Last week at the Upfront Summit in Pasadena, there was no shortage of glitz, from the venue (the Rose Bowl) to the catering (Wolfgang Puck) to the guest list (Ice Cube, Paris Hilton and John Legend, to name just a few). Still, there were also plenty of sessions that provided the investors and founders in the audience practical advice, including, notably, a session led by Upfront co-founder Mark Suster, who interviewed his longtime peer Josh Kopelman of First Round Capital.
The topic was how to raise a debut venture fund — as well as keep the whole operation afloat over time. The bottom line, suggested Kopelman, is that it’s a lot harder than it looks. Indeed, according to other investors at the event with whom we chatted, the seed and early-stage funding environment has grown especially brutal. As more debut funds have sprung up on the scene, more established firms have begun throwing elbows.
Part of Kopelman’s chat with Suster made its way around the Silicon Valley last week, when Axios’s business editor, Dan Primack, tweeted a part of the conversation about First Round’s accelerated deal-making pace. We were also in the audience and think other aspects of the conversation worth flagging, too, including how to establish a brand, how to think about valuations when they’re soaring out of control and how to approach institutional limited partners (or LPs) when trying to raise a fund.
Josh Kopelman of First Round Capital: we can look at every company we’ve ever funded, and learned that the time from first email/contact to term sheet has shrunk from 90 days in 2004 to just 9 today.
— Dan Primack (@danprimack) January 29, 2020
Suster first began by talking about the crowded market, asking Kopelman how First Round has adapted to the resultant pace of dealmaking.
The biggest thing you mentioned is that something that we actually measure is time for decisioning. We’re pretty data driven, so we use Salesforce, [and] we can go back and look at every single company we funded since 2004: the date of that first email with a founder, the date we signed the term sheet. And it’s fascinating. You just see sort of what was a 90-day process shrink to an average of nine.
So that just creates real challenges in terms of your ability to make high-quality and high-confidence decisions. We now have partner meetings twice a week, rather than once a week, because we want to be able to make sure that we’re communicating and talking with our partners in order to be able to, to be able to move quickly enough.
Also, just the proliferation of funds has made brands far more important. You know, when we started, there were just a handful of [seed] funds [including those of] Ron Conway, Mike Maples, Jeff Clavier. There were, like, six funds. So imagine if you walked into a Foot Locker, and there were six sneakers on the wall. That was it. You could just try every one to see what fits, which feels the best. [Now imagine] you walk into a Foot Locker, and there are a thousand sneakers on the wall. You’re not going to try all of them. You’re going to have to use proxies. You’re going to have to say, ‘I want the Nike.’ ‘I want the Adidas.’ You’re going to [pick out something] based on brand and that brand is based on persistency, so there are benefits. There are benefits to having been associated with [particular] athletes, in the sneaker metaphor.
And so it’s helped change a little bit the way we [do things] and led us to create things, like the First Round Review; it’s why our [annual] holiday video was so important to us in the first 10 years.
Suster then asked how one establishes a brand in a market where the product is money.
I think brand has to represent the value and values that you as a firm aspire to. [For us], in the beginning, all of our partners started to blog. I was Redeye VC. I don’t think I’ve posted in 10 years, but I’ve been busy [laughs].
We also have this business online network [with] software engineers who try to connect all of the employees of all of our companies together, so that if you’re a mobile marketing manager at an up-and-coming company and you want to know how to get featured as the Apple App Store recommendation, maybe you could ask me, but it would be much better if you go on [the] network and ask the mobile marketing manager who’s working at Warby Parker or HotelTonight or Square or Uber — just ask them directly.
What we found was that so much great content was being created there — but it was only limited to our community — that we said, ‘Let’s let’s run an experiment. Let’s try to liberate the content that’s trapped in the minds of these practitioners’ . . . [meaning] the head of growth [at a company] or [another company’s] head of recruiting . . . and now we have two full-time people creating content, the majority of [which] isn’t even from companies in our community, but [just people in the startup world] trying to . . . . further the entrepreneurial ecosystem . . .
Going back to the speed of deals, Suster asked Kopelman, does he have valuation guidelines?
