Shardul Shah: How Index Makes Decisions & Why Benchmarks & Averages in VC are BS | E1202

Intro (0s)

• It is important to be authentic and find your own unique strengths in venture capital, rather than trying to copy someone else's style. (1m16s)
• Mentorship and apprenticeship are crucial for career development in venture capital, allowing individuals to learn and grow. (4m6s)
• Intentionality with time and communication is essential, with a focus on shorter, more efficient meetings to maximize productivity. (5m18s)

Deciding Between Personal Meetings & Delegation (5m52s)

• Meetings are viewed as requiring a high threshold for scheduling, ideally involving two people to maximize the use of time. (6m14s)
• Meeting delegation occurs when a colleague might have better rapport with the other party or possesses more relevant expertise for the topic. (6m30s)
• An example is given regarding delegating meetings related to vertical SAS companies to colleagues Nina or Paris due to their expertise in that area. (6m40s)

Why Specializing in VC is Crucial (6m49s)

• The speaker believes in concentrations rather than majors, drawing from their liberal arts background at the University of Chicago. (7m5s)
• The speaker sees value in focusing on specific areas within venture capital, such as selection, winning, and supporting portfolio companies. (7m23s)
• While the speaker and their firm, Index Ventures, invest across all stages, they acknowledge that most investors specialize by stage. (7m41s)

Navigating Mental Plasticity Across Investment Stages (7m51s)

• The most important factor in evaluating businesses at any stage is the team leading it. (8m21s)
• One of the biggest determinants of success for founders is starting their entrepreneurial journey early in life. (8m57s)
• When making investment decisions, it's important to balance intuition with an analytical framework, but avoid being overly dismissive of disruptive ideas due to perceived expertise. (11m19s)

Valuations: Striking the Balance Between High & Too High (11m22s)

• There is a balance to be struck when evaluating companies at later stages, as price becomes a representation of future expected free cash flow. (12m17s)
• High prices paid for investments in companies like Datadog and Whiz, if they result in positive outcomes, demonstrate that the initial price may not have been excessive in hindsight. (12m42s)
• Seeking comfort in investment decisions is not the goal; instead, embracing discomfort and taking risks is essential, as the focus is on identifying outlier investments with the potential for disproportionate returns. (13m11s)

Balancing Execution, Market Timing, and Sizing Risks (13m32s)

• Market sizing is considered less important than a founder's ability to identify and capitalize on market opportunities. (14m16s)
• Market dynamics, particularly competition and timing, are difficult to predict accurately. (14m37s)
• It's important to avoid making hasty conclusions and to recognize exceptional individuals and companies. (15m20s)

Has Shardul Misread a Founder’s Potential? What Went Wrong? (15m51s)

• There are business models that require significant capital, and sometimes founders are unable to raise enough capital or their distribution model hinders growth, leading to an overestimation of market upside and an underestimation of capital intensity. (16m2s)
• An example is given of an investment where a partner is working on returning capital, but it is not the desired outcome. (16m44s)
• The best founders are not necessarily the best fundraisers, as exemplified by Olivier and Alexis, the founders of Datadog, who were not initially great fundraisers but evolved over time. (16m52s)

How Capital Requirements Affects Shardul’s Investment Strategy (17m24s)

• Capital requirements and future dilution are not major considerations in investment decisions, with the exception of extremely capital-intensive business models like biotech drug discovery. (17m49s)
• Conviction in a company's potential is built by conducting thorough due diligence, including reassessing the management team, customer calls, competitive analysis, and financial modeling. (19m10s)
• When making investment decisions, particularly at growth stages, the focus is on identifying companies with the potential for 5x or greater returns, rather than aiming for average returns or relying on the concept of a "safe 2x." (21m4s)

The Hardest Part About Doubling Down on Investments Like Wiz (22m37s)

• Identifying whether conviction in a company is delusional or valid can be challenging. (22m52s)
• Multiple approaches were used to justify doubling down on investments in Wiz, including analyzing the cloud security market size and growth potential, comparing Wiz to public companies in similar categories, and evaluating the company's performance, team, and growth trajectory. (24m5s)
• Despite strong conviction in Wiz, there was pushback and debate regarding the company's valuation and other investment themes, including product, technology, competition, traction, and market, during each round of funding. (25m41s)

