David Frankel, MP @Founder Capital: Investing Lessons from Seeding Uber, Airtable & Whoop | E1214

Intro (0s)

• Managing reserves and understanding how to handle reserve requirements is one of the most challenging aspects of venture investing (1s).
• The concept of "PR rot" is considered the original sin against entrepreneurs, emphasizing the importance of entrepreneurs owning their destiny by controlling their monthly burn (10s).
• The current focus of Limited Partners (LPs) in the asset class is on Distributed to Paid-In Capital (DPI), indicating a shift in priorities (15s).
• A comparison is made between LPs and a casino, referencing a call to John (presumably a LP) with a 20 on 80 deal, highlighting the ease of securing funding (23s).
• David Frankel expresses his excitement about being in person for the conversation, appreciating the opportunity to connect with Harry in London (46s).

Massive Seed Rounds: How Can Traditional Seed Funds Compete? (50s)

• Traditional seed funds of $50-100 million can still play a significant role in the current market, even with massive seed rounds of $6-10 million, by focusing on non-consensus founders and markets (1m6s).
• Non-consensus founders include those from less traditional backgrounds, people who come from secondary schools, and those who have failed in the past (1m27s).
• Non-consensus markets still exist, and being right in these markets can be beneficial, but it's essential to define what non-consensus means (2m7s).
• Non-consensus can be found in new markets, such as being early in emerging markets like Bitcoin or Ethereum, or in old markets with a unique approach, like Smalls, a cat food company (2m33s).
• Smalls, a cat food company, is an example of a non-consensus market, as it operates in a space that is not currently popular, with many investors preferring dog-related businesses (2m43s).
• Old markets can still be non-consensus, as seen in the example of a company called Aloe, which operates in the restaurant space, but with a unique approach (3m13s).
• When the market moves in a certain direction, seed pricing adjusts, and it's essential to pay the market-clearing price, but these prices are not comparable to AI deals (3m36s).
• In situations where the pricing is extremely high, such as a $100 million pre-money valuation, it may be necessary to bow out, but there can be exceptions, as seen in the example of a $100K check being invested despite breaking the usual rules (4m8s).
• Investing in a company is not just about the financial aspect, but also about the social validity that comes with being an early investor in a successful brand, which can have a positive impact on future investments (4m22s).
• Being the first-round investor in a company like Uber or Airtable is crucial for the next generation of similar companies, and it's a financially good decision that can also bring great brand ramifications (4m47s).
• The time factor is an important consideration when investing, and there are situations where writing a smaller check can be beneficial, but it's essential to be fair to founders and have open communication about the investment (5m6s).
• There needs to be economic alignment between the investor and the founder, and the investor's time and interest are valuable assets that need to be considered when making an investment (5m28s).
• The outcome of an investment should be aligned with the investor's goals, and the return on investment should be significant enough to make a meaningful impact, such as a $1 million return on a $100 million exit (5m39s).

Do Founders Understand Venture Today? (5m47s)

• Some founders still prioritize securing funding from well-known venture capital firms, such as 16z or XL, over other considerations, and may not fully understand the venture business (5m48s).
• Founders who focus solely on securing funding from prominent firms may not realize that only a small percentage of startups, likely less than 10%, receive funding, and the rest may struggle to find support (6m8s).
• Startups that are rejected by prominent venture capital firms may face significant challenges in securing funding from other investors, as the initial rejection can be seen as a negative endorsement (6m18s).
• Many founders who are rejected by venture capital firms may not understand that 90% of startups do not receive follow-on funding, and may regret not being more disciplined in their approach (6m36s).
• Venture capital firms have rules and guidelines that they must follow, including avoiding conflicts of interest and maintaining loyalty to existing portfolio companies (7m14s).
• Some venture capital firms, including Founder Capital, prioritize adhering to these rules and avoiding investments in competitive companies, even if it means missing out on potential opportunities (7m29s).
• The decision to prioritize rules and guidelines over potential investments can be difficult, and there may be instances where a firm regrets not making an investment, such as the case with Pinterest (6m54s).
• Maintaining a strong reputation and adhering to rules and guidelines is essential for venture capital firms, as it helps to establish trust with founders and other investors (7m23s).

How Fast David Spots a Bad Company? (7m38s)

• It is possible to determine if a company is not good within the first three months of involvement (7m48s).
• In Enterprise sales, the sales cycle can be very long, leading to uncertainty about the company's potential, but initial impressions can still be formed (7m56s).
• Feedback on a company's potential can be obtained quickly, and there have been instances where initial doubts were later proven wrong due to lucky events, particularly in consumer businesses (8m29s).
• The velocity of getting things done is an important factor in evaluating a company's potential, and slow progress can be a warning sign (8m43s).
• Patience and pain tolerance are essential for entrepreneurs and investors, as the journey to success can be long and challenging (8m59s).
• Being an entrepreneur requires the ability to withstand difficulties and setbacks, with one founder describing it as the ability to "get punched in the face every single day" and still come back (9m15s).
• A more optimistic view of entrepreneurship is that it involves taking risks and hoping that the team will overachieve, much like jumping out of a plane with a box of silk worms and hoping they will thrive (9m26s).
• The founder of meditation app Calm is mentioned as a friend who has shared insights on the challenges of entrepreneurship (9m7s).

