107. Reinventing Venture Capital, Part 1 (Bryce Roberts)

*Please excuse any errors in the below transcript

Nick: Today #Bryce Roberts joins us from Salt Lake City, Utah. #Bryce co-founded # O’Reilly AlphaTech Ventures with #Tim O’Reilly and #Mark Jacobsen, and more recently founded #Indie VC, one of the most unique and contrarian venture firms I’ve come across in my time doing this. #Bryce, you may be the most recommend potential guest from other VCs that I’ve ever had. It’s really a huge pleasure to have you on the show!

Bryce: Thanks for reaching out! I’m glad we get a chance to talk.

Nick: Absolutely! So, can you start off just with kind of your story and your path to venture?

Bryce: Sure. Yeah, I’ve always had an interesting entrepreneurship, started a few companies, joined a company kind of at the tail end of the dot com boom, that ended up getting acquired by monster.com. I was in Salt Lake City, Utah at the time. And a friend of mine was, was a VC in town and he asked me to come spend some time with them and four years later I had a pretty good, good sense for at least what the business was and what it could be and, and what interested me about it. And so I had also felt like it was an opportunity or good timing for me to step out and, and try something on my own to start my own firm. And so that’s when I, that’s when I got to know #Tim O’Reilly and #Mark. We, we had started to kind of coalesce around the same kinds of ideas. So this is back in 2005. And these ideas were driven a lot by, you know, some of the publishing that, that #Tim was doing, some of the investing that he and #Mark had been doing, and then some of the trends that I had been seeing at least in, in venture, which were kind of conventional wisdom now but it was, you know, pretty radical thinking back then that open source software, hosted infrastructure, all of these dynamics that were coming together to drive the cost out of getting a business up and off the ground, could open up a new class of investment. And so, you know, in the earlier stage it was called a lot of different things but, you know, super angels or micro VCs, there were a lot of different terms were kind of floating around. But there were a handful of us that were institutionalizing in it. So we, we founded #OATV in 2005. We raised a fifty-ish million dollar fund to go after what’s now become known as the seed category. But this idea of half a million dollars to a million dollars of investment an entrepreneur can take that kind of straddles, straddles of gap between, you know, where traditional angels were investing and where more established Sand Hill Road types of VCs were investing. And so we’ve been doing that, you know, we just, we hit our 11 year mark recently. And so, you know, I was reminded of that because we were, I was getting a lot of LinkedIn congratulations just this week. And I couldn’t figure out what I was getting congratulated for. But, but that was it. We, you know, we feel really fortunate to have been at the front end of what’s now proven to be a really compelling investment category for companies and for LPs. I mean, you know, that first fund took us nearly 2 years to raise. It was, it was not an easy story to tell and it wasn’t one that particularly institutional LPs were all that interested in at all. And so, you know, it’s been fascinating to kind of watch the seed category grow from, you know, a handful of us, 5 or so firms to about 500, you know, institutional seed funds since. So it’s been amazing to watch that, that kind of category reshape and look at the impact we’ve had on both founders and, you know, kind of overall conversation around venture.

Nick: So what was the original thesis and, and focus area when you guys launched #O’Reilly AlphaTech?