How To Balance Debate & Team Harmony (26m3s)

• Walking meetings can be beneficial for conflict resolution as they encourage movement in the same direction, even when there are disagreements. (27m21s)
• Building trust, mutual respect, and admiration within a team is crucial for making high-quality decisions, but it requires time and effort to cultivate, especially in a venture firm where the power law dynamic can lead to ego and insecurity. (27m52s)
• While virtual meetings offer diverse perspectives and the ability to read body language remotely, they can also present logistical challenges due to time zone differences, potentially impacting cognitive function and decision-making. (29m46s)

Importance of Signaling for Founders with Multi-Stage Funds (31m10s)

• Founders should not be overly concerned about signaling when working with multi-stage funds. (31m22s)
• A strategy for working with founders at the seed stage is to underwrite the entire round and split it into three sleeves: one for index funds, one for seed funds, and one for angel investors and operators. (31m50s)
• The most difficult sleeve to accommodate is the seed fund sleeve because seed funds often have rigid ownership requirements. (32m50s)

Tips for Structuring Angel & Operator Allocations (33m34s)

• Founders should consider including allocations for individuals they may not need to contact frequently but who can provide support when necessary. (33m54s)
• It is not advisable to accept investments from customers due to potential conflicts of interest. (34m12s)
• Limiting the number of investors in a funding round is a recommended strategy. (34m18s)

Best & Worst Areas: Sourcing, Selecting, Securing, Servicing (34m27s)

• The most difficult competency to develop is sourcing, as it is nuanced and requires a targeted approach rather than aiming to see every opportunity. (34m47s)
• The speaker believes they are best at winning deals, and they spend the most time thinking about how to better support entrepreneurs. (35m32s)
• The speaker believes that while some of the best founders may not need VCs, having a valuable board, whether investors or independent members, is invaluable to businesses that want to dominate. (36m31s)

Key Lessons on Being an Effective Board Member (36m35s)

• Effective board members should focus on a few important matters rather than trying to help everywhere. (37m13s)
• Reflecting an entrepreneur's own words back to them can be a valuable tool for decision-making. (37m53s)
• Building strong relationships with board members allows for open communication and support, especially when making difficult decisions like declining big opportunities. (38m17s)

How VCs Can Be Damaging on Boards (40m2s)

• Venture capitalists (VCs) sometimes prioritize their own interests, such as securing a quick return on investment, over the long-term goals of the entrepreneur. (40m17s)
• This misalignment of interests can negatively impact a company's capital allocation strategy, leading to overly conservative investment decisions. (40m46s)
• VCs may push for mergers and acquisitions, even if it means acquiring struggling startups, to create a faster exit strategy, which might not align with the company's overall growth plan. (41m6s)

Right Timing on Selling & Taking Liquidity (41m18s)

• A long-term buy-and-hold strategy is preferable, allowing the market to determine the optimal selling time. (41m41s)
• If an entrepreneur exhibits unethical or incompetent behavior, immediate divestment is recommended. (42m13s)
• While venture investors may possess deeper insights into a company's operations, it's crucial to acknowledge the expertise of public market traders and avoid excessive confidence. (43m43s)

The Future of Venture: Boutique Firms vs. Cash-Rich Giants? (44m35s)

• There are two dominant models in venture capital: the "Chanel" model (benchmark-driven, constrained fund sizes, specific investment focus) and the "Walmart" model (large pools of cash). (44m42s)
• The venture capital industry is driven by the power law, allowing some firms to withstand cycles longer than expected. (45m39s)
• Venture capitalists are seeing a changing landscape in terms of investable assets, with healthcare, defense, and physical infrastructure becoming more prominent. (46m12s)

Quick-Fire Round (46m40s)

• The most important advice for improving public speaking skills is to have fun, be authentic, and record yourself to identify areas for improvement. (46m51s)
• Working closely with someone in a new office environment reveals shared values and trust, particularly in decision-making regarding office details. (47m41s)
• A common flaw observed in venture capital is the use of vague and unsubstantiated praise for founders, particularly the term "A+ founder." (48m20s)