Cem Sertoglu: Lessons from the Greatest Venture Investment in European History | E1228

Intro (0s)

• The best single venture investment known is a $16.5 million investment that brought back $2.1 billion in proceeds, resulting in a 20-time multiple on invested capital (4s).
• Approximately 85% of the proceeds from Fund One have been from UiPath, with the remaining 2.7% coming from non-UiPath investments (13s).
• UiPath achieved significant growth, going from $1 million to $100 million in annual recurring revenue (ARR) in 21 months, which was the fastest growth at that time (20s).
• The conversation with Cem Sertoglu began with an informal walk around the park, which was not recorded, but is now being shared in this discussion (41s).
• Cem Sertoglu is excited to be part of the conversation and is thanked for joining (45s).

Entry Into Venture World (48s)

• The journey into the world of venture investing began with founding a company called SelectMinds in 1999 in New York, which was a social networking software company and one of the earliest participants in that space, but it hit the crash hard and ultimately did okay with a nice exit (55s).
• After the exit, a move to Istanbul was made, where young Turkish tech companies, mostly consumer internet businesses, were met, and excitement was generated because of the potential for growth (1m19s).
• Two key things were observed: people behave similarly everywhere, especially in their interaction with consumer technology, and the playing out of consumer internet in the west could be replicated in other parts of the world (1m41s).
• As an angel investor in these early companies, a few early investments turned out to be the biggest exits in the Turkish market, including an e-commerce company sold to eBay and a food delivery company sold to Delivery Hero, with an overall return of around 10x (2m22s).
• The transition to venture investing was made due to the difficulty in syndicating larger investments and the lack of funding for companies in the region that needed more than $5-10 million, leading to the decision to raise a fund to focus on opportunities in Eastern Europe and Turkey (2m54s).
• The lack of funding in the region, particularly for companies that needed more than $5-10 million, was a significant challenge, and the presence of "tourist capital" that moves into geographies without understanding the nuances of the region can lead to a huge retraction of cash (3m42s).
• The nuances of the region that are often missed by tourist capital include the local environment, the background of the founders, and the companies they worked at, which can only be understood through immersion (4m37s).
• Despite the challenges and the presence of tourist capital, the job of a venture investor is to continue investing in the strongest opportunities, regardless of the market conditions, and not to try to time the market (5m13s).

How Venture Capital Evolved into a Low-Margin Business (5m43s)

• The venture capital industry has seen an explosion of capital, with some arguing that it has become commoditized, but this perspective is disputed, as the value of capital is not solely determined by its price, and founders often prioritize the quality of their investors over the amount of capital they can provide (5m43s).
• The idea that the early-stage market is becoming commoditized is challenged, as it is a limited market that cannot be scaled simply by pouring in more money, and the quality of investors and their ability to add value to startups is still a key differentiator (6m24s).
• The fact that many multi-stage funds are now investing in seed rounds does not necessarily mean that the market is becoming commoditized, as these funds are often using different strategies and approaches to investing in early-stage companies (6m34s).
• Some firms, such as Benchmark, have stuck to their seed strategy and maintained a concentrated portfolio, while others have expanded into asset management and may appear to be offering commoditized products (7m23s).
• Founders often prioritize quick cash at a good price and may not want investors to be too involved, but the best founders are often looking for a partnership with investors who can provide value and support throughout their journey (8m0s).
• The multi-stage funds are creating competition for seed players by offering higher prices and more money, but the best founders are often looking for a more nuanced partnership with their investors (8m11s).
• The contract that founders are looking for with their investors can vary, with some prioritizing cash and independence, while others are looking for a partnership with co-founder-like investors who can provide support and guidance (8m21s).
• Top founders often pick their investors carefully, looking for partners who can provide value and support, and may not necessarily choose the largest or most well-known firms (9m2s).
• The analysis of a successful investment in UiPath showed that even if the initial investment was made at twice the valuation, the outcome would still have been fantastic, although the multiples would have been lower (9m59s).
• The investment in UiPath brought back $2.1 billion in proceeds from a $16.5 million investment, demonstrating the power law in action (10m27s).
• Fund one had a 20-time multiple on invested capital, with 85% of the proceeds coming from UiPath, and the remaining 2.7 times multiple from other investments (10m59s).
• Despite knowing that valuation doesn't matter, the firm still needs to operate with an idea of value and consider whether the entry price is fair (11m37s).
• The firm tries not to lose on price but constantly questions whether the entry price is fair and whether the company warrants it (11m49s).
• In the past, the firm has passed on price and has a mixed track record on whether that was the right decision or not (12m12s).
• One of the biggest losses was not investing in Bolt (formerly Taxify), a ride-hailing company, due to concerns about the market and take rates (12m30s).
• With the benefit of hindsight, it's clear that being more open-minded about the ultimate margin structure of the business would have been beneficial (13m11s).
• The firm met Bolt during their seed round, and the margin structure of their business was not a major concern at that stage (13m19s).
• Information about Cem Sertoglu and his background
• Discussion about the greatest venture investment in European history
• Lessons learned from this investment
• Insights into the European venture capital ecosystem
• Examples of successful investments or companies