Bryce: So, so for #OATV it’s always been around this idea of watching the alpha geeks. So, you know, we define an alpha geek as someone, you know, there’s, there’s a class of people whether it’s in, you know, fashion or whether it’s in sports or whether it’s in art, there is this kind of core group of folks who always seem to be a couple of steps ahead of people. They’re always kind of playing with the most interesting toys. They’re always wearing the kind of thing that’s not on a runway yet or that will be kind of influencing culture. And we think tech has always had those as well. And, and we think those technologies and those alpha geeks tend to kind of evolve in a, in a certain way. And so if you looked at one of our pitch decks from a few funds ago, you would have seen that kind of evolutionary graph of, you know, the, the ape evolving into the upright human. And, you know, we talk about our investment theme along those same lines. Meaning we look for kind of a primordial soup of technologies that the alpha geeks are hacking with, things they’re spending their time on nights and weekends with. And then we invest behind those trends in terms of that timeline. So we try to find those themes that are going to evolve over time from the hobbyist into venture fundable, you know, enterprise level types of technologies and companies. And so, you know, we, some of those themes have been, you know, in the early days of the maker movement we were very involved in that. When you look at when we were very first starting, there was a theme that #Tim was really promoting heavily that seemed to really take hold, which was the Web 2.0 theme. And you watched the evolution of the Web 2.0 theme from very what would be considered maybe even silly little consumer services, #Bloglines and #Del.icio.us and #Flickr, and you watch, you know, the kind of impact that each of those have had has been tremendous. And so we’ve kind of picked up little themes along the way that dovetail into this overall theme of what alpha geeks are hacking on. So early on watching the alpha geeks hacking on Google maps and doing mashups, which led to location services and now, you know, you’ve got Pokemon Go that’s out there. And there, we, we think that those tend to be early signals. And so I think as much as we’ve tried to be pickers and investors, we’ve also tried to be spotters in terms of what the long term trends are that folks will be influenced by. And so that’s kind of what we built our themes around. And so if you look at the historical #Indie VC or #OATV portfolio companies, you’ll see a pretty eclectic group of companies but combined they’ve made for a fairly compelling portfolio effect and, and the returns have been beneficial for us as well over the years.

Nick: Pretty cool that that was the viewpoint 10, 11 years ago. I feel like, I feel like I hear some of the most famous VCs in the industry sort of projecting that same message now. So

Bryce: Well, you know, we, like, we’ve always told our LPs, you know, we, we may not always be right in terms of the individual picks, but we’ll always be interesting. We’ll always be in kind of the right areas. And, you know, I think over the last 10, 10 to 11 years we’ve been very fortunate to be early to a lot of those emerging trends and, and that theme. And we’ve kind of, you know, from the very foundation of the firm, right, you know, this idea of kind of spotting the seed trend early. And we’ve definitely honed and developed that, that idea of spotting trends early on. We’ve been at the front of those which has oftentimes been lonely and scary for a little bit. But ultimately it ends up being pretty rewarding.

Nick: Got it. So what was some of your functional background with the, the company that was purchased by #Monster? Were you a technologist, were you a designer, what?

Bryce: I, I, so my undergrad was in, in philosophy and I was, I was, I was planning to go to law school with the idea that a law degree would give me this great skill set to bring into business. I always had, I always wanted to be an entrepreneur. I always wanted to start things and be involved in starting things. But, you know, my, my grand plan of, of being the startup lawyer never really panned out. I started doing companies instead and realized I had some other, other skills that were equally beneficial. So, you know, I’ve been more in a sales marketing product capacity in most of the companies that I’ve been involved with.

Nick: Let’s transition to, to #Indie VC a little bit.

Bryce: Yeah

Nick: And for the audience, you got to jump on this website. So it’s indie.vc . There’s a picture of a flaming unicorn on the cover page, not much else

Bryce: Subtle, right?

Nick: Yeah. If you’re not into unicorn hunting, then this is probably the interview for you. So, you know, it’s kind of been in stealth mode. There hasn’t been a lot of information on it. But before we get into all the details, can you talk about how you transitioned from #OATV over to #Indie?

Bryce: Yes. So, about, you know, it’s probably just over a year and a half ago now, we, we put up essentially a landing page and a blog post at a URL that was indie.vc . But it was probably 5 to 6 years of, of soul searching and conversations and wrestling with what, what this thing could or or should be or, or, you know, what kind of impact we want it to have and what, what our objective was with it. But ultimately, January 1 of 2016, 2015, I hit publish on #Indie VC. And, you know, that, the idea behind #Indie VC was one that had kind of been building over the years. I mean, we talked about the early days of seed investing, and what the objective was in seed investing early on I think was really well captured in a blog post that #Joe Kraus wrote in 2000 probably 2005, 2006, where essentially, you know, the idea that seed investing shouldn’t just be a bridge from angels to traditional VC. It should create this fork in the road, right. It shouldn’t create a new kind of optionality. When you got a smaller fund, writing smaller cheques in the companies that can go further on those cheques, those cheques should create an optionality. And so the optionality back then as we envisioned it was one of those options would need to get momentum, to hit milestones and then go raise a little bit more funding from more traditional VCs and raise in a position of strength. One was to take in a little bit of money and to be able to take advantage of early acquisitions because, you know, a small, even a small acquisition for a small firm, it really moves the needle for a seed stage fund, at least as we envisioned it back then, you know, kind of a thirty to fifty million dollar fund. You know, an early pop for an entrepreneur has a life changing financial event for themselves and, and we can kind of participate in that upside. We thought there would be, you know, that ought to be an option for entrepreneurs early on. And then the third theme that, you know, on a relatively amount of capital these technology businesses are insanely cash efficient and very, very profitable, or have the potential to be very, very profitable early.