Why Are Reserves So Hard in Venture? David's Key Lessons (9m27s)

• The decision to not do reserves was influenced by past experiences with companies like Clubhouse and B, which lost money, and slower-growing Enterprise companies that turned out to be phenomenal investments, suggesting that reserves would have been better allocated to companies with traction (9m39s).
• Initially, no reserves were allocated in Fund One, but a negative correlation bias was observed, where companies that needed help were not getting there fast enough, leading to the need to break rules and invest in them (10m0s).
• An example of breaking the rules was Eric's investment in Trade Desk, which was out of money and needed funding, despite being a disciplined investor, he invested in the company as a follow-on, putting in around half a million to a million dollars (10m26s).
• A reserve strategy was created in Fund Two, where 50% of the fund would be allocated to companies that needed the money, but this strategy was later challenged by the market, which moved away from the initial rules (11m1s).
• The current reserve policy is a one-to-one reserve policy, but it is struggled with, as good companies often don't need the reserves, and the fund size is limited, with 75 million dollars allocated, and a 1:1 reserve policy, leaving around 25 million dollars for initial checks (11m47s).
• The COVID-19 pandemic led to a reevaluation of the reserve strategy, with the initial fear of a market closure leading to a decision to put fewer funds into companies, but the market ultimately became flooded with capital, making it challenging to navigate the reserve strategy (12m20s).
• The reserve strategy is considered one of the most challenging aspects of venture capital, as it requires forward-looking decisions about the portfolio and is difficult to get perfectly right, especially with new investments that haven't been made yet (12m45s).
• When deciding whether to reserve more or less money for a company, the market's reaction can be unpredictable, and it's essential to consider the company's needs and the founder's vision (13m3s).
• If a company is struggling and the founder is losing faith, it's crucial to provide honest feedback, even if it's difficult, as not doing so can be seen as abrogating one's duty as an investor (13m18s).
• Sometimes, founders may not want to hear hard feedback, but it's essential to communicate concerns, especially when the company is running out of money (13m27s).
• A personal experience with a carbon sequestration business that closed down due to high burn rates and the founder's reluctance to cut costs illustrates the importance of providing honest feedback (13m48s).
• The founder, Marty, was burning $3 million a month and had $10 million in funding, but was unwilling to cut costs, and eventually, the business was closed (13m54s).
• Founders often feel loyal to their team and investors, which can make it difficult for them to slow down or change direction, even when it's necessary (14m37s).
• The same traits that make entrepreneurs successful, such as determination and confidence, can also lead them to take risks and push forward, even when it's not advisable (14m47s).
• In some cases, enterprise clients may still be providing hope for a struggling company, offering large contracts or deals that can be tempting to pursue (15m1s).

First-Time vs. Second-Time Founders (15m8s)

• First-time founders and second-time founders have different psychologies, with the latter often having a chip on their shoulder and a desire to prove themselves after a previous failure (15m9s).
• Founders who have had enormous success and exits often approach their next opportunity with a degree of hubris, which can lead to poor outcomes (15m27s).
• In contrast, entrepreneurs who have tried their best, raised money, and failed often come back hungrier and more determined to succeed, making them more attractive to investors (15m51s).
• Second-time entrepreneurs who have failed and come back for more can be great people to back, as they have learned from their mistakes and are often more humble and determined (16m3s).
• Tom Lee's experience with Motorway is an example of a successful second-time entrepreneur, who built a billion-dollar company after failing with a previous venture (16m7s).
• To attract second-time entrepreneurs, investors need to be able to get them to come back and speak with them, and to acknowledge that their previous failure was not due to a lack of effort or talent (16m37s).
• Investors should focus on the team rather than the theme, and recognize that failure is a natural part of the business, in order to build strong relationships with entrepreneurs (17m10s).
• By acknowledging the lessons learned from failure and expressing a desire to be in business with the team again, investors can build trust and attract second-time entrepreneurs to work with them (17m20s).