How Cem Prioritizes Founder, Market, and Traction (13m41s)

• The prioritization of founder, market, and traction is crucial, with the founder being the top priority because ultimately, at the early stage, it's the only thing that matters, as great starts can get bungled badly due to founder problems (14m13s).
• The founder trumps all, and some promising companies have been passed on due to issues with the founder, including character, ethical, and values problems (14m29s).
• Market is the second priority, as everything done needs to be able to return the fund if all goes well, and a small or crowded market can lead to passing on an investment (14m40s).
• Traction is a distant third, as it tells something in some cases but is not as important as the founder and market at the early stage (14m55s).
• Scenario planning on outcome sizing and where the return on investment would be is done, but sometimes the actual outcome can be very different from the initial analysis, as seen in the case of UiPath, which has returned 12 times the fund already (15m12s).
• Founders have a choice between different investment products, and the advice is to consider the care and attention they will receive from the partner, as a small partnership can offer more distinct capacity, attention, and care (15m59s).
• The typical first check ownership is between 10 and 20%, but it can vary depending on the situation, and sometimes not being dogmatic about ownership can lead to better outcomes (16m54s).
• Sticking to principles is important, and passing on investments due to ownership issues has been done in the past, as having a certain number of bullets per partner per fund is a consideration (17m17s).
• The number of companies per fund can vary, with fund one having only 15 and fund two having 18, and selective pre-seed and B round joiner checks have also been done (17m31s).
• B round joiner checks can be good, but they are not always the strong performance driver for the fund, and their success depends on the company's outcome (17m51s).

Signalling Does Exist? (18m11s)

• Signaling is considered to be very real and can have dangers, with the importance of analyzing signals from the capital table and everyone involved in an investment being emphasized (18m18s).
• Analyzing signals from the capital table can provide interesting insights, including how investors are behaving and making follow-on decisions (18m25s).
• The biggest reason companies don't scale efficiently from 0 to 1 is often assuming product-market fit prematurely and being tempted into hyperscale mode too early (18m55s).
• This premature assumption of product-market fit can be due to a combination of factors, including having the wrong data, wrong objectives, or simply believing the hype (19m17s).
• The industry's focus on growth can also contribute to this issue, as it creates a sense of perverse validation for founders who prioritize headcount growth (19m26s).
• When companies scale too quickly, they may lose the ability to adapt and iterate, particularly on the go-to-market side, which can lead to sideways trailing and a decline in performance (20m11s).
• A common scenario where this occurs is when a company raises a large round, hires recruiters, and scales its go-to-market team too quickly, without ensuring that the sales script is a perfect fit for the company's current stage (19m48s).