I’m remembering what [famed VC] Jim Breyer said once years ago. He said that valuation is part art and part science; 90% of the time, it’s science and you need to be tight on valuation, but the art is the 10% where you need to totally cave on valuation. [Laughs.]
But in general, I’d say we’ve been disciplined on price. We aren’t the highest price investor, but we are players in the market, and we recognize that it would be too much adverse selection if we tried to . . . go against the market.
It’s really humbling. The more [years I work as a VC] the more I remember banging the table for something or against something, and I look back with hindsight and just cringe. But two numbers matter: the price you get in at and the price you exit. And when we started, we were talking about $4 million pre-money valuations, and now you’re seeing some companies that raise [at far higher valuations]. And what does that mean? Well, if nothing else changes, that one change takes what would have been a 9x fund and makes it a 3x fund, or it makes what would have been a 3x fund a 1x fund. So valuation definitely matters.
Suster also asked how Kopelman thinks about assembling a remote workforce, given that First Round has partners in San Francisco, New York and Philadelphia.
Our largest office is in San Francisco. Philly is our smallest office. We have 30 people in San Francisco and six or seven in New York.
You’re seeing a real boom in distributed companies, as we’ve operated as a distributed company now for the last 13 years. Video conferencing by far [has had the biggest impact for us], though you have to keep doing things to build culturally connective tissues . . . so we do two partner meetings instead of one [both because of the pace of investing] but also [because it] gives us as a partnership more time to interact. Every month or so we try to do an in-person [partner meeting]. We do partner retreats twice a year instead of one time a year. And we’re pretty good about using Salesforce and other tools so that knowledge gets distributed pretty quickly, either in terms of how portfolio companies are operating, or the needs that our portfolio companies have. We have a platform and operational support team of over 30 people. So I think the distance thing is less important.
Invariably, Suster asked why First Round hasn’t raised a much larger fund, as have most of the firms that launched around the same time, back in 2004 or 2005.
I think the first 24 months of a company’s life are magical. It’s the hunt for product-market fit. You’re building your culture, you’re hiring, you’re figuring out pricing and distribution. So much of a company gets baked in the first 24 months. And I think we chose a business and a craft where we could be privileged enough to be participants at that stage of the company’s life. . .
I wouldn’t rule out other opportunity funds or growth funds, but every time we’ve looked at [the possibility] over the last 15 years, it wasn’t driven from an insight and a passion. We found we’d be doing it for the wrong reasons. So, if we do it, we’d have to convince ourselves that we’re doing it because we think that we have a marginal advantage there.
The two talked, too, about what goes into constructing an LP base.
Given that the fund size really hasn’t increased meaningfully with us — 10% or 20%, but not multiples [of what we started with], we’ve been fortunate that we’ve had a lot of the same LPs from when we started. But for us, the benefit of who we’re working for matters. Especially if you’re building a broader team, it really ties into your mission.
So around 80% of our limited partner base is nonprofits. So, whether it’s Children’s Hospital or Sloan Kettering, there’s a real benefit to knowing that you’re not just doing this to make rich people richer. If you can generate multiples [that benefit broader society], that’s an additional ROI.
For us [too], we wanted to have a diverse LP group; we didn’t want to [be seen as working for one entity], so our two biggest LPs have the exact same amount.
We also wanted people who were really committed to the asset class, where this is not an experiment
for them but they understand the nuances and the challenges of venture. We didn’t want our relationship to be driven by their lack of knowledge about market cycles.
Not last, Suster asked what advice Kopelman offers others who are newer to the industry about meeting LPs.
It’s always going to be harder than you think. Even if you had a great track record as an angel, it’s going to be harder. If you’re an individual GP, it’s going to be even harder, because the institutional investors are going to be thinking about longevity and duration.
Also, LPs reference you very heavily with existing GPs, so if you’ve been an angel investor [for a] while, that helps you because you have strong GP relationships.
And I would find that transparency is super important — and lack of promotion. It took me a long time to realize that unrealized returns will likely often never get realized, but LPs [already] know that, so when you walk in and you’re promoting your IRR and you’ve been [investing] for 18 months or 36 months, there’s so much unknown there that I think walking in with a level of humility is important.
You can talk about why you’re excited about companies. But talking about numbers [when they aren’t yet concrete isn’t advisable].