We are a B2B IT focused VC firm based in Silicon Valley, CA, one of the key innovation hubs in the world where many of the world’s valuable companies are currently taking shape. In the process of sourcing the highest potential innovative companies, we met with number of people frequently across greater Silicon Valley landscape, who play various roles from startups sourcing and to investment decision and subsequent exit. It is hard for technology focused individuals, the ‘founders’ to get a sense of who is doing what daily in the VC ecosystem and which actor can help secure that capital they are in search of, so that founders can go back quickly to continue working on their products/services ideas. We want to shed lights on some of the activities and psychologies that go behind the ‘deal makings’ - most used verb in VC language, unknown to first time entrepreneurs. Below are some of the uncomfortable facts on the deal making aspects of VC ecosystem for people who are not devoting majority of their time ‘networking’ in Silicon Valley.
Investment Sourcing
Sourcing is the foundational activity of VCs. Most VCs have so much inbound deals they can’t possibly need a new tool that will help them source hidden investment opportunities. Yet, given the broad distribution of outcomes in VC, with many funds underperforming market benchmarks, VCs are now trying hard to improve their top-of-funnel startup universe with new ways to capture under the radar deals. To expand their reach to hunt for startups, some VCs have started to view the deal pipeline like a mechanical sales process, measuring conversion from one step to the next and iterating constantly to make the flow better. The fluid criteria for startups to move from one stage to another in the funnel is constantly evolving VC and hence the startups are rarely evaluated on the same set of criteria even if they belong to the same vintage.
VC Associates, with little work experience beyond college internships are usually the first in line to scout for deals. But due to lack of successful professional calendar and email management skills, they are not very effective at sourcing deals. They have no clue how many founders they should meet every day to increase the chance of finding that once in lifetime deal. We line up 25-30 startups calls every week, but VC associates will lament to you that things have been too “crazy” on sourcing side, because they’ve got 15 calls lined up a week. 15 is not a lot. A normal week for a salesperson entails 30–40 calls of 30 minutes each, and this is table stakes.
Then there is the traditional Monday partner meeting that is now as outdated as the New York Times Page One review meeting, few VCs have taken steps to change that notion. Some VCs have moved away from evaluating pitch decks to just telling the founders out of laziness to compose an investment memo for them in Notion that they can forward to other partners before the Monday partner meeting.
Art/Science of Deal Picking
This is a long running debate in VC ecosystem w.r.t the approach of successful investing. Due to VC firm economics and succession, there is generally an “old guard” defending the art of selecting an investment. Once an investor gets an impressive deal under their belt, they analyze the exact conditions of the deal and try to draw a correlation to non-essential things for that deal. VCs themselves try to do a set of things they were doing when they sourced their other once-lifetime deal to find more such deals. The senior investors at a firm make exceptions for themselves, often as a rationalization for why someone doesn’t need to be contributing to deal sourcing in a methodical way, entering opportunity data into the CRM, taking more meetings, and generally participating in the vetting process in the same way as others. This creates quite some turbulence among aspiring partners at VC firms. Depending upon the amount of pushback junior VCs get from the big dogs, they may leave their firm to start their own fund. They justify their new approach to LPs and hope to secure their first fund. Big does themselves also have personal interest to keep emphasizing that the VC act is more of an individual trait that cannot be boiled down to a few mechanical steps and hence want to preserve their value to the firm. Ever Insistence on “pattern matching” to justify irrational behavior in VC firms is resilient when favorite anecdotes of unicorn-sized wins are trotted out to justify the latest trend. A command of truly objective data-driven pattern matching is still unpopular with the old guards.
Once a while, a crop of associates and analysts have tried to bring the science to venture capital investing. But justification for such cult-like behavior which may or may not ever work again usually lasts less than a year at the firm and gets replaced with some new superstition, new approach. Some firms go so far as to turn these superstitions into their investment theses for LPs, and it seems to be a rising trend to rewrite a thesis on a quarterly basis, rather than sticking with some much deeper investment theme. Although secular technology trends are quite long, VCs investment thesis inside the broader secular technology trend changes every quarter. There are some next generation VCs that have built their own data lakes and running AI models to capture the signals of a high caliber deal. These VC firms are calling themselves the Quant VC funds, like Quant Hedge funds on Wall St. The superior investment returns of these approaches will be clear only in the coming years.