When & How to Address Concerns with a Founder (20m24s)

• When addressing concerns with a founder, it's essential to communicate clearly and carefully choose the right moment to share strong opinions, as being overly negative or critical can be detrimental to the relationship and the company's growth (20m29s).
• A healthy board dynamic is crucial, where all board members, including VCs, can have open and honest conversations with the founder, both in group settings and one-on-one, to discuss sensitive topics and provide valuable input (22m47s).
• The valuable relationship between a board member or VC and the founder should allow for better timing and introduction of sensitive topics, rather than bringing them up for the first time in a board setting (23m5s).
• Choosing the right topics to discuss and bringing them up in a carefully considered manner should not be a problem, as long as the board member or VC is prepared and has a deep understanding of the company (23m23s).
• The primary commodity that VCs sell is not cash, but rather their time, attention, and capacity, as well as a spot in their fund's portfolio, which is a valuable resource for founders (23m49s).
• The best founders need a group of smart, aligned individuals who are on their side and pushing in the same direction, rather than just an investor, to help them create a successful startup (24m19s).
• The goal of a board should be to support the founder, rather than to demonstrate value or contribute unnecessarily, as the founder typically knows their business better and has more skin in the game (25m15s).

Advising Founders on Early-Stage Valuations (25m32s)

• Advising founders on early-stage valuations involves considering a heuristic where the founder should feel incredibly confident in raising the valuation 3x the price in the next round, with a benchmark of 2-3x depending on the stage (25m39s).
• Early rounds are not considered real rounds, but rather contracts demonstrating alignment around a target that is far out ahead, with investors essentially buying a very out-of-the-money call option on these businesses (26m2s).
• The early-stage investment is not a trade, but a construct for alignment and partnership between the founder and investors, where the founder is committing to a journey with a select few people and investors are committing to be all-in with the founder for the next five years (26m27s).
• The seed round is viewed as a contract that establishes this alignment, rather than a real investment, and is not comparable to buying established company shares (26m52s).
• The goal is to align with founders and establish a partnership, with the understanding that the founder team will be one of the top priorities for the fund over the next five years (26m42s).

Where Founders and VCs Often Diverge (27m1s)

• Founders and VCs often become misaligned due to disagreements during the term sheet process, which can lead to a lack of trust and a negative environment to operate in (27m1s).
• A contentious negotiation around specific governance terms in the early round discussions can leave a bad taste in the mouth on both sides and create a lack of trust (27m25s).
• A rushed process can also lead to misalignment, as some VCs may not feel comfortable making decisions without fully understanding the business and digesting the opportunity (27m53s).
• Founders are often advised to run an efficient process, but this can sometimes feel manufactured and may lead to VCs feeling rushed and uncomfortable making decisions (27m55s).
• In 2021, when the market was in a frenzy, some VCs would not categorically pass on a valuation, but would pass on not having enough time to understand the business and digest the opportunity (28m11s).
• In cases where the process does not allow for sufficient understanding and digestion of a company, VCs may pass on the opportunity, which can be disappointing and may result in missing out on good companies (28m35s).
• Categorically passing on an opportunity is not ideal, and VCs may regret passing on companies that felt rushed but may have been good investments (28m41s).

Do High Prices Lead to High-Quality Investments? (28m52s)

• High-priced investments do not necessarily lead to high-quality companies, as some expensive checks written have matured into great companies, while others are still on their way or have struggled due to a lack of focus and urgency (28m59s).
• A few critical investments have grown into multiples of their initial valuation, but the portfolio is still young, making it difficult to assess its overall performance (29m7s).
• Having too much money too soon can be detrimental to a company's growth, as seen in the worst-performing segment of the seed portfolio, where companies struggled to raise the next round due to high prices (29m23s).
• The lines between different funding rounds, such as seed, pre-seed, and Series A, have become blurred, making it challenging to analyze track records and mistakes (29m51s).
• Pre-seed rounds have become less common, and the term is often used to describe a round with a large amount of money for a company with little to no traction (30m10s).
• Investing in companies with great founders and market potential but no traction can be uncomfortable, but it's a high-risk, high-reward situation that is normal in venture investing (30m47s).
• Venture investing is a hard profession, and one of the most challenging aspects is the time it takes for investments to mature, with even successful companies taking longer than expected to grow (31m20s).