Why Does David Call Pro-Rata the Original Sin of VC? (17m25s)

• Asking about investment themes is considered a lazy question, as it's an easy option for funds, and instead, investors should be all-in or all-out on a particular theme (17m26s).
• Pro-rata (pro-rata) rights are seen as the original sin against entrepreneurs, as they give venture capitalists a superpower, allowing them to buy more shares at a later stage, which can be terrible for entrepreneurs, especially when they're struggling (17m52s).
• Entrepreneurs often give pro-rata rights without fully understanding the implications, and it's standard operating procedure for venture capitalists to test the market to determine the price, which can make the entrepreneur a stalking horse for other investors (18m34s).
• Pro-rata rights can be difficult to negotiate, especially when the company is not doing well, and even when it is, it can be challenging to get deals done unless the company is killing it (19m23s).
• In some cases, investors may want a significant ownership stake, which can lead to dilution, and pro-rata rights can make it harder for entrepreneurs to negotiate (19m50s).
• Being the first to commit to an investment can be a sign of conviction, but it can also make the investor a stalking horse, allowing the entrepreneur to use them to get a better price or structure from other investors (20m11s).
• If an entrepreneur uses an investor as a stalking horse, it can be a good signal to the investor that the entrepreneur is transactional, and it's better to find out early on (20m35s).
• Josh Kopelman's strategy at First Round Capital involved giving uncapped notes to founders in quadrants that were performing exceptionally well, which served as a selling point for future rounds and a form of testimonial marketing for the founder (20m53s).
• There is a debate about the use of preferred shares, with some arguing that they are fundamental in ensuring investors get their money back before distributing profits, while others disagree (21m35s).
• In the case of Uber, the company had preferred shares, but the large amount of capital raised made the preferred shares equivalent to common shares (22m5s).
• The terms of investments are getting tougher, especially for later-stage companies, with the preference stack becoming more prominent and founders not adjusting to the changing market conditions (22m44s).
• The market has changed significantly, with listed markets and SaaS multiples decreasing, which affects the valuation of private companies and the expectations of later-stage investors (23m25s).
• Founders need to be mindful of their monthly burn and adapt to the changing market conditions to maintain control over their company's destiny (24m11s).

Has DPI Died in 2024? Is PE the Answer for VC Exits and Liquidity? (24m14s)

• The current state of venture capital is uncertain, with many limited partners (LPs) questioning whether venture can survive without a reflation of public market multiples, and some wondering if DPI (distributions to paid-in capital) is dead (24m16s).
• The 2018 vintage funds are a perfect storm, with many LPs looking at these funds and wondering where the DPI is, but the reality is that DPI was already being given in earlier funds through companies like Cruise, Desktop Metal, and DataRobot (24m28s).
• The 2018 plus vintage funds were affected by the perfect storm of 2019 and 2020, with the rise of day trading and the involvement of firms like Tiger, a16z, and SoftBank, which led to a surge in funding and valuations (25m15s).
• LPs are still looking for DPI, but they are not being direct with managers, and instead, are looking at the performance of funds and the potential for exits through PE (private equity) players (25m51s).
• PE players are now looking at vertical SaaS businesses and seeing potential for disruption, and are investing in these companies with the intention of selling to larger PE firms or companies (26m18s).
• The current IPO market is not open, and is not expected to open until H2 2025 at the earliest, and the M&A market is also not open, but one good IPO could change this and lead to a surge in IPO activity (26m58s).
• Pre-election in the US, IPOs are likely to be closed, but post-election, one or two good IPOs could lead to a swarm of bankers telling companies that the IPO market is open again (27m24s).

Why Are LPs Frustrated with VCs, and What Will Change It? (27m39s)

• The IPO market is currently closed, and it will only open when a company like Stripe, Starlink, or SpaceX goes public, as this will signal to LPs that it's time to invest again (27m40s).
• LPs are currently looking at their DPI (Distributions to Paid-In Capital) and are concerned about the lack of returns, with some considering it a permanent loss of capital rather than a delay (28m0s).
• The performance of a fund is highly dependent on its vintage, with some funds performing better than others due to the timing of their investments (28m43s).
• To return a seed fund, it's not enough to have one or two successful companies; you need four or five good companies that can sell for $250 million each (29m18s).
• Having "Demi fund returners" that return 25-40% of the fund can be beneficial, but it's not enough to rely solely on these types of investments (29m43s).
• Uber was a highly successful investment that returned the fund multiple times, and other companies like Tryes, Kong, and Pillpack also provided significant returns (29m59s).
• Pillpack was a particularly successful investment, returning the fund and providing a significant return on investment (30m25s).
• The size of a seed fund can impact its ability to move the needle, with larger funds requiring more significant investments to make a meaningful impact (30m44s).
• Entrepreneurs need to do the math on the investments they receive, considering the size of the fund and the potential for the investment to move the needle (30m57s).
• A $10 million investment from a large-scale fund may not be as significant as it seems, especially if a partner doesn't join the board (31m10s).
• Multi-stage firms versus seed firms have different dynamics, and a partner at a multi-stage firm joining a company's board can be a strong signal, making it tough for seed firms to compete, especially if the partner is committed to spending time with the company, although some partners at mega funds may not show up as often as expected (31m27s).
• The size of a fund and the check size in a company versus the size of the fund can indicate how much time and attention the company will receive from the investor, with larger funds often having less time for smaller investments (32m19s).
• Limited Partners (LPs) continue to invest in the asset class, but their capital deployment may change due to IL liquidity, depending on the type of LP, with endowments and pension funds potentially dialing back their investments (32m32s).
• The Yale model, also known as the Swenson model, allocated a significant portion of its portfolio to venture capital, but this approach may not be replicable in today's market with lower liquidity and hit rates (32m57s).
• High net worth family offices and some large LPs may pull back from investing in venture capital, but others may be hesitant to sit out vintages, fearing they might miss out on successful investments (33m21s).
• LPs may lower their investments in a fund but try to stick around if they believe it's a great fund, as long as the fund maintains a good track record (33m42s).
• Smaller funds may welcome LPs bowing out, as it can reduce the time spent on fundraising and allow the fund to focus on finding and supporting good companies (33m50s).
• The founder spends a significant amount of time finding and supporting good companies, with only a small percentage of time spent on fundraising (34m18s).