Warren Buffett captured this mentality perfectly when he wrote in his 2000 Chairman’s Letter:
The line separating investment and speculation, which is never bright and clear, becomes blurred still further when most market participants have recently enjoyed triumphs. Nothing sedates rationality like large doses of effortless money.
After a heady experience of that kind, normally sensible people drift into behavior akin to that of Cinderella at the ball. They know that overstaying the festivities — that is, continuing to speculate in companies that have gigantic valuations relative to the cash they are likely to generate in the future — will eventually bring on pumpkins and mice. But they nevertheless hate to miss a single minute of what is one helluva party. Therefore, the giddy participants all plan to leave just seconds before midnight. There’s a problem, though: They are dancing in a room in which the clocks have no hands.
What is the risk then to a VC you ask? The biggest risk to VCs is missing the whale. It is the secret of Silicon Valley hiding in plain sight, the thing no one wants to talk about. When every other VC sees a whale, you should see the whale as well. Missing a whale can be catastrophic to a fund vintage. Some of the VCs keep an anti-portfolio of whales they missed, but they rarely analyze why they missed it.
Brand and Halo
Every VC firm has a brand. First time founders try to understand VC at the firm level, but it is far more helpful to realize that firms are a collection of individuals with wildly different approaches to investing and success/results. In Silicon Valley, big-name VC firms usually create halo effects for partners with otherwise unimpressive personal track records. And there are VC firms with mediocre to poor results, or good results but a less flashy brand, that boast several investors with stellar accomplishments who relatively go unknown. Once VCs establish brands, they venture out to start their own fund, if they have good set of LPs in their rolodex.
At the firms themselves, there is rarely a meritocratic template or evaluation system on how one goes from associate/analyst/principal to partner level at a VC Firm. One might not still get promoted after sourcing 10 deals, sitting on a couple boards, having one portfolio company go public. Figuring out who sourced a great deal in the deeply interconnected world of Silicon Valley is tough, and often is quite political. Being seen as someone who can regularly bring in new opportunities in hot companies before any other firm sees them is the most important currency for promotion and long-term job security. Some VCs are adopting a CRM system like Salesforce, RelateIQ or Pipedrive but few use just CRM as the system of record for whether a “deal scout” gets compensation/recognition. The people who are founding and/or senior partners in a VC firm aren’t necessarily interested in creating that framework as they are not great managers of people. There is no real economic interest to do such things at the firm - every man for himself in the VC world. There are very few true friends in the VC world one can count on due to the fierce competitive nature of the landscape. There is a strong sentiment to keep the craft of successful investing secret for obvious reasons.
The New World
With various tools available today, many VC firms are building systems to look at everything and everyone in an ecosystem and create better IT infrastructure to bring more data driven investing mindset, eliminate some of the biases from the system. Given many associates and analysts do not stay on to become partners and see the economic impact of an investment that takes 7–10 years to ripen in the best-case scenario, VC firms are creating incentives that are less about “paying dues” to work in the VC industry and more about rewarding the hustle every day. Some VC firms are creating short and medium-term cash bonus incentives for junior members to motivate sales-like behavior for things like meeting volume, qualified deals brought in beyond the meeting one, and deals sourced KPIs. There will be moments when current successful VCs will join the “old guard” and hence they are working on passing the accumulated knowledge and successful investment methods to deserving successors.
Being in Silicon Valley, we at Service Ventures try to get to know other investors and build lasting relationships that go beyond the immediate deals and financial incentives. We crave the level of camaraderie with our VC peers that we enjoy with founders we backed, even as we compete for same LPs capital and same high potential deals. In the current COVID-19 world, it’s amazing to us how often we find two investors in various innovation hubs that become fast friends and fantastic working together, and yet never met in person.
/Service Ventures Team
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