Are Richer Investors More Successful? (31m32s)

• Wealth can impact an investor's mindset, and being incredibly wealthy may make an investor better, as they only see upside, but it's not a definitive factor in success (31m33s).
• A high GP commitment in a fund can show confidence and alignment with LPs, but it may also make the team nervous and more risk-averse, as they have a lot of personal money invested (32m1s).
• GP commitments can be flawed, as they don't account for proportionality, and a young emerging manager may not have the same liquidity as a more established investor (33m3s).
• LPs should consider the proportionality of GP commitments when evaluating a fund, rather than just looking at the absolute amount (33m22s).
• Institutional American LPs have not yet allocated to the region on a large scale, and the LP base is diverse but not concentrated in large North American institutions (33m41s).
• Venture Capital has made a mistake by following private equity in terms of LP allocation categorization, as regional investment strategies in Venture Capital are not exposed to regional macro dynamics (34m6s).
• Venture Capital outcomes are typically global, and regional macro dynamics do not impact the outcomes, so LPs should not be deterred by perceived regional risks (34m26s).
• When responding to LP concerns about political and currency risks, it's essential to show a track record of successful investments that were not impacted by these risks (34m58s).
• Portfolio companies can be impacted by various risks, but these risks are not unique to a particular region and can happen to any company, regardless of location (35m12s).
• Venture investors need to underwrite to a certain level of return, and if they can't offer a high enough price or desired ownership, they may lose deals to other investors with a lower cost of capital (35m27s).

Making $2.1BN on UiPath (36m6s)