Nick: Sure

Bryce: And so, you know, the, the third option was, you know, if you’ve got a company you really like and you don’t want to be told how to run it by outside investors and you don’t want to sell it because you enjoy building it and building it with the people you are creating it with, you ought to have the option to continue to run it indefinitely. So that’s how we kind of originally envisioned seed investing. And I think part of #Indie VC initially was just kind of response to a bunch of conversations with, that I had had with entrepreneurs who had wanted to build their business in a certain way but found that they had to position it and to build it in a way that really kind of mapped to the pattern recognition of Sand Hill Road and traditional VCs. So rather than the seed round that we did creating optionality for them, it ended up getting them, you know, kind of hooked early on venture capital and then kind of getting on these fund raising cycles.

Nick: Yeah

Bryce: And so rather than being a pain reliever, it became kind of a gateway drug to, you know, this idea of, you know, building a massive business, you know, raising loads of money and kind of creating what our world has, you know, kind of deemed the archetype of what a successful business ought to look like. And so, you know, after those conversations and after recognizing that we had lost a good chunk of that optionality that we had originally envisioned for seed investing, #Indie VC was an attempt to try to reintroduce and hard code that optionality into both the messaging and also into the terms that we use when we invest. And so we, what we ended up doing is with our third fund I had mentioned, #Indie VC had been on my mind for a while, for years and years and years. So when we raised our third fund, which was an $85 Million fund that we closed in 2012, we told our LPs we wanted to take a small allocation and try this kind of very formative idea of, of what I had been thinking of that became #Indie VC. And, you know, they were on board with it. We, we ended up doing a small pilot last year with 8 companies, that was a result of that landing page and, and getting people to apply. And, and we we offered to invest 100K in 8 companies. And part of that was that, you know, if we didn’t get, you know, if we didn’t meet 8 companies that we were excited about, we wouldn’t do it at all. And, and that was part of what I had to be open to going into kind of hitting publish on the #Indie VC site, was that there may not be a market for it, there may not be entrepreneurs who were interested in this, or the companies that it might attract might not actually be very good companies. And so,

Nick: Sure

Bryce: what was interesting initially was that there was just this kind of immediate response to it. And, you know, I think when we first published the site, it was somewhat anonymous. The only way you would have known who was behind it was if you clicked the link to email me about a slack channel that I had set up for people to ask questions. And so, but probably within, within an hour or so, and this was new year’s day 2015, within an hour or so of hitting publish it was at the top of Hacker news and it stayed there for days.

Nick: Wow!

Bryce: As people were asking questions and trying to kind of crack the code on who was behind this thing and is this real, it seems shady, and, and, and so the response was kind of immediate. And ultimately we ended up finding 8 really great companies that we ended up investing a $100,000 in under a kind of unique set of terms. And I don’t know, we’re, we’re a year an a half later and a bunch of those companies are very profitable. A few of them are very close to profitability. But all 8 of them are still, are still going. They’re still all in business. And so that’s kind of how #Indie VC started. And then it’s, it’s evolved from there. It’s, we released a, a Version 2 of it and, a couple of months ago. And the, the changes with Version 2 are that the terms have tweaked a little bit, the cheque sizes have increased, and it’s the primary focus of our newest #OATV fund, which is our fourth fund.

Nick: Got it. So, on first pass there wasn’t a ton of information at first about what #Indie VC was,

Bryce: Yeah

Nick: Despite this fact that you guys are, are fairly transparent, I’ve seen your terms are published on #GitHub,

Bryce: Yeah

Nick: you’ve done a couple articles that detail out all the specifics on what #Indie invests in. But, you know, some people I think have been quick to classify, you know, is this a small business loan program, is this a funny accelerator, is it an incubator?

