Ideas aren’t worthless

I wrote this post years ago on my personal blog, but after having invested in ~40 companies (and raised a multi million $ seed round) I’m way more convinced about it and wanted to share it again here on Medium.

Let’s end this bullshit now. Ideas are not worthless. Ideas are important and the very foundation of every successful company.

TL;DR at the end.

The “ideas are worthless” mindset

I feel the industry is failing in messaging a very important point, and that is the fact that ideas are not the only thing in the success of a company. Being in love with the valley’s state of mind, I too have been drawn by this to think that ideas are worthless and execution is king. I actually believed this and told this to every founder that came in pitching their business while I was working in VC as well as almost everyone who asked for advice.

Well, turns out I was wrong. I’m sorry. Your idea was not worthless (even thought it was probably pretty bad).

It took me a while, but slowly I realized how broken this mindset is.

What is an idea?

It might help to define what we’re talking about.

I like to think about an idea as the sum of:

finding a pain
in a fast growing market
hypothesizing a product or service solution
and understanding how to bring it to your customers

So, for me at least, an idea is not: “hey, let’s build an app to get a black car”, but more of:

getting a cab sucks
transportation is enormous and people hate driving their cars around, parking is scarce and expensive
the easiest thing to do is to work with black cabs
we’ll build it as an app and get it to the tech elites in SF to make it look exclusive

It’s a story.

Do VCs value teams or ideas?

Valley VCs like to make you think that they only decide on investments based on the team, but in reality (consciously and unconsciously) what they are really valuing is a mix of factors, best represented by your idea (as defined above). The questions a VC asks and answers in his mind are along the lines of:

does this make sense? Is there a real pain and opportunity? Is the solution smart? Will people use it?
is there a big and growing market for this? if not, can it create a new market?
is this the right team to execute on this idea?

You only get to the team part if the ideas makes sense and the market for it is huge. On top of that, you have to be the perfect fit for the idea you chose (right skills, unfair tech or knowledge advantage, etc.).

Only very few and very early investors can afford to invest based exclusively on the team (Y Combinator most of all), and are probably skewing the message that needs to pass to entrepreneurs.

When I raised my multi-million $ seed round, no one dug into the team’s expertise as deeply as they did into the pain, market, solution and customer acquisition strategies.

The canonical pushback on the argument that ideas are important is the following.

Ideas are cheap. What matters is execution.

Which I would rephrase as:

Bad ideas are cheap. Good ideas are extremely rare and executing them is incredibly hard.

Ideas are valuable. Good ideas are scarce.

And when an investor finds one, he’ll definitely get interested into it even if he’s never heard of the team. That doesn’t matter that he’ll be funding it or that it will work.

There’s one catch tho: evaluating ideas might be one of the hardest and most counterintuitive thing ever.

Paul Graham recently wrote:

“the best startup ideas seem at first like bad ideas. […] if a good idea were obviously good, someone else would already have done it. So the most successful founders tend to work on ideas that few beside them realize are good.”

Not many investors realize good ideas actually look pretty dumb in the beginning to people who still can’t connect all the dots together. That is as true as hard to admit for an investor, so big kudos to PG on that.

This is also the only reasonable counterargument to the “ideas are important” philosophy: “ideas are extremely hard to evaluate”. YC now actually lets you apply without an idea. Does this mean that ideas are worthless? No, it means that they are receiving a ton of bad ideas and want to make sure that good founders work on good ideas. So often smart investors will strip down the idea into its core parts of market, opportunity and solution and will evaluate on those before moving on to the team.

When is an idea good or bad?

At this point we should probably start to explore what makes an idea good and what makes it bad, cause this is where most of the confusion happens. But don’t hold your breath, I don’t really know. I like to think that you have a good idea when you have a good number of those elements:

A deep understanding of something specific. An obsession.
Knowing something is true that almost nobody agrees with you on (cit. Peter Thiel)
The realization of a problem, gap in the market, future market shift
A creative and innovative way of exploiting that knowledge
A new enabling technology that dramatically lowers the barrier to creating something (better if proprietary)
A marketing insight to get people to notice your product
Some unfair competitive advantage and barrier to entry in respect to other competitors

A good idea is derived from spark, creativity, business acumen, luck, technical knowledge, madness, experimentation and sometimes laziness.

Wow cool, so that means I should ask everybody to sign an NDA before telling them my idea!