• Daniel, the founder of UiPath, was building a company called Desk over, a consulting firm that provided custom automation and back-office applications for various clients, when he was first met in Bucharest in 2014, with the company having 12 people at the time (36m28s).
• Daniel struck a strong impression with his deep understanding of the problems his clients were facing, his technical expertise, and his strong vision for solving immediate problems, although he didn't initially have a clear picture of what UiPath would look like 10 years out (37m0s).
• Despite being very pragmatic, iteration-focused, and hands-on, Daniel wowed with his ability to see the applicability of his product in diverse situations and convinced that every single company in the world could be his customer (37m51s).
• Initial concerns about Daniel included whether he could be a go-to-market leader, given his limited English fluency and narrative storytelling skills, but these concerns were alleviated as he interacted with potential co-founders and early hires (38m28s).
• The deal to invest in UiPath involved raising $1.5 million, with the initial plan to do the full amount, but ultimately, Kredo co-invested, and the company was shown to 14 funds at the first seed round (39m44s).
• The investment in UiPath is considered one of the greatest venture deals in European venture history, with a return of $2.1 billion from an initial investment of $16.5 million (36m6s).
• A company, UiPath, initially raised $1.6 million in its seed round, with a pre-money valuation of around $7 million, despite having only half a million in revenues at the time (40m11s).
• The company's founder, Daniel, had started out as a solutions provider before finding a product idea and building a product, which took around nine years to develop (40m32s).
• A $150 million fund invested $1.5 million in UiPath, which is a 1% check, due to the company being off the beaten path and not fitting the typical mold for investment (40m48s).
• The fund's initial investment was not enough to build a global software company, and they had to bridge the company by themselves, with the help of co-investors, after around 40 firms passed on investing in UiPath (41m24s).
• The company was doing well, with clients getting value out of the product, but the numbers were not exceptional, and the fund had to use their reserves to support the company (41m44s).
• The fund proposed a deal at 20, but Daniel would have taken 25, and they couldn't agree, which led to a learning experience about doubling down when the numbers are pointed in the right direction (42m16s).
• The feedback from the market was poor, with many firms showing little interest in investing in UiPath, which led to the fund agreeing on a convertible structure that ultimately converted at around $60 million (42m54s).
• The fund regretted the price of the convertible, but when the numbers started to show, the picture changed, and everybody became interested in investing in UiPath (43m26s).
• The fund invested a total of $6.5 million in UiPath, including $1 million in the seed round, $2.5 million in the bridge round, and $3 million in the A round, and introduced them to Excel (43m41s).
• What changed in the business was the numbers and traction, which provided proof of the company's potential, leading to increased interest from investors (43m50s).
• Everybody wanted a piece of the company, and Exel led the A round, with the company raising $80 million at a valuation, then Rich Wong at XL Growth led the B round at a billion-dollar valuation about a year and a half later (44m1s).
• The company wrote a $10 million late check with their hands shaking at the time, but it turned out to be a bold check for a strong performer (44m25s).
• The company raised the size of their fund to $1 billion, which was a tough one to underwrite, but they saw the trajectory of the company and the fact that there were a few things in place, including the Japanese market being a very important early market for UiPath (44m46s).
• The Japanese uptake was very fast, and the company could see that when the market conditions are right, back office clerical work in Japan is hard to fill by enterprises due to demographic reasons (45m5s).
• The revenue trajectory of UiPath was impressive, going from $1 million to $100 million ARR in 21 months, which was the fastest ever for a company to grow that fast at the time (45m30s).
• The company decided to write a $10 million check at the billion-dollar valuation, but it was not a fast decision, and they ended up deciding to write the check, which turned out to be the right decision (46m14s).
• When Sequoia led the $3 billion next round, the company did not participate, and when the $7 billion valuation series C happened, they started to carefully divest and realize some of the gains (46m22s).
• The company's kind of prudent investor responsibility to their LPs was to try to start to realize some of these gains, and they sold between 1% and 10% of their holding in each case, with their secondaries being all at a premium to the primary round (46m57s).
• The strategic thought process behind how much to sell was an analysis at the time of what their holding of that asset looked like, and they tried to triangulate to the price they may be able to sell at (47m26s).
• The company's share class was at the lower class on the liquidation stack, and the subsequent sell-down resulted in a high watermark ownership of 18% before entering the IPO at slightly below 10% ownership (47m56s).
• After the IPO, the company executed an investment structure that allowed for a sell-down of 10% a year for the remaining five years, resulting in a realization of three to four times the fund's value (48m36s).
• Post-IPO, the company felt it had lost its edge in managing the investment, as the stock was now public, and the decision to manage the investment was left to the limited partners (LPs) (48m54s).
• The company distributed shares in-kind to LPs who preferred to receive shares instead of cash, allowing them to make their own decisions about the investment (49m8s).
• The success of the firm raised concerns that people might not need to work for the firm anymore, as they could become angel investors or stop venture investing altogether (49m20s).
• However, the firm's goal is to create an institution that will last for decades, and the team wants to work for a firm that they will one day inherit (49m48s).
• The firm believes that its edge in managing investments decays quickly in the tech sector, and it's best to leave the decision to LPs after the company goes public (50m34s).
• The firm's funds have a specific lifetime, and even if they wanted to hold onto their stake, they would only be able to do so for a few years post-IPO before having to divest (51m0s).
• The firm believes that venture structures need to change, as the current 10-year life for a fund is too short, and most early-stage VC funds are not liquid by year 10 (51m21s).
• There is a need to create friction for a GP team to consider liquidity as they approach the 10-year mark, despite the implicit understanding that the fund may not be fully liquid by the end of its life as defined by the first LPA (51m45s).
• In hindsight, it would have been beneficial to participate in the $3 billion round by SEOA, and the post-IPO divestment strategy could have been different (52m11s).
• Post-IPO block trades were made, but they felt like playing in a market that wasn't naturally suited, suggesting a potential change in divestment strategy (52m20s).
• The UI path process could have been improved, with the benefit of hindsight, particularly in terms of participation in the $3 billion round and post-IPO divestment (52m7s).