Bryce: Yeah

Nick: Can you talk about or give us an overview of what it is you are doing, and even more importantly, what are you not with #Indie?

Bryce: Yeah. So what we’re doing is we’re hard coding that optionality that seed investing was originally designed to do into a set of terms. Those terms are designed to encourage entrepreneurs to build independent stand alone profitable businesses rather than achieve the next fundable milestones to attract more follow on capital. So our focus is on businesses and entrepreneurs who want to build long term sustainable growing, thriving businesses that don’t require a ton of VC cash. They want to build their company on their terms. And I think what we’ve seen as VCs over the years and, and as the venture market has matured, is that, you know, there, there’s kind of, there’s essentially one track that a lot of the venture product ends up selling, which is this idea of a unicorn. That’s why it has kind of captured everyone’s imagination. But it’s also the reality of, of the venture industry, right? I mean there’s, you know, the unicorn was based on a study that was done by #Aileen Lee while she was defining her own investment style. What they found was that .09% of companies achieve a billion dollar plus type of valuation. The flip side of that is that those billion dollar companies drive the vast majority of returns for the traditional venture market. And so if you’re an entrepreneur and if you go  the traditional VC route, all of the emphasis and all of the focus is on finding and growing those businesses that could potentially become unicorns. And so we think that’s great. And, and I think the way we’ve structured our terms are such that if it turns out that one of the companies that we’re involved with has the founder with the proclivity and the desire and wherewithal to build a massive billion dollar business, we’re thrilled to be a part of that and help support that entrepreneur. I think we’re also, you know, what, what we’ve designed is the situation where if a founder is happy running, you know, if he, if they build their business in such a way that it turns out it is not the .09% of companies that go on to become a billion dollar company, that they can run it on their own terms, that they can continue to have that optionality based on, you know, focus on revenue versus having to be wholly dependent on, you know, the VC market or the overall financial markets or any kind of return for themselves or for their investors.

Nick: Yeah, I think that the reality is there’s this huge gap between the boot strap companies and the billion dollar unicorn venture funded companies. There’s,

Bryce: Yep

Nick: There’s just a, an enormous number that, that are in between the two, right? That don’t have access to capital but

Bryce: Yeah

Nick: may not want to get on the, the venture funding perpetual circuit

Bryce: Or, or may want to put it off for as long as possible. They may want to only consider taking venture money when they’re in a much more leveraged position and they are with a napkin or even a, a little bit of data,

Nick: Right

Bryce: on, on what it is they have. Yeah, I mean, one of the, one of our little catch phrases that we’ve developed over the, over the last year is that, you know, there is a lot of opportunity that sits between a lifestyle business and a monopoly, right? VCs need monopolies to drive their returns. We don’t. And I think part of the frustration that I had as, as a seed investor for the last few years is that I had to essentially use the same lens for a small fund that could get meaningful returns off of things that aren’t billion dollar companies. I had to use essentially the same lens to evaluate seed stage companies because I needed, I became dependent on upstream capital to be able to support the kinds of things that we were investing in. And

Nick: Sure

Bryce: so, you know, it just, it really makes you reframe what it is you’re looking at when the objective is what’s something that could become a billion dollar company. And you’re, you know, what kind of milestones though can we, do we need to hit in the next 12 to 18 months to be able to show signals if that’s the case and to be able to attract follow on capital. That becomes a fairly frustrating dance that you have to do as a seed stage investor. You know, if you like founders that don’t fit the, the Sand Hill Road mould, if you like themes that are out of favor, if you like, if your fund works with a $100 Million exit or a $50 Million exit, all of those what seem like kind of small detail that are small nuances, they actually become pretty massive. It becomes a very big overhead that you have to process as part of your evaluating investments. And so as a result I think that leaves a lot of entrepreneurs on the sidelines. I think it leaves a lot of things that might be considered niche or out of favor on the sidelines, when it reality like so many of those niches, so many of those sectors that are out of favor, you know, if they can put themselves into a position where they can be growing on their own revenue without having to rely on outside funding, we think a lot of those, there’s a lot of uncapped opportunities that sit out there getting ignored or overlooked. We just think it takes a really serious and important, not only mind shift from a founder to be focused on growing their business and growing their revenue, but it also takes an entirely different network of folks to be supporting that entrepreneur because the advice they’re getting from the mainstream channels of venture VC blogs and startup blogs is actually not very good advice for someone who’s trying to build a, you know, a revenue generating, independent profitable business.