Should Seed Funds Actively Navigate Secondary Markets for Exits? (34m36s)

• Secondary markets are more active than ever, with many limited partners (LPs) showing interest in them, but navigating these markets can be challenging, especially for seed funds managing portfolio exits (34m36s).
• Secondary markets are elusive, and it's difficult to find opportunities, especially in smaller private companies, with most secondary deals happening in high-flyer companies or pre-IPO (34m56s).
• Companies that raise funds from prominent investors like Tiger, Andreessen, and SoftBank but have down rounds may face decimation or plateauing if they fail to maintain product-market fit and growth (35m40s).
• Companies without product-market fit are often abandoned by their boards or investors, and even some late-stage companies that have IPOed can struggle if they fail to maintain growth (36m10s).
• Being private can be a luxury, especially for companies with a lot of money, but burning cash quickly can lead to problems, and investors may eventually walk away (36m30s).
• A generation of VCs may be quick to give up on companies, and while this can be a problem for entrepreneurs, it's also a natural part of the ecosystem, with investors and LPs moving on to new opportunities (36m40s).
• The decision to stick with a company or move on depends on the relationship between the investor and entrepreneur, with some investors taking a more sentimental approach and others being purely commercial (37m1s).
• Investors may choose to stick with a company if they believe in the entrepreneur's potential, even if the business is struggling, but ultimately, the decision to move on is a natural part of the investment cycle (37m36s).

IPO Strategy: When to Sell & How to Distribute Effectively? (37m42s)

• When considering an IPO strategy, the decision of when to sell and how to distribute effectively is crucial, and there is no one-size-fits-all approach, as different investors have varying preferences and goals (37m42s).
• The process of liquidating and distributing shares can be complex, as some investors may want to hold onto shares for their foundations, while others may prefer cash or may not know what to do with the shares (38m4s).
• In general, the decision to distribute shares or cash is often based on the size of the position, with larger positions typically being distributed to investors to decide what to do with, and smaller positions being sold and the cash distributed (39m0s).
• The size of the fund versus the size of the position is also a key factor in determining the distribution strategy, with larger positions in smaller funds often being distributed to investors (39m16s).
• In hindsight, it may be beneficial to never sell shares of great companies with strong moats, as they can continue to grow and provide returns over time (39m35s).
• The concept of a "green fund structure" is also discussed, which involves holding onto shares of great companies for the long-term, but the timing of such a strategy can be problematic (39m56s).
• The success of such a strategy depends on the company being extraordinary and having strong growth potential, and only a few companies may be able to execute on this strategy effectively (40m15s).
• The strategy of holding onto shares of great companies for the long-term is impressive, but the timing of such a strategy can be unfortunate, and it requires careful consideration and execution (40m22s).

What is Leech? (40m24s)

• LEECH is an acronym that stands for Lethargic Economic Extractor Causing Harm, referring to legacy companies that were innovative in the past but now add no value and use various tactics to maintain their position, such as lobbying, lawyers, and PR. (40m25s)
• Examples of LEECH companies include pharmacy benefit managers (PBMs) that connect pharmacies to insurers, but now have hundreds of billions of dollars in market cap while adding no value. (40m46s)
• Taking on these LEECH companies can be challenging and underestimated, as they use their resources to maintain their position and may even claim that challenges to their business are illegal. (41m20s)
• The experience of Pillpack and SeatGeek are cited as examples of companies that have faced challenges from LEECH companies, with SeatGeek's co-founder Rusta Souza testifying to the Department of Justice about the difficulties of competing with Ticket Master. (41m50s)
• The merger between Live Nation and Ticket Master is given as an example of a merger that should not have been allowed, as it has led to a monopolization of the ticketing industry. (42m58s)
• The challenges of taking on LEECH companies with regulatory power, lobbying power, and significant capital are highlighted, with the example of the ticketing industry being particularly difficult to compete in. (43m9s)
• Other industries, such as travel, are also mentioned as being challenging to compete in due to the presence of LEECH companies like Booking, Expedia, and Trip Advisor. (43m41s)
• The recording industry has taken a strong stance against Sunno))), using a similar playbook as before, but venture capitalists (VCs) can add significant value in such situations by providing guidance on navigating the challenges, including legal issues, lobbyists, lawyers, and PR consultants (43m54s).
• The legal challenges faced by Sunno and Open AI are different, with Sunno's challenge being on the input and Open AI's challenge being on the output, and VCs can help companies prepare for these challenges (44m13s).
• In some cases, the goal of the incumbent industry is not just to extract a "pound of flesh" but to prevent the new company from entering the market, and VCs can help companies develop strategies to counter this (44m34s).
• Companies like Sunno, Pillpack, and Whoop have been successful because they have customers who love and adore them, and having a strong customer base is essential for success, regardless of the amount of cash or strategies a company has (45m21s).
• The success of companies like Spotify, which has disrupted the recording industry, is an exception to the general trend of incumbent companies maintaining their market position, and Spotify's success can be attributed to its ability to provide a new distribution mechanism for music (46m25s).
• The use of AI, as seen in companies like Sunno, is allowing for new and creative ways of doing things, and is enabling companies to disrupt traditional industries in new and innovative ways (47m5s).
• The widespread availability of professional tools on personal devices has created a problematic situation, as even the best professionals now face competition from individuals with access to the same tools (47m19s).
• The rise of new technologies and platforms does not necessarily mean the demise of existing industries, as seen in the case of the recording industry and Spotify (47m30s).
• Incumbent companies may not disappear, but their market share can change dramatically due to new competition (47m45s).

