STEVE ANDERSON IS THE founder of Baseline Ventures, a pioneering micro venture capital firm (a “micro VC”). Before starting Baseline, Anderson worked at Starbucks, eBay, Microsoft, Kleiner Perkins, and Digital Equipment Corporation. His venture capital investments have included Heroku, Instagram, Machine Zone, Social Finance, and Stitch Fix. Baseline Ventures has only one decision-maker, which makes the firm very nimble and quick to make a decision. The firm focuses on early-stage seed investing, which means Anderson has a particularly interesting viewpoint on the startup process. The differentiation has worked out very well for Anderson and Baseline.
1. “In 2006 I was starting to ruminate on the idea of founding a company. When I began to think about raising seed capital, there were few alternatives to consider.”
The average exit over the last ten years … has been $100 million. If I own 10 percent of a $100 million outcome, that is real money for me and my cofounders. Why isn’t anyone in venture capital aligned for that sort of outcome? There is an informative video on YouTube in which Anderson talks with the entrepreneur and venture capitalist Chris Dixon about how, early in their careers, they each wanted to finance their businesses and found themselves faced with the need to sell more than half the equity in their businesses at seed stage to get the cash they needed. Dixon describes the situation he encountered this way:
When I started my first VC-backed company in 2004, there were ten to twenty firms who might consider investing in consumer Internet companies, and they were all bigger VC funds that were designed to invest in series A or later. In our seed round, we had to give up more than 50 percent of the company for $2.6 million (plus the deal was tranched, which added other challenges). It was pretty obvious that the market needed a new product. I ended up cofounding my seed fund (Founder Collective) and investing in Baseline, Lowercase, and a few other people who saw the same opportunity.
What founders should seek when their business is at seed stage is a lead professional investor who can add more than just capital. What do I mean by the professional investor? Professional investors are more than just wealthy, well-connected individuals. They can help founders solve real business problems, rather than just write checks.
2. “You have to sell at least 20 percent of your company at every financing.”
Traditional venture capital firms can put a partner on only so many boards and help only so many startups at any given time. They have a high opportunity cost and in many cases can’t invest without taking a significant equity stake. Compared with the period when Steve Anderson and Chris Dixon were both having a hard time raising funds for their startups without massive dilution, there are now many more professional seed-stage venture capitalists offering much more attractive terms, assistance, and valuations to founders.
Life for a business founder today is much better than it was in the past. Founders have better information and more choices.
3. “On average, I invest $500K.”
If a micro VC like Anderson raises a $100 million fund, it can obviously make a lot of seed-stage investments. And, theoretically, it could make enormous seed-stage investments. But early-stage businesses should not raise too much capital since (1) too much money can be counterproductive for the business, and (2) equity must be retained to preserve incentives for founders, employees, and future investors.
4. “Ten years ago, you needed $5 million to start a business. Today, you need $70 and some coding skills.”
One remarkable thing about raising funds at seed stage today is how little cash it takes to fund a company. Access to cloud services and modern software development methodology also contribute to startups needing less money and fewer people to create a successful business than ever before. However, this also means more competition among startups in many categories.
5. “My goal as an investor is to make sure there’s enough financing to give companies enough cash to last a year to eighteen months.”
When I invest, I want to leave enough room for pivoting or re-examining goals. Most of the time, entrepreneurs are realistic near the end and say this isn’t working. Those decisions aren’t that difficult. It gets more difficult in later stages when you’ve got millions of dollars invested.
Too much money can distract a young business from focusing on what is necessary to become a successful company. Businesses do not die from starvation alone—they can just as easily die from indigestion. And they often do. The cause of a business running out of cash is often that the firm has lost focus and diverted resources to activities that are not on the critical path toward success.
Cash starvation or indigestion is often a symptom of bad decisions, like premature scaling, trying to do too many things at once, or pivoting too often.
6. “Generally speaking, most of my investments are pre–product launch—they’re just an idea.”
There is so much risk, uncertainty, and ignorance involved in seed-stage investing that evaluating the strength of the team is extra important. The seed-stage venture capitalist Jason Calacanis has said, “Startups before their A round—which is where I operate—are a high-mortality business. Eight of ten startups angels invest in, in my experience, are a doughnut (zero dollars returned).” In the United States, there are typically about 1,200 seed-stage startups in a given quarter (plus or minus a couple hundred) depending upon the business climate. Of about five thousand seed-stage startups, both reported and unreported, only eight hundred raised a series A round in 2016, according to Mattermark. That’s about an 84 percent fatality rate just at seed stage. Mattermark calculates the odds of survival here at far less than 10 percent. This calculation is based simply on a startup not getting to the next phase. Other research, using different definitions, concludes,
about 75 percent of U.S. venture-backed startups fail, according to Harvard Business School senior lecturer Shikhar Ghosh. Ghosh’s research estimates 30 percent to 40 percent of high-potential startups end up liquidating all assets—a failure by any definition. But if a startup failure is defined as not delivering the projected return on investment, then 95 percent of VC companies are failures according to Ghosh.
7. “With series A, B, C, or growth investments, you already know what you want to invest in.”
Investing in a business before product–market fit is proven means decisions are relatively more instinct based. Anderson has even said in an interview that he tends to go with his gut on his seed investments. What underlies a venture capitalist’s instinct and gut feelings about a potential investment is pattern recognition. That pattern recognition comes from experience, which takes time to develop.
8. “It’s all about networks. I spend time with entrepreneurs; I meet them mostly through other entrepreneurs.”
For a venture capitalist, investing at seed stage is a process that benefits from hustle but also generosity. Reaching out and helping people in advance pays big dividends owing to an aspect of human nature known as the “reciprocity principle.” Doing favors for people begets favors being done for you.
9. “You will know if you like venture capital well before you know if you are any good at it.”
It takes five, six, seven, eight years…. The cycles of feedback are long, which is difficult.
Sometimes a venture capitalist makes a mistake and does not pay the price for many years. This delayed feedback lengthens the learning period. For this reason and others, becoming a successful venture capitalist can take many years. A venture capitalist is paying the equivalent of tuition every time he or she invest in a business. Investments made early in the career of a venture capitalist tend to be more “tuition heavy” than those made later in his or her career.
10. “There is a robust seed market now.”
Returns dictate everything. If the asset class has the financial returns, more money is going to come.
There are hundreds of micro-VC firms in the United States alone. The jury is still out on the right number of firms engaging in this type of venture capital. As with venture capital in general, a significant constraint on industry size is the aggregate dollar amounts of financial exits for portfolio companies. When micro VCs collectively put X dollars of capital to work, they must eventually generate enough financial exits for themselves and their investors, or they will not return enough capital to keep the category healthy. Venture capital has been, and is likely always to be, a cyclical business.
11. “Accelerators were created for people who don’t have their own networks or can’t grow their networks. How often do you show up to one place and see eighty companies? Of course with that scenario, you’ll pay a higher price because more people are looking. That’s fine. Entrepreneurs have more transparency today than ever before; they can choose the types of investors they want to work with.”
It’s great that investors and founders today have so many choices, including participating in accelerators. The clearer the choices are for founders, the better off everyone is, and the higher the success rate for startup businesses will be.
12. “In this business, you will have a long list of things you could have done. If I miss something, I try to learn from that.”
Every venture capitalist has investments they pass on, which represent missed opportunities. That is the nature of the venture capital business. The important thing is not whether venture capitalists make these “mistakes of omission” (because they always will to some extent), but whether they learn from their mistakes. An entrepreneur should not take a rejection personally. Some of the most valuable businesses in the world were rejected repeatedly by venture capitalists.