Not even in the slightest. Even tho ideas matter:

execution is still what makes them successful
you should have had the idea because you are passionate about the market and have either an obsession or deep knowledge that other people don’t so:
other people will probably not think that your idea is good and thus:
nobody will even consider copying your idea when they have an already long list of theirs to execute
As a bonus, I’m a firm believer that you should be the right team for the right idea (probably another post about that too), meaning that anyone who copies your idea should fail. (They called this founder/product fit in the meantime)

But what about pivots? Every successful company pivoted from an original idea to something different!

You can’t pivot yourself from a stupid idea in a small market into a great one. Your original insight has to be a decent one first. you have to find the pain.

A pivot should come from a much better understanding of the market, the customers, the technology etc., and should be the ultimate good idea.

A pivot is not: oh photo sharing didn’t work so I’m going to do a subscription e-commerce for pets. And, as a bonus, a pivot is not: “oh podcasting didn’t work so let’s do status updates”, cause that should be phrased like “ok podcasting didn’t work, it was a bad idea because there was no market for it, let’s call investors and tell them they can take their money back or stick with us while we work on a new thing”. That’s not a pivot, but a new company entirely.

SHOCKER: most people invested in Twitter when it was already Twitter. And everyone invested in Facebook, Square, Evernote and Dropbox, when they were already working on the companies we know today.

Further awesome reading: The only thing that matters by Marc Andreessen (spoiler: it’s the market).

—

Happy to chat more about it on Twitter here

Why we need an alternative to venture capital

Having recently left San Francisco for the Italian alps, I have been reflecting a lot on the opportunities and problems for companies outside of startup hubs which, by the way, are the vast majority of the world’s companies.

In this post I’ll try to put down on virtual paper my current observations and the reasons I think there is a clear opportunity for alternatives to standard VC approaches at the moment and in the future.

The trends

1: VC isn’t for everyone.

Running a micro venture fund, I can more and more understand how VCs need huge outcomes to make any attempt at a decent return for their LPs.

The VC model makes it absolutely non-profitable to invest in any business which doesn’t have a very real chance of being a $100M+ business in a relatively short timeframe.

Oftentimes I’ve found myself saying:

wow, this is going to be an awesome business, but I seriously doubt it could scale past $5–10M in revenues.

If you think about it, that’s a crazy thing to say: an “easy” $5–10M business is amazing!

But the risk / reward balance is completely different from how we (and most VCs) set up our fund, where most businesses are expected to fail (because they risk big trying to become #1) and so the successful one needs to return the fund multiple times (eg return 50-100x).

This means that any business who structurally only has the possibility to become a $1M-$10M business, or is playing in markets who don’t enjoy massive margins and stellar growth, needs to find an alternative to finance itself.

And guess what, that’s 99% of all businesses in the world which are getting overlooked by VCs.

2: Growing trend of businesses aiming for healthy sustainability

Some savvy businesses now openly reject the VC-first, growth-at-all-costs mindset and intentionally go out to create a small, sustainable business that doesn’t drive them crazy.

This growing number of entrepreneurs is thinking very strategically about their funding options, and is not compromising on control of the company and dilution.

This is not only happening in not-sexy-anymore markets like retail, ecommerce, and services; but also more and more in traditional VC hotbeds like SaaS.

Building a 500+ person business or being the market leader in a category is not in the wildest dreams of most people. Most entrepreneurs start out wanting to bring something to the market and then use employees and growth as a tool to deliver a better product or service, while also making more money.

Most entrepreneurs are perfectly happy running a profitable business, which gives them a high quality of life and fulfills them.

3: Alternatives suck

So, we have VCs that rightly focus only on what will drive their very specific returns, but at the same time we would expect the market to take care of the remaining 99%.

Somehow that’s not the case. Financing a non-high growth business is a mess and business owners spend way too much time between bank loans, government programs, friends and family, reward crowdfunding, equity crowdfunding, etc

None of these options are easy to access, and most importantly none of these options are optimal for these businesses.

This means that these businesses also often go and try to raise money from traditional VCs and accelerators, wasting everyone’s time and creating a lot of discontent in the process: VCs are overloaded with mediocre “venture” deals, and entrepreneurs need to face multiple rejections (try hearing all over again “your business isn’t good/fast/big enough” multiple times per day) and end up spending a ton of time on activities which don’t contribute to the business.

