/ee204/ProductMarketFit.html

ekianjo 13y ago

What's the point of making a "rational decision tree" when your first decision point is based on awesomeness level of the founder. That's a useless tree if I ever saw one.

seiji 13y ago
How else can you take credit for picking the winner? Otherwise you're just following something any dumb programmer could put together. You're not a dumb programmer. You're an awesome VC who controls the lives of dumb programmers. The rules of logic, society, and sanity don't apply here.
- syntern 13y ago
  Not surprisingly, the same argument can be applied to: - investment decisions, - hiring/contract decisions, - travel agencies, - and probably countless other services too. We only need some service provider that automates all these functions...

LambdaAlmighty 13y ago

TLDR: Primarily looks for a good market. Without a market, fund only if founder top 0.01% (whatever that is). An insightful, actionable blog post. A true gem in the HN treasury.

graycat 13y ago

"Always look for the hidden agenda." Okay: (1) Get publicity for the VC firm and, thus, more deal flow. We can conclude that they are not getting much deal flow. (2) Have criteria that look good to the LPs, that is, easy to understand and like nearly all other VCs. Then forget about the 20% and live on the 2%.