Does AI Shift Your Beliefs on Capital Efficiency & Small Rounds? (47m48s)

• The view on investing in AI companies is that teams are more important than themes, and even in AI, teams need to achieve some level of product-market fit before scaling, which can still be done reasonably capital-efficiently (48m7s).
• However, to scale and distribute AI companies, significant amounts of capital are required, as seen in Josh Kushner's $1 billion investment in Open AI at a $100 billion valuation (48m29s).
• While it's possible to make a 2x return on such investments, betting against it is not advisable, but the required capital to play in the hyperscaler game is substantial (48m45s).
• New AI technologies, such as tiny language models, require significant capital for programming overhead and engineering, even for applications running on mobile phones (49m6s).
• When navigating AI seed rounds, a contrarian approach is taken, avoiding highly competitive and priced rounds, and instead focusing on rare instances where a team is exceptional and cannot be ignored (49m52s).
• Most AI seed rounds are too expensive, with valuations like $25 million on $100 million, making it challenging to make a return on investment in a seed fund (49m47s).
• An example of a highly valued AI company is Open AI, which had a first round valuation of $250 million and later reached a valuation of $5 billion, with significant dilution expected (50m21s).
• Building a fund strategy around investing in generational companies is not advisable, as they are rare, and instead, a disciplined approach to investing in AI seed rounds is necessary (50m57s).
• Investing in companies like Uber, Airtable, and Whoop requires understanding the potential for exponential growth, as seen in the 10x return on investment in companies that break the rules and achieve massive success (51m24s).
• The success of companies like Open AI depends on their customer base and distribution, with widespread adoption being a key factor in their growth and potential to disrupt industries (51m38s).
• Open AI's growth and potential to continue scaling and creating revenue make it a significant player in the industry, potentially forcing companies like Microsoft to take notice and consider strategic partnerships or acquisitions (52m4s).
• The regulatory environment surrounding potential mergers or acquisitions between companies like Open AI and Microsoft could pose significant challenges and may influence their decision-making (52m24s).
• Perplexity is a phenomenal product that has impressed many, but the speaker prefers to start with Chat GPT due to its cleaner and more summarized answers that provide faster results (52m33s).
• The speaker's behavior has shifted to using Chat GPT as their primary tool for finding information, even for everyday tasks like finding restaurants, due to its ability to provide more efficient and effective results (52m57s).

Will AI Spawn New Giants or Consolidate Power in Existing Titans? (53m10s)

• The impact of AI on the market is expected to be significant in the long term, but may disappoint in the short term due to the large amount of capital expenditure and limited earnings generated initially (53m10s).
• The development of AI will likely have a profound impact on various industries, from hyperscalers to data centers, steel, and chips, but it may take time to materialize (53m41s).
• The progress of AI can be compared to the development of self-driving cars, which took longer than expected to become a reality, but will eventually have a significant impact (53m53s).
• It would be unwise to discount the potential of AI in the next 10 years, as it is expected to bring about profound changes (54m21s).
• However, the challenge lies in identifying the companies that will be successful, as only a small percentage will achieve significant growth, and it is difficult to predict which ones will succeed (54m27s).
• A key principle for investing in companies is to look for opportunities where it is possible to 10x the investment, and if that is not possible, then it may not be worth investing (56m2s).
• This principle, known as Eric's rule, helps to create alignment between investors and entrepreneurs, and guides investment decisions (56m28s).
• Having a disciplined approach to investing is important, and it is essential to be humble and recognize that it is not possible to predict with certainty which companies will be successful (55m22s).
• Eric's approach to investing is characterized by humility, and he has acknowledged that he did not know which companies would be successful in advance, but rather looked for opportunities with high potential (55m5s).
• To think bigger, one should not underestimate the size of their winners, as every great company, such as Snap, Procore, or Shopify, was initially underestimated, and this mindset can lead to missing out on amazing returns from companies like Olo or Pillpack, which can become $20 billion companies (56m35s).
• It's considered insanity to only focus on creating huge companies or unicorns, as this approach can be boring and doesn't allow for exploring fascinating directions, whereas considering 10x possibilities can provide an easier onramp into interesting situations (57m11s).
• Downside protection is not a major concern, as the most one can lose is all their money, but the potential upside is unlimited, making it an unfair feature of capitalism (57m47s).
• This unfair feature of capitalism leads to the idea that limited partners may not want to lose money, but not taking enough risk can be a problem, and it's essential to consider this when investing (58m14s).
• The focus should be on finding great companies and operators, such as Stripe, rather than solely focusing on downside protection (57m49s).
• Reading Bass's memos can provide valuable insights into the mindset of successful companies and the importance of not underestimating the size of winners (56m44s).