View at Medium.com

As you can see from Frank Denbow’s post, it doesn’t look great for someone who wants to fund their business without venture capital. Especially if outside of the US.

There isn’t much for most small internet businesses that need an investment and which are somewhat risky (no bank loans), will only be able to return it in the medium term (no pure debt), and don’t have the possibility to become a $100M+ business (no venture capital).

4(a): Plummeting cost of starting an internet-enabled business

Nothing new here: cloud, open source, great content, etc.

What is rarely mentioned is the, quite obvious, impact this has: many, many more internet companies are being created every single month.

4(b): It’s getting harder and more expensive (plus physically and mentally taxing) to become a gorilla business

Uber has famously raised $12.5B in funding, and doesn’t look like it’s done, in order to become the dominant player in its market. Many other venture businesses are following suit and are having to raise bigger and bigger rounds in order to keep the growth trajectory needed.

Increased number of companies means increased competition, which in turn leads to higher customer acquisition costs for virtually anyone, requiring more and more cash in order to grow big.

It’s not easy wanting to become a big startup when you start with 3 competitors with $20M in funding each. Take for example all the food ordering startups, or even the much more unproven market of “we’ll park your car for you in SF”.

VCs are also all trying to put the most cash possible into the few deals who will return the most money, meaning funding for non-category winners could be scarce.

4(c): Bigger and bigger online markets

Again nothing new here, I could insert any other up-and-to-the-right graph in here to explain just how many potential buyers of products and services exist today online.

4(d): Increasing number of very successful niche businesses

The above points, mean that I believe we will continue to see more and more successful small internet businesses — which is an awesome thing.

These businesses will continue to enjoy the key traits of vc-funded internet businesses (high-margins, easy to distribute, scalable, easy to pivot and adapt to the market, etc.) but won’t have to compete to the extreme in order to become the dominant player in a specific market.

In fact, VCs’ biggest problem today isn’t finding which business will work and which won’t, but finding which business will scale and become massive.

Christoph Janz and Josh Hannah famously wrote that building a $1–2M SaaS business and a $10–20M ecommerce business is not that hard.

5: Not everyone can be located in a startup hub

Creating a high-growth startup outside of the traditional startup hubs adds another (big) layer of difficulty to achieving unicorn status.

Local VCs can surely fill the gap, but oftentimes it’s not particularly profitable to set up a VC fund in non-hot ecosystems which leads to scarcity of venture capital. Italy is a prime example of this.

The opportunity

Given all of the above, I think there is a clear opportunity for creating alternative financing programs that target this emerging crop of successful, profitable, quality businesses which I like to call SIB (small internet businesses).

I think the bulk of businesses that would be interesting candidates will fit in the three very broad categories of ecommerce, saas and services; and will exclude anything that is social, consumer and big tech; but I won’t be surprised to find unexpected business types in the mix.

I’m still figuring out what the perfect instrument would look like. It will most likely have to be a mix of equity, convertibles, pure debt, royalties, preferred dividends, and other exotic structures.

Who’s doing something about it

There are dozens of new venture funds launched each month, but surprisingly there aren’t many people tackling this new opportunity.

The one that drew the most attention recently is Bryce Roberts’s Indie.vc effort which started out as an experiment but has since raised a “big” dedicated fund to continue on the vision. They recently got a feature on the WSJ as well.

View at Medium.com

Indie.vc works in a very, very, very entrepreneurial friendly way: as soon as a company decides to pay a dividend, Indie.vc receives 80% of it until they get 2x their investment, after which point they will get 20% until a 5x return.

If a company decides to raise follow on funding or sell the company before they have returned the 5x, the investment will convert to a negotiated equity amount.

This model is very innovative and seems to have stirred up the interest of many entrepreneurs.

It remains to be seen how this translates to returns. 5x is not that much of a return, meaning that the margin of error in selecting the companies is very small and they can’t afford many to fail, otherwise they wouldn’t even be able to return the capital, let alone an interesting IRR (given that the return is also probably going to take a while).

That being said, Bryce has been thinking about this more than anyone else and already have a full batch of data to evaluated what would work best.

Others include Lighter Capital, which loans between $50,000 and $2M and gets repaid through a percentage of the company’s revenue. This approach is a mix. On one side, it can be considered less entrepreneurial-friendly and aligned to the company, as it takes away very valuable money from the company’s balance sheet, especially if still unprofitable.