Nick: Right

Bryce: And so, you know, I think part of your question was, you know, what’s the difference between this or VC or loans. I think what we’re really trying to create is essentially an alternative universe for startups that are, that are ambitious but they, you know, they, they want the support and oversight that a VC can provide, they want access to capital, but they want to be able to build their business on their own terms. They don’t want to have to be totally reliant on those investors, they don’t want to have to give up control of their business. Those are the entrepreneurs that, that we’re speaking to. And I think what’s been encouraging us from that very first landing page that went live in 2015 is that that audience seems to just be growing, right? And I think from our standpoint, if we have an opportunity to have that dialogue and to shape that dialogue, we think that that’s a pretty unique opportunity to be in as a fund. And so that’s why with, with the new fund we just raised, our focus is going to be primarily on, on that #Indie VC style of investing versus the kind of traditional funding for every 12 to 18 months seed round type of stuff we’ve been doing.

Nick: Sure. I think part of the reason I appreciate this so much is when I first started I came from a company called #Danaher, where cash flow was king. Everything is all about cash flow with them. And we would look to acquire companies, we would look to invest in companies, but these were really high potential, great tech companies that never had any unicorn potential really. They were in, you know, nuance niche markets. And so when I first started investing full time, my first handful of deals were more in line with what you’re doing. Now I didn’t have all the same terms that you do, I was using something called convertible debenture,

Bryce: Yep

Nick: I was using cash flow kickers, gross profit kickers, but basically doing a hybrid structure where, you know, an investment could function kind of like a loan, but in the event of a good exit, then it could convert into equity and also some payments, you know, some liquidity in payments back from the companies because the deal flow I was accessing at that time was in that massive middle. It was

Bryce: Yeah

Nick: you know, not these slack type companies but really great companies that had maybe less ambitious goals but were more revenue focused and cash flow focused in the near term.

Bryce: Yeah, no, I mean, I think for us what we, what we try to do in, as it relates to terms was we tried not to be a, we tried to align ourselves with the founders. And so if you look at our, even our cash flow distribution type of option, it’s tied not to revenue, it’s not tied to profitability, it’s not tied even to a timeline. It’s tied to the founder’s incentives. And so if the founder wants to keep continuing to invest in growth, we never see a cash distribution and we’re, we’re happy to be involved with the business who wants to keep investing in growth and continue to grow. If an entrepreneur says okay, I love running this size of business and now I’m going to start taking cash off the table, it’s only at that point that we start participating. When they’re ready to stop investing in growth and start realizing some of the cash flow that’s coming through the business, that’s when we start participating in terms of any kind of a dividend or cash returned to us. So we think there is, our, our objective early on was to keep it simple, to keep it kind of one sheet of paper and ideally aligned with, with entrepreneurs and hard coding that optionality in. And as you said, there is a lot of companies that, that are overlooked by VCs, but there’s also a lot of companies who really, the’ve kind of gone the VC route and they either want to avoid it or they want to put it off as long as possible. And I think as we started to unpack our story a little bit more, I think there has been a pretty broad cross section of each of those groups for whom our story resonates. And I think with the new fund at least we now have a focus and an ability to explore who those folks are, what those opportunities look like and how to best support them to achieve whatever outcome it is they are looking for. And I think if we can be helpful in helping them do that, I think our fund will end up being, you know, a top performing fund alongside anybody else.

Nick: Yeah. So while we’re on this topic

Bryce: Yeah

Nick: I want to get more into the details of sort of the structure of the investments and how the economics work

Bryce: Sure

Nick: I would encourage the audience to check out the show notes and I will link up the links to #GitHub that detail out all the, the term sheets and, and various economics. But at a high level, can you give us some of the specific differences on the, on the term sheets that you structure versus maybe the, the traditional term sheets or convertibles?