David's Biggest Losses: How Did They Change His Investment Mindset? (58m25s)

• The concept of loss ratio in investments is discussed, with the acknowledgment that losses are inevitable, and there are "good losses" and "bad losses" - the latter being those where judgment was poor (58m47s).
• "Bad losses" often occur when an investor's judgment is clouded by their affection for the idea or product, rather than the entrepreneur themselves, highlighting the importance of evaluating the entrepreneur behind the idea (59m7s).
• The distinction between "red button" and "green button" entrepreneurs is made, with the former being those who would not be desirable to work with, and the latter being those who are a pleasure to collaborate with (59m12s).
• A key lesson learned is that it's essential to love both the "what" (the idea or product) and the "who" (the entrepreneur), as well as having good chemistry with them (59m35s).
• The importance of context is emphasized, as even the best entrepreneurs can fail due to factors like being too early to market or facing strong competition from incumbents (59m51s).
• A piece of advice is shared, suggesting that if an investor is willing to take less in a deal, they should reconsider participating in the deal altogether, but this advice is also nuanced by the importance of context and collaboration (1h0m11s).
• The idea that "heat" in a deal does not necessarily correlate with its quality is discussed, with the suggestion that high demand can sometimes be a sign of a deal that is overvalued or not worth investing in (1h1m9s).
• In situations where there is high demand, it may be wise for investors to consider taking secondary shares off the table, rather than investing more, as a way to mitigate risk and lock in returns (1h1m24s).
• The difficulty of knowing when to take secondary shares is acknowledged, with the admission that this decision can only be evaluated accurately in hindsight (1h1m56s).
• Regrets are shared about selling shares in successful companies like Uber and The Trade Desk, highlighting the challenges of making investment decisions and the importance of learning from mistakes (1h2m12s).

Advising Founders on Secondaries (1h2m29s)

• Founders have been criticized for taking secondaries, especially as the market has turned, but a rule of thumb is that taking less than 10% off the table is generally acceptable and won't be heavily scrutinized by investors or limited partners (LPs) (1h2m36s).
• Taking a small amount of secondary, such as $1-2 million, can alleviate pressure on the founder and allow them to focus on the business, which can be beneficial for both the founder and the investors (1h3m8s).
• The first million dollars a founder makes can make a significant difference in their life and can help alleviate financial pressures, making it a binary difference (1h3m11s).
• Giving founders secondary can be self-serving for investors as it allows the founder to focus on the business without worrying about personal financial issues (1h3m25s).
• The context of the founder's situation matters, and if they are young and don't have significant financial pressures, taking secondary may not be as necessary (1h3m47s).
• Growth investors who provided large amounts of capital to founders during good times and are now criticizing them for taking secondary are being hypocritical (1h3m52s).
• The large amounts of capital provided to founders in the past were a significant mistake, and it's unclear how founders were expected to manage such large sums of money effectively (1h4m10s).
• An example of this mistake is a deal where a founder was offered $10 million on a $40 million valuation, and then another investor offered $20 million on an $80 million valuation, which was accepted, but in retrospect was a mistake (1h4m26s).
• The investor regrets being caught up in the moment and encouraging the founder to take the large amount of capital, which was not in the best interest of the company (1h4m47s).
• The investor advised the founder against taking the deal, but the founder ultimately decided to go with the larger investment (1h5m10s).
• In retrospect, the investor believes that the large amounts of capital provided to founders were a sin and that it's unclear how founders were expected to manage such large sums of money effectively (1h5m46s).
• The current market is divided into the "Haves and Have Nots" in terms of AI, with vertical SaaS companies doing $50 million being constrained by listed multiples, making it difficult to achieve a 20x multiple (1h5m55s).
• This situation presents an opportunity as everyone is moving out of vertical SaaS, thinking it's not attractive, and the fascinating thing is that it goes back to the idea that "software is eating the world" (1h6m26s).
• The amount of data that vertical SaaS companies or horizontal SaaS companies have is enormous, and they can leverage AI tools to create new opportunities, with companies like Salesforce having a significant advantage due to the amount of data they possess (1h6m42s).
• If a company enriches its customers' data, it can increase its revenue and customer base, but if it fails to do so, it will be out of business (1h7m1s).
• The question remains whether AI will allow companies to increase the price they charge per seat or just maintain their position with denigrated margins (1h7m18s).
• The CPO of Canver mentioned that AI has led to margin denigration with every query, but the company still announced a 300% price increase, indicating that people will pay for the value provided by AI (1h7m30s).
• In the short term, the right play is defensive, focusing on enriching data and retaining customers, and once that is achieved, there are opportunities to increase revenue and customer base (1h7m55s).
• The idea that AI means companies will be able to build their own vertical solutions tailored to their specific needs and see the end of vertical SaaS is not agreed upon, as the underlying tools are becoming commoditized, and vertical SaaS or horizontal SaaS companies will be able to access them reasonably cheaply (1h8m27s).
• The technology sophistication of companies is often overestimated, and it's unlikely that every single company will be able to build its own vertical solutions with AI (1h9m13s).
• Software providers that enrich their tool set will do exceptionally well, and the underlying tools will become more commoditized, making it more accessible to companies (1h9m7s).
• Solutions often struggle to onboard large clients, such as Slack, due to the clients' existing infrastructure and capabilities (1h9m21s).
• The founder of an ISP had a similar experience when trying to offer internet services and e-commerce options to large banks and the national railway owner, who claimed to have a superior network (1h9m27s).
• Despite initial rejections, the ISP was able to secure large clients, including the university network in South Africa, which became one of their biggest clients (1h10m0s).
• The initial rejection was due to the clients' perception that they did not need the ISP's services, but ultimately, the ISP was able to provide value through smart software solutions (1h10m11s).
• The experience suggests that there will always be short-term skepticism from potential clients, but there is still a viable business in providing smart software solutions (1h10m16s).