Cem’s Biggest Loss (52m39s)

• The biggest loss was around $6 million in an HR business that faced regulatory issues, making it difficult to execute their vision, and ultimately led to liquidation (55m3s).
• The loss was partly due to writing a follow-on check without enough data to evaluate it properly, which could have minimized the loss (55m30s).
• The experience taught the importance of thoroughly evaluating follow-on investments, especially in the early stages of fund management (55m57s).
• The approach to follow-on investments has changed, with a more nuanced consideration of the investment amount and the stage of the company's journey (56m5s).
• A key rule for follow-on investments is to consider whether a great fund would do the next round, which can be a strong signal, but not the only factor in decision-making (56m21s).
• Having the luxury of getting validated by a great fund can be beneficial, but it's not always necessary, and conviction can be built internally (56m35s).
• The loss ratio in fund one was relatively low, with only three out of 15 investments not returning capital, and six companies still active and expected to generate returns (52m57s).
• Some returns in fund one were capped, which may have cost the opportunity for higher-risk, higher-return investments (53m40s).
• Downside protection is considered, but it's not a major factor in investment decisions, as it's often renegotiated at the point of liquidity and hasn't made a significant difference in outcomes (53m52s).

Concerns Over Current Liquidity Markets (56m41s)

• Current liquidity markets are a concern, with M&A markets closing up and IPO markets almost shutting down entirely, but this trend is likely cyclical and will come back as markets are known to be exuberant (56m41s).
• Great companies are defined by their sustainability and are not dependent on the mood of the markets, so their outcomes are not heavily influenced by current market conditions (57m17s).
• The performance of a fund is heavily dependent on its vintage, with the biggest predictor of a fund's performance being its vintage, and funds are often benchmarked based on this (57m32s).
• The majority of funds from 2021 are unlikely to achieve a 1X return, and this is likely due to the challenging market conditions at the time (58m14s).
• The current market is a difficult time to be investing, with pricing being considered "insane" and the AI bubble being particularly prolific, even more so than in 2021 (58m30s).
• It's essential to have a clear strategy and stick to it, especially during uncertain market conditions, to maintain confidence in investment decisions (58m58s).
• AI is a significant aspect of the current market, with every software company utilizing machine learning and artificial intelligence in some way, but not all investments in AI companies are considered wise, especially those involving hundreds of millions of dollars in foundational models (59m13s).
• The idea that it costs $100 billion to enter the AI race, as stated by Larry Ellison, is not necessarily true, and there may be more players in the game than he suggests (59m44s).

Quick-Fire Round (1h0m0s)

• Most people believe that an early-stage investment is a trade, but it's actually a contract for long-term alignment to build a great company (1h0m8s).
• The venture investor who is most respected and learned from outside of their own firm is Fred Wilson, who was the first person to tell them they might make a good venture investor in 2005 (1h0m29s).
• Other respected firms include USV and Benchmark, which have kept their discipline around what they think they do better than anyone else (1h0m54s).
• The most memorable first founder meeting was with a founder who was met when he was six years old, and later funded when he was around 42 years old (1h1m9s).
• The most contrarian or unorthodox advice for founders is that they usually underestimate the leverage they have on their cap table, and should know that it's their company and they will have a lot of flexibility around managing things when the opportunity comes (1h1m33s).
• Founders most care about in the term sheet that they shouldn't is the probability of success, and whether the round will impact their potential of getting where they want to get to (1h2m21s).
• Predatory terms have rarely been seen in the departure of tourist capital, but usually, they're in very difficult situations, and it's doubted that there will be any good outcomes coming from those dirty terms (1h2m56s).
• The biggest concern in the world today is that technology has been a factor in concentrating resources in the hands of very few, causing a lot of problems, and it's hoped that solutions compatible with capitalism will emerge (1h3m16s).
• One thing that is known now that was not known when getting into venture is that things take long, and patience is necessary (1h3m58s).
• A question that is not often asked but should be asked more is about data around follow-ons, which is an important indicator of care from investors (1h4m8s).