One could probably argue that Floodgate, the Bay Area-based seed-stage venture firm, punches above its weight. The roughly 15-year-old firm has just around $500 million in assets under management — including a $150 million fund that it quietly closed in January — and it makes just a handful of new investments each year. Yet with investments in Okta, Lyft and Starkware, which was valued at $8 billion in May, among others, its concentrated approach appears to be paying off.
Writing so few checks, particularly in a booming market, might prove frustrating to some investors. But over the years, it has forced Floodgate’s small team to sort through many thousands of pitches and identify those it thinks have the most potential. Now, co-founding partner Ann Miura-Ko and Tyler Whittle, a senior associate with the firm, have developed a new program to help student teams similarly develop an understanding of what big ideas look like — and why most concepts are not big ideas.
To get more details about the program — and also to hear Miura-Ko’s current perspective on the seed-stage startup scene — we talked with her earlier this week. Excerpts from that chat, edited for length, follow. You can hear our fuller conversation here.
TC: This summer, you invited a lot of students to work on startup ideas with you here in the Bay Area. Were you incubating companies together? How did the whole thing work?
AM: We went to a builders community we’d built the year before, and to [Stanford’s] engineering school [where I teach], and to the CS department at a number of universities and said, ‘Hey, if you’re interested in being a future founder, and you’re a great builder, then we are interested in talking to you.’ The main message there was: ‘We don’t need you to actually have an idea that you’re working on. We just want you to be an amazing builder with an incredible amount of curiosity.’ Partially, [that’s because] you need to be able to build fast and actually throw away product [sometimes] but you also have to be curious about the history of the industry that you’re working in. . .
The aim is to help them identify big ideas. What is your definition of a big idea and how do you know when you see it?
I’ve come to realize that there are two types of businesses that can actually become really big. One is: you have an idea, and most people actually already understand this idea, but you’re just operationally better, and so you out-execute everyone else. What I realized is that as a seed investor, we don’t really have an advantage investing into those companies because we don’t see enough of the operations to know who is best at operating that kind of startup. So when founders hear, ‘[You] need a little bit more traction before we make a decision,’ that’s most likely because you are running a business that is more operationally focused, versus the second type, which I believe is insights focused.
An insights-led business is really about identifying what we call an inflection point, which has a few components to it. First, there is some sort of change event that has happened. It could be technical — CRISPR got invented — or a regulatory change event, like telemedicine across state lines is allowed, or it could be societal. The most common one that people point to now is just work from home.
The change event makes a new feature possible, or it makes it possible for a product to be built cheaper or faster, or you could also have a completely different business model that’s made possible. [For example] you license it out versus having to pay for it on a monthly basis, or vice versa. Or the business ecosystem fundamentally changes.
When that happens, if you can tie it [that inflection point and change event to], ‘This is therefore going to create a fundamental pull and adoption of my product in the next two to three years,’ now you have an insight that seed investors should be [funding]. [And] that’s the type of thing that we’re really looking for our students to really figure out.
Are you funding these students?
Yes. We are writing $50,000 checks into all of the companies, and then a bunch of them will just say at the end, ‘We’re not going to do this anymore’ and in that case close up shop. [But] we had two companies that are [going concerns] with investment from from us, and then one that might actually take on additional investment and one that [already] took an outside investment. And so we have four companies that are continuing to operate out of 10.
How much of a stake does that $50,000 buy you?
We’re still revising that for next year, so I don’t want to put a pin in what we’re going to do. But it is a SAFE note. And then for the follow-on financing, it ranges in terms of what the person needs and also [it’s tied to] when we invest into that company, so it ranges in valuation, as well. [Edit note: see update below.]
Four out of 10 is a pretty good hit rate. Were these students primarily from Stanford?
What’s really wonderful about it is that we did have Stanford students, but we had students from University of Texas, with other students from Yale and Penn and WashU, so it it actually spanned multiple different universities . . . and we’re really excited to try to expand to as many universities as possible. One interesting piece that we learned is that Stanford students are just very well-educated when it comes to startups. The beauty of having Stanford students within this network was that our Stanford students pulled the other students into the networks that the Stanford students are so fortunate to have.
I remember talking to a 19-year-old Stanford student, probably 10 years ago now, who said he felt pressured to become a founder because of the culture at the school. Does that concern you?
Yes. That’s why I really mindfully designed it so you have a way out. I think it’s so important to recognize that not everyone is supposed to be a founder. And in fact, in the relationships that I have with my students, I will tell certain students who I know really well, ‘You have these incredible skill sets that are so unique and not found in many people that you should go to a large company; you will have so much impact there.’ I will actually directly counsel students not to become founders [because] it’s such a specific desire or [requires] such a specific skill set in a specific moment that from my own personal perspective, it shouldn’t be for everyone.
I agree with you. I think there is to some extent a major push for people who are technical [and] for people who have good ideas to head in that direction. But my hope is that really by giving them this kind of exposure, they can figure out if there is a founder within.
Out of curiosity, does Floodgate use scouts?
We do not have a Scout program. I guess our network of friends and family and founders is technically our scouts. But we don’t have a financial program the way many people do. I have this sort of network of ‘unpartners’ who I meet up with on a regular basis — these are angel investors and investors at small funds — and what we do is we will literally share three or four interesting companies that we’ve looked at in the last two weeks. And then we’re sharing with one another how we would diligence it. And if the other people are interested in looking at the company, we invite them in.
Somewhat relatedly, Y Combinator just wrapped up its latest Demo Day. As a seed investor, do you follow YC closely? What do you think of the organization as it exists today?
I think they provide a tremendous service to founders, and I think people who want to get exposure get [it]. I have a lot of respect for the product that they offer, and the community that they offer, and the way in which fundraising is enabled as a result of that.
For me, it’s just a harder platform to engage with. If I’m only making two to five investments a year, being asked to put in a check with a rolling SAFE note that, if I sign tonight, you know, is one valuation and if I sign tomorrow, it’s at another, and [the founders] don’t even really know me, but they’re willing to sign on with me — like, none of that feels quite right. So the ones who I’ve been engaging with are actually founders who I knew even before they got into YC.
But I do see why founders love it and I think that there’s tremendous work that they put into the product and I would not count out YC. I know every year, some people say the classes are too big and everything is too diluted and expensive. But you know that in every group, there’s going to be one or two runaway hits.
Update: At Reactor’s site, where new applicants are invited to submit information about themselves, it now states that “each team will receive $100k for 5%.”