How to Be a Great Board Member (1h10m18s)

• To be a great board member, it is essential to have economic alignment with the founder, meaning owning a significant percentage of the company, as this ensures that every decision made is in the best interest of the company, rather than just the founder or the board member (1h10m35s).
• Owning less than 15% of the company can be problematic, as it may lead to the board member feeling like they are working for the founder rather than being a partner (1h10m59s).
• Economic alignment is crucial because it allows the board member to be patient and make decisions that are in the best long-term interest of the company, rather than just focusing on short-term gains (1h11m20s).
• Having more alignment in terms of ownership between the founder and the board member can lead to a more effective and collaborative working relationship (1h11m35s).
• While economic alignment is important, it's not a hard and fast rule, and there may be cases where it doesn't matter, such as when the company is performing extremely well (1h11m40s).

Biggest Lesson on Dilution (1h11m51s)

• The impact of dilution is often forgotten, and as a seed-stage fund, the strategy is to dilute alongside the founder, focusing on time and alignment rather than dilution itself (1h11m51s).
• By the time the next set of capital is raised at 3x or 4x, it's often not affordable to maintain the same percentage of ownership, and the opportunity cost of capital can be too high to sustain (1h12m30s).
• Vinod Khosla's statement that 90% of VCs don't add value is agreed upon, emphasizing the importance of being aligned with the founder and taking an active interest in the company (1h12m50s).
• Having a good relationship with the founder is crucial, and even if economic ownership is lower than desired, it's essential to be involved and provide value, rather than focusing solely on ownership percentage (1h13m21s).
• Providing advice, connecting founders with useful contacts, and being self-serving in a positive way can make a venture capitalist feel useful and valuable (1h13m38s).
• The challenge for VCs is to add value, whether through connections, advice, or other means, and to make the energy and time invested worthwhile (1h13m59s).
• Having experienced only one bankruptcy in hundreds of investments, the importance of learning from experts and taking care of investors is highlighted, even if it means giving back profits (1h14m33s).
• The experience of working with an expert in bankruptcy, Lou Rosenblum, demonstrated the value of being taken care of and the joy of unlocking chemistry and future collaborations (1h15m41s).
• The possibility of more frauds existing in portfolios than are publicly acknowledged is raised, and the era of easy money may have given rise to more fraudulent activities (1h16m17s).