On the other side, the business won’t give away any equity should it get acquired or raise more money, Lighter is incentivized to have the business grow faster, and the maximum repayment will be around 1.2–1.8 times the investment.

RevUp by Betaspring has the same model, but act as an accelerator program at a much earlier stage.

As I enter the next dimension of my life outside of a startup hub, I’m extremely interested in understanding how this growing number of businesses can be financed to enable more innovation, economic growth, job creation and ultimately value creation in places that can’t rely on billion dollars venture funds.

If you have any thoughts, I’d love to hear them. And if you’re going to be at Microconf Europe in Barcelona, I’d love to chat about it there!

p.s. I’m still very bullish on the venture capital business model for high-growth companies located in startup hubs and I’m still investing out of Mission and Market in such companies out of San Francisco, like our portfolio companies Eaze, Padlet, Transcriptic and more.

We’re specifically looking at any company that can leverage proprietary deep learning techniques to create previously unimaginable value and efficiency such as our portfolio companies Atomwise and Enlitic.

What it takes to start your own venture capital fund

It seems that becoming a VC is a dream of many, and rightly so: it’s really a fantastic job.

As a venture capitalist, you’re paid to learn as much as possible about new markets and to meet with the smartest people you can find. You get to follow along the entrepreneurial journeys of founders much smarter, determined and audacious than you are, without the massive amount of risk of having all your assets and a lot of your professional reputation tied to a single outcome. That seems like a dream job description to me.

Working as a VC associate right after school, I really got spoiled and so after 3+ years in an operational role at a startup, I decided I wanted to start investing again.

There were just a couple of problems:

I did not have any money whatsoever to invest
It was highly probable that no VC firm would have hired me as anything more than an associate
I had an idea I was deeply passionate about and wanted to bring to reality:

While talking with my friend, he started suggesting we start our own fund and run it part time as “angels”.

I obviously thought he was crazy.

But dozens of espressos later, he had convinced me.

We came up with the idea of allowing our friends who are living in Europe to get exposure to the asset class of silicon valley startups.

The first person we pitched, gave us a resounding no. Not because he didn’t want to invest, but because he wanted to join our crazy adventure, and so over breakfast Mission and Market was born.

I get asked by a lot of people how they can get into venture capital. The answer is that it’s not easy given that jobs in the industry are scarce and usually reserved for people with a very specific background.

So, after having invested in more than 30 companies including Eaze and Transcriptic, I thought it might be helpful to explain what we did and why, and give a rough framework for people who want to get into venture capital by themselves.

HOW TO START YOUR OWN FUND

These thoughts are meant for people who want to start a small fund. If you’re starting a 10M+ fund, most of the below won’t apply!

1. Commit mentally

Talk to people who’ve done it before. I reached out to Semil, Zac and Shruti to understand what they did and how, and it was super helpful.

Be sure that you’re ready to commit to this for a long time.

2. Do the math!

RETURNING A FUND IS HARD!

There is plenty of money floating around startups and (as this post demonstrates) it is fairly easy to become an investor.

This means that the gold mines are getting crowded and the chances of finding that big nugget are getting slimmer. Fortunately for us, startups are not a non-renewable asset like gold, so if you put in time, effort and get a bit of luck, it still is very possible to generate meaningful returns.

But going at it without modeling out all possible scenarios is not a good idea. The math will inform a number of key decision you need to make:

how many deals you want to make.
what check size you’ll be writing.
how much of the fund you will be reserving for follow on investments.
how many follow-ons you’ll be able to do and the amounts.

Doing the math will also show you how much enterprise value you’ll have to generate in order to return the fund, and how entry valuations will impact this.

In our case, we’re aiming to make 60 investments out of our first fund. That means investing $1.5M in first checks, and then keeping what’s left (~ $1M) for follow on investments.

The reason to make 60 investments is simple: building a highly diversified portfolio is key to having a higher chance of funding one “unicorn”, which means better returns and better brand, which leads to better dealflow, and circularly to better returns (even for potential future funds).

We’ve done 30 in our first year, and will be making 30 more in the following 1.5–2 years, and then will just use the remaining capital to continue investing in the winners.

3. Define your compensation

Given we’re doing this part-time, we decided to not take any management fee out of the fund.

