You were a Managing Director at Madrona Venture Group for many years but recently left to found Pioneer Square Labs. You employ a different model for building startups, i.e,. it is neither a venture capital firm nor an accelerator. How is this new model different or better?
The traditional way of starting a company will remain the most common, which is you have an idea and bootstrap it or raise capital from angels or venture capital firms.
This studio model is a different. We generate ideas internally and from our partners and then prototype them rapidly. Our partners are the 14 venture capital firms and over 50 angels who have invested in us, as well as the many entrepreneurs in our networks.
Over the last 10 months, we’ve started 21 projects–and this means we’ve actually built software, and done customer validation for all them. We killed 18 of those projects and spawned off three companies from the ones that showed promise.
Most of the time the ideas don’t pan out even though we thought they were great when we started them. The economics may not work, we can’t seem to scale or customers are simply not willing to pay for the solution we built.
The other mode we use is a great entrepreneur with a track record will come to us and say, “Hey, I don’t exactly have an idea, but I have an area I want to explore with you.” We then provide our team of developers, designers and business folks that can help find, turbo-charge and get an idea to market.
Is it similar to an Entrepreneur-In-Residence program?
Yes, it is similar in many ways. We really emphasize the quality of the entrepreneur. One of the things we like to say is, if we are great at coming up with ideas but mediocre at finding talent for our spinouts, we likely will lose all our money. But if we are only so-so at coming up with ideas but exceptional at attracting talent, we will be very successful. Of course, our goal is to be great at both.
Can you give two examples of companies you’ve started using this studio model? One success and one failure. I am especially interested in ideas that seemed like they should obviously work but then failed.
Sure. We haven’t yet publicly launched the three companies I mentioned so I can’t talk about those but I’ll give you one example from Madrona Labs where I initially pioneered this model before spinning it off into Pioneer Square Labs.
We started a company called Spare5. It is a mobile-first, micro-work platform focused on training for machine learning. The idea is, we go after well-defined audiences and get them to generate information in their spare time that is then used to train machine-learning algorithms.
People have these really powerful computers in their pockets and knowledge on particular topics. Why not use the two to make some money in their spare time? For example, you can perform tasks when sitting in a bus or just whiling away time.
We structure the information gathering as fun games and surveys that they are paid to take. This generated a lot of initial interest among individuals so we then looked for companies willing to pay for the data. Within months, we’d signed up a few customers and also attracted an incredibly talented Getty Images executive, Matt Bencke, to lead the company as CEO. He has subsequently raised venture capital, and Spare5 is one of the hot companies in Seattle!
A project that failed at Pioneer Square Labs was a coaching marketplace we built for eSports. When you want to get better at tennis, it isn’t enough to watch Rafael Nadal hit a backhand on YouTube. You would likely hire a coach at your local tennis court. We tried to do this for eSports and focused our early efforts on Heartstone, a popular game.
The problem was it cost us $35 to acquire a customer whereas the typical coaching session cost $15 and our cut was only $3 or 20%, a common marketplace percentage. While there was repeat business, it took over 10 coaching sessions just to break even. The unit economics simply did not make sense.
You didn’t think you could make it up in volume? You know the old MBA joke: We’ll sell each unit at a loss but make it up in volume!
Haha, maybe we should have changed our bank like in the Saturday Night Live sketch.
On a serious note, we might have optimized more—maybe we should have hired you ‘cause that is what you do—but we just weren’t as excited by what we were seeing from a unit economics standpoint so we killed the project.
What would you say are three things that turn you off when an entrepreneur pitches to you?
I like entrepreneurs who are not negative and don’t talk poorly about past experiences or other venture firms. At the end of the day, it is not PSL or Madrona making a decision. It is Greg Gottesman choosing the person across the table.
I have to like you and you have to like me too! That is the way deals get done. You absolutely need to be able to say, “I want to work with this person for the next 10 years. I have been on one board for 17 years. So you really have to think of it like a long-term relationship.”
The other thing I don’t like is over-the-top exaggeration. Sometimes we’ll have an entrepreneur come in and say, “We’ve landed this customer, made this key hire or over-inflate something on a slide deck and think we won’t check.”
Nowadays integrity is even more important because you have all these big acquirers like Google, Apple or Microsoft constantly dangling tempting exit packages in front of entrepreneurs.
They might say upon an exit event, “Hey, would an extra $10 to $20 million be of interest to you? We know you have these venture capital firms but what if we give them 3x to 4x their money to keep them happy and then funnel the rest to you? In other words, let’s effectively change the cap table ex-post.”
This is a lot of money we are talking about and so it is really appealing. You want to believe that the person pitching to you will say, without any hesitation, “No, I signed a deal with this investor, and I intend to honor it.”
You talk about this liking factor a lot. I’ve heard some successful investors say that the key to their success is being clinically dispassionate about liking people. They instead judge the idea, opportunity and entrepreneur purely on merit, i.e., you can make money with entrepreneurs you don’t particularly like. What do you think of this view?
I am sure that may be true for some investors, but I prefer to work with people I genuinely respect and like. For example, I was a founder of this company called Rover. Aaron Easterly took it over as CEO, and he’s been the driving force behind its success. He has executed exceptionally well, and he has done it with integrity and by building a positive culture that allows him to recruit the most talented executives. I think if Aaron was the type of entrepreneur that was less authentic and less likeable, Rover would be in a completely different place. People want to follow authentic, self-aware leaders. It’s harder to recruit the best talent if you’re a jerk, especially in this market.
Who are two fellow VCs you admire and why? You mentioned Brad Feld. Is there anyone else that immediately comes to mind?
I like Brad because I share his philosophy about being entrepreneur-driven and friendly. It’s just a much more fun way to live life. The other person that comes to mind is Tom Alberg, a founder of Madrona.
Both he and Brad are subservient to the entrepreneur and truly happy for their success. I remember early in my career being in Tom’s office one day and talking about a sale of one of our portfolio companies. I heard Tom say, “Gosh, this young kid Matt Williams [the founder of LiveBid] is going to make many millions of dollars on this exit. Isn’t that the greatest thing ever?” Tom totally gets it. It’s first and foremost about the entrepreneurs and trying to make them successful.
Of course, I love the entire team at Madrona, but since you held me to two, there you have it.
In addition to “breathe”, do you have any other parting thoughts or advice for entrepreneurs? I noticed that was your one word of advice on your profile.
Have something else besides your company. Being an entrepreneur is a roller-coaster ride. It can be stressful and I think it’s important that you have something else that is meaningful to you and keeps your grounded. It could be family, a sport, hobby or faith.
If your company is all you have, it will affect your decision making during the inevitable down times, and you may do things that are unhealthy or lack integrity.