The Small Fund vs. The Big Fund (1h16m31s)

• A small fund's primary objective is to make introductions to other funds, acting as a "glorified Matchmaker," whereas a large fund has no incentive to do so as they prioritize their own investments at every stage (1h16m36s).
• Large funds, such as Sequoia, have no incentive to matchmake for their portfolio companies, as their primary goal is to maximize their own returns (1h17m12s).
• The difference between financial investors and others lies in their approach, with financial investors focusing on investing at market-clearing prices and not providing support beyond that (1h17m42s).
• Seed funds, on the other hand, have an incentive to get their portfolio companies funded and often dedicate resources to finding the right partners for them (1h18m4s).
• Over time, some seed funds have operationalized this process, using software like Airtable to manage their matchmaking efforts (1h18m21s).
• Founders need to have a seed partner who knows the specific partner at the firm to ensure successful matchmaking, as it can fall through the cracks otherwise (1h18m40s).
• Successful matchmaking requires both science (knowing the right partner) and art (testimonial sales), with the latter being more authentic when coming from a third party (1h19m6s).
• A company's performance plays a significant role in successful matchmaking, as it is easier to sell a company that is performing well (1h19m26s).
• Founders should be aware of incentives that may lead to people bringing in investors who are not the best fit for the company, but rather those who owe them a favor (1h19m38s).
• Founders are often influenced by venture capitalists who have a personal connection or owe a favor, which can lead to less-than-ideal investment decisions, and this phenomenon is more common in hot deals (1h19m46s).
• In tough times, founders may accept investments from less-than-ideal investors, as having some funding is better than none, and this is reminiscent of the phrase "half a loaf is better than no bread at all" (1h20m11s).
• Market sizing is important, but it's not the only factor in investment decisions, and some successful companies have achieved significant growth despite initial concerns about their total addressable market (TAM) (1h20m30s).
• The example of Media Radar, a vertical SaaS play in the media industry, illustrates how underestimating TAM can lead to missed opportunities, as the company's value grew to billions despite initial market sizing concerns (1h20m45s).
• When starting up, the size of the TAM may not be as crucial as having a great founder who can adapt and find new markets, and the difference between a $1 billion company and a $10 billion company often lies in the founder's ability to execute a successful second act (1h21m55s).
• Great founders can find and create new markets, and the example of The Trade Desk versus Olo illustrates how different companies can achieve success despite varying TAM sizes (1h22m15s).
• The story of Noah, who raised $600 million for 10% dilution when he IPOed, highlights the importance of having a solid founder who can make smart decisions and achieve significant growth (1h22m40s).

Quick-Fire Round (1h22m55s)

• The biggest change in perspective over the last 12 months is the realization that private equity (PE) firms can be valuable in portfolio companies, providing rigor, financial discipline, and help to the entire cap table, contrary to the initial view that PE firms were the enemy of seed-stage companies (1h23m0s).
• The investor whose portfolio would be most desirable to swap with is not specified, but rather companies like those involved in applied AI, such as Micah Rosenbloom's company, or Josh Wolfe's company, which applied AI to drones (1h23m37s).
• The best board member to sit on a board with is Jake Saper from Emergence, who has been an incredible partner to have on the company, providing valuable advice and support (1h24m4s).
• The best investment advice received is to be patient, as investing is a long journey that requires perseverance (1h24m45s).
• One thing that is now known but was not known when starting Founder Collective is that even when a company has a real moat and is difficult to compete with, it's essential not to sell too soon and to stay the course (1h24m50s).
• The biggest loss was an investment in Marty O'Donnell's company, Running Tide, which failed to translate its product vision into something commercially viable, resulting in the loss of all invested money (1h25m6s).
• The biggest sin of the Zero era is the excessive amount of money that drove everything, with too much capital being stuffed down entrepreneurs' throats (1h25m50s).
• The heaviest thing in life is not iron or gold, but unmade decisions, which can weigh heavily on individuals (1h26m6s).
• The unmade decision that weighs the most is not specified, but it is acknowledged that every great decision involves weighing up scales and getting to conviction, which can be confusing for people (1h26m13s).
• The biggest decisions in life can be binary and difficult, such as leaving South Africa to start Founder Collective with Eric, which was a tough choice due to the emotional attachment to the life left behind (1h26m55s).
• When making decisions as a founder, it's essential to have thought them through thoroughly, and sometimes, it's necessary to go with emotions rather than intellect (1h27m24s).
• The decision to invest in a company can be a rollercoaster of emotions, from feeling energized and excited to having doubts and fears, but ultimately, it's crucial to trust one's instincts (1h27m51s).
• To ignore the emotional and visceral response when making decisions can be wrong, and it's essential to consider the emotional aspect of a decision (1h28m24s).
• What matters most in life is love, friendship, and loyalty, which are essential values to prioritize (1h28m38s).
• The favorite book being read at the moment is "The Path Between the Seas" by David McCullough, which tells the story of the building of the Panama Canal between 1870 and 1914 (1h28m54s).
• The building of the Panama Canal was a massive undertaking that involved significant financial investment, loss of life, and colonialism, but it's an example of a "moonshot" project that showcases the power of human ingenuity and capitalism (1h29m10s).
• The story of the Panama Canal is a reminder that the principles of capitalism, including lobbying, politics, and media influence, remain the same today, and it's essential to learn from history to navigate the complexities of modern business (1h30m0s).
• As a founder, it's possible to get involved in "moonshot" projects and make a significant impact, even with limited resources, by being strategic and taking calculated risks (1h30m23s).