Bryce: Yes. So, you know, most of the convertible notes that are out there right now anticipate another round of funding. So they have things like, you know, maturity dates, they have interests, they have, you know, a bunch of, there’s a bunch of things that are baked into those with the idea that you’re going to, you know, they’re called convertible notes for a reason, right? They are intended to convert into a round of funding. And so what we did is we stepped back and we said okay our objective was full control to the entrepreneur, no kind of preferences or votes or influence over the company other than being a business partner to the founder and helping them. We don’t have, we don’t want to have any kind of formal oversight or governance structure. So we essentially came up with a, a note that is an indefinite note, with the idea that there was kind of three features to it. One is, you know, in the event that a founder chooses to sell the company, we, we are never a shareholder unless one of, one of two things happens. One, they choose to sell the company. In that case, we have already agreed upon a percentage of the company that we would own if they end up getting bought in. So we just go, you know, we convert common stock and we go through in a transaction when they, when they get bought at that agreed upon percentage. If they end up raising a round of funding, we use that same percentage we had agreed upon earlier and we convert into whatever round they do, we just convert in as a preferred shareholder in that round so we’re on an equal footing with, with the new investor that’s, that’s leading that round. So that’s, that’s another option. And the third is because the note doesn’t have an expiration date, they can continue to run their business indefinitely. We do not have an interest rate, we don’t have any of those types of things tied to the note. But what we do have is when we structure the investment, we have a conversation with the founder and say what’s a reasonable salary that you’d like to be able to pay yourself, what’s a market for a company in your market? And we agree to a base salary. And then when they, when they want to pay themselves total comp, so, you know, salary, bonuses, all that stuff, more than a 150% of that initially agreed upon comp, we consider that a cash distribution. And so we split whatever, whatever’s above 150% with them, we just split with them until we receive a multiple on our investment. And then at a certain multiple we stop sharing in those distributions at a, what we have is a 5x return on our initial investment, we stop sharing in any further participation. The other thing we baked in as part of the Version 2 that we rolled out recently was that if they, if the founder hits that 5x cap in under 4 years, we will cut the equity option that we agreed upon earlier in half. And so that’s a bit of an incentive for them and it’s certainly an incentive for us to try to help get them to profitability, you know, as, as quickly as possible. So those are the, those are the kind of terms. You mentioned we’ve published all of these on #GitHub. We have terms that are available for seed corps and we have terms that are available for LLCs that kind of map to that, that general philosophy.

Nick: Would it be possible to walk through sort of a simple example of how these economics may play out in a couple common scenarios?

Bryce: Yeah, of course. So let’s see, let’s just use round numbers. And so, you know, let’s say we find a business, they find us, they want a $500,000 investment from #Indie VC, the conversation is something along the lines of $500,000 and again, we’re just using round numbers for simple math. This is not any particular deal. But $500,000 for that $500,00 we agreed on any, you know, sale or conversion that #Indie VC receives 10% of the company. We are not shareholders, we are not setting evaluation. We’re just saying in some future event we might, you know, we would own 10%. And we also agree with that founder that the market salary for them for a kind of a seed stage funded company for a CEO and management team is roughly $100,000. And so let’s say we’re a year or two into it, the company is doing well, you know, the founders have been increasing their total comp, they’re now at a $150,000 but it’s been a really good year, they want a bonus out a million dollars to, to their executive team. What we would do is that, you know, as part of our deal structure we receive 80% of those distributions until a 2x cap is met. And then at 2x it lifts to a 20/80 profit sharing. And so on that first million dollars out, we would take 800,000 of that, the management team would get 200 once they hit the 2x cap which would be a million dollars on our initial $500,000 investment. Then it switches to 20/80. And that’s how the, the profit sharing would go. And as we discussed a little bit earlier, once they’ve returned to us 5 times our original investment, then we cap our distributions. If they want to keep paying out cash to themselves, that’s great. We achieved our return and there’s no more expectation that we’re going to be getting any more cash out of the business. It’s now theirs. And if they, if they hit that cap in, in the first 4 years of our engagement, then that agreed upon equity of 10% would get cut to 5%. So that’s, that would be a scenario. Is that helpful?

Nick: Yeah, very helpful.

Bryce: Okay

Nick: Can we talk a little bit about the companies that you’re choosing for the, for the investments? Can you talk maybe about your filters, what level of traction you’re looking for and what else you’d like to see in prospective applicants?