By doing this on a $2.5M fund, you are deciding to use the $50k a year in fees to make more investments and have a higher chance to provide solid returns to your investors. Incentives are also much more aligned.

If we had taken out the fees, over 10 years we could have drown $500k. That’s insane. It’s one fifth of the full fund gone. So now, you need to return a multiple of a $2.5M fund, but with only $2M to invest.

Our compensation is fully based on carry, and only kicks in after we’ve returned the full amount invested first. After that, we start sharing 20% of the returns. If we double our investors’ money, then we receive 30% of the following profits.

Do not expect to get rich out of this.

Say we return 3x our fund, $7.5M. That translates to $2.5M * 20% + $2.5M * 30% = $1.25M. Divided by 3 people that’s $400k, and divided by 10 years, that’s 40k/year. We could all get $40k more a year just by switching jobs.

And that’s assuming you return 3X the capital!

4. Find a solid team.

You can go at it by yourself, like Semil did, but if you want to do this while still working at a company or even running yours, it’s pretty mandatory that you join in with one or two other people.

If you think you have what it takes to go at it alone, you’re better off angel investing or doing syndicates over AngelList. Raising and running a fund is a lot of work, and should only be done if you have the time and flexibility to do it.

It’s very important to choose people that you like A LOT.

Choosing partners for a fund is even more critical than choosing a co-founder, as you’re actually writing down on contracts that you’ll work together for 10 years minimum.

It’s also pretty important to choose very smart people with a solid network and flawless reputation. Investing experience is the least of the concerns.

Francesco and Simone are the two best people I could have started this with!

5. Define your thesis and value propositions.

A thesis is not only what you’ll invest in, but in my opinion should also include the reasons you’ll do what you’ll be doing.

As an investor, you have two customers: your LPs (which act as both customers and bosses) and the entrepreneurs.

Our value proposition to LPs is access to a diversified portfolio of SF/SV-based startups with a small sum of money, which would be impossible to achieve by direct investment. European investors don’t tend to have much access to funds or startups, other than what they can do on AngelList and so it’s been a fairly easy sell.

Because of that, we don’t need a very specific thesis about the type of investments that we look at (other than the fact that they should be local to the Bay Area).

If you’re going to target LPs who already have access to deals and funds, you might want to “verticalize” your thesis on a specific edge (some special dealflow source, some industry that you’re particularly connected in or knowledgeable about, some underlying trend that will make you deliver a higher return, etc.). Read my post on the rise of the thematic VC for more thoughts on this.

But it’s for you to figure this out.

6. Define the vehicles and incorporate.

Traditional funds are comprised of a Limited Partnership (the fund itself) and an LLC General Partner (which managed the fund).

We followed this traditional model but using a simpler LLC as the fund itself.

This setup is not extremely expensive and provides good flexibility, as well as a well tested and known structure to investors, accountants, etc.

Today, there are many options that make this much simpler, the most obvious of which are AngelList Syndicates and FundersClub Partnerships. (There’s a ton of content out there on this, so I won’t go into the details here.)

We still decided to create our own structure, even if more expensive, for a variety of reasons. If we ever raise a Fund II, we’ll revisit!

If you build your own structure, get a good lawyer who’ll defer your fees until closing!

7. Get some good people doing your backoffice

We initially had a startup do our taxes and reports, and it was the worst decision we ever made. We’ve now switched to a solid backoffice firm who specializes in VC and PE funds, and it’s absolutely worth the money.

8. Start pitching!

IT’S GOING TO TAKE MORE TIME THAN YOU THINK.

LIKE, A LOT MORE TIME.

Also, it’s going to be way harder than raising money for your startup, should you know what that’s like.

So start pitching. Find all the rich people you know, and ask them to trust in you.

Accept small checks.

9. Start investing!

It’s super important to start investing as soon as possible.

If you can afford to, you should start angel investing way before your fundraise. If not, and if your structure enables you to, try to write some first checks as soon as you have enough money for them.

Investing in companies is the best strategy to get more quality dealflow, and will also help you get into other deals. It provides the foundation of your reputation and will help entrepreneurs judge you a bit better.

Additionally, showing LPs your first picks are good will make the closing process much easier.

Hopefully this is helpful to folks who are considering starting their own fund. It is a big undertaking in terms of time, money and mental energy, but it is fun and incredibly rewarding.

Best of luck to those of you who decide to take the leap!

P.s. You should follow me on twitter here.