Investor Stories 20: My Investing Strategy (Huston, Brown, Heltzer)

*Please excuse any errors in the below transcript

Nick: On today’s special segment we have #John Huston. John, you’ve been very generous with me sharing your investment philosophy and the ways that you work at critical due diligence risks in pre investment discipline as well as post investment management. Would you take a few minutes to talk about your investment strategy and how you evaluate startups for investment?

John: Yes, at a high level, I have three major approaches to do diligence. I got to like person and think they deserve to win and they admit they need help and I think it can be a good investment but the most important thing to me is the exit and by that I mean, who really is going to drive it. I’ve said that many times but working back from the exit, I want to make certain that the people who will be orchestrating the exit are good at it and if they’re VCs, I will not presume there’s exit oal congruence with the angels. So that’s a risk that personally tends to make me more hesitant to invest in deals where I know VCs will drive the exit because there was to their L.P.’s. just like I’m loyal to the Huston household, particular my wife and I wouldn’t expect them to care about the Huston household and I certainly don’t want them to care about my wife. So, we really have different concerns. I’m not whining, it’s just the reality and so when it comes to the exit. I am trying to as my return for the Angel group as well as if I’m on the board, all shareholders but particularly for the entrepreneurs and if I know that the VCs are driving the exit, I really have to believe that the company can attract top tier expert. VCs at exits before I get excited. I guess I just can’t say enough about the exit risk and who’s driving the exit; and that dovetails with the financing risk that concerns me which is how much money has to be raised and can they raise it. One other thing I’d say Nick that I’d like to believe I’m better at… I don’t as frequently get involved in short funded early rounds. Well, as I look back at my first five years in the business are far too many times that we really short funded the company the initial Angel round. We didn’t buy them enough runway to really take off and you know where that leads. They really haven’t proven the business model. They really haven’t done much. They have run out of all cash and they’re coming back to investors saying, “Let’s give me a little bit more and we will get the necessary traction.” Too many investors get fatigued and the company, it’s crash, burn and die. So I think I place more emphasis than ever on dimension in the first round and ensuring that it buys enough runway to get airborne where I have fumbled there frequently in my first five years. That was the number one cause of my losses as I look back at it… Investor fatigue caused by insufficient runway.

Nick: Do you look at that is sort of an absolute dollar raise a mount or do you try and calculate the burn rate for the next call it, twelve to twenty-four months and then see how much time runway the raise will buy them?

John: I calibrate with this really elegant question and it goes like this and I ask it every time. So let’s put off to the side the amount of this around and let’s presume you have raised it. You were accurate in your burn rate, you have six months cash left in the bank at your burn rate and now you are going to raise the next round. Tell me the story that you feel you’ve got to tell the A1 investors so that you can accomplish the following things. First of all, you can get it done in six weeks so that you can get back to actually running the company. Secondly, you will be able to attract at least fifty percent of the investors will be new money. So you get new smart wallets and thirdly that you will be able to warrant least at twenty-five percent uptick in value. Stand up right now and make the pitch. Give me the five bullet points that you will be pitching to the A1 investors at that pitch party so that you’re confident you can meet those three criteria; Uptick, fast, new, smart meaningful money. The issue to me is try for dimension of the first round. That’s something that took me a long time to learn a short funded too many companies. So now before I agree to the size of this round they want me to invest in or lead, I wanted to tell me the pitch that they will be making after they burn through this round with the exception of let’s say six months burn in the bank and what compelling pitch will they be able to make to the A1 investors call that the next round that will enable them to get out least a twenty-five percent uptick in evaluation and they can coach the round within six weeks and they can attract smart meaningful money translate as fifty percent of the dollars are from new check books.

___________________

Nick: On today’s special segment, we have David Brown. David, can you describe your thesis or philosophy on startup investing, and how it may be unique from other practitioners?
David: You know, I think the thing that is unique about TechStars is creating this communal environment to help startups. And the original investment—especially in the early years—the amount of money was very modest, eighteen thousand dollars. But the real investment here is that you bring them in early, right. You get them in the communal environment and get to know them really well and when you go ahead and make subsequent investments in them, it’s because you really got to know them over a period of time and understand really needs for capital and who’s going to be successful with it.
Nick: Are there certain sectors or verticals and/or thermals that you guys monitor and are looking for?
David: Yeah, I mean, we don’t focus around specific verticals, other than the vertical programs that we run. So of the fifteen programs that TechStars run, about half of them are what we call a horizontal program. Don’t have any area or thesis around any vertical other than they’re generally internet, hardware companies. And then the other half are the vertical programs. The ones we run with Disney are all entertainment and media companies. The ones that we run with Barclay bank are all around syntax. When we run those caps around education, ed-tech, etcetera. So in those particular programs, we have a thesis around a particular vertical, but in the ones that are horizontal, we don’t.

_________________

Nick: On today’s special segment, we have Jason Heltzer of #Origin Ventures. Jason, can you talk about your thesis and also how you evaluate early stage startups for investment and maybe mention aspects of your approach that may be unique from other venture investors?

Jason: One of the things I try to think about and this is something that #Jim Schrager, he’s a professor at booth taught me when I was a student is you really have to unpack the strategy of a business first because without understanding how a company is going to compete, it’s really difficult to understand the key questions. To me, I want to get down to “What are the key drivers of value in a business?” and I want to get to that as quickly as possible and in the initial meeting, that’s what I really focus on is, “What things have to happen for this to be a valuable business and how does the company make that happen? and when I do that, and it’s a part of our thesis, if I can figure that out really quickly in the evaluation, I can get to those key questions much faster and so much about venture is if you’re only investing in a very small fraction of investments and deals you look at, the faster you can come to those conclusions, the faster you can distill down the company’s strategy, the more efficient you’re going to be and the more time you can spend thinking about the ones that are on the margin, the ones you think really a potential are the more time you can spend helping your companies; and so to me, that has been a key part of how evaluated deals in my career. Our thesis as an investor; We are like a lot of funds where we believe in the growth of technology and you see the shift towards Mobile, you see the growth in ecommerce you know, all those things are again being ‘Captain Obvious’. You can see them. I don’t think that distinguishes us. What I do think is happening in our marketplace and I think it’s a profound change in the marketplace that you think about venture capital really hasn’t changed that much since World War two when General Doriot really kicked off modern venture capital after World War two.

Proud funding, I think is going to force a major change in the industry and if I think about our thesis, we think about that a lot and we think about how do we change as a fund to differentiate? How do we change as a fund to incorporate the benefits of crowdfunding? There’s a lot of strategic thought that we’ve put into how we have all of us a venture fund. Look venture funds have these long term arrangements with their L.P.’s for a fee income and while if you have lousy returns, you can’t raise another fund. You do a fee income streams for long periods of time and so it’s ironic because it’s an industry where we’re in the business of disruption and funding disruption but our industry hasn’t changed in the course of you know sixty years and so I think that’s changing now with crowdfunding and so for us it’s thinking about how do we do better at the things that we can do better that crowdfunding as a harder time doing and that’s a big part of our strategic thinking and you’ll see changes from us in the coming months, in coming year where you’ll see how we go to market and how we operate to be different and I’m really excited to roll out those changes. Some of them are happening now.

Nick: Based on your comment about ‘what is driving the core value in the business?” is that more about you understanding the dynamics of a particular vertical or sector or is that more the entrepreneur.Being able to communicate the business plan, what you need can how it’s going to be defensible?

Jason: You know, I would say it’s part what’s the industry dynamic is happening with competition. You know, what’s the unique unfair advantage in the company and how it creates value but again, it does boil down to strategy.You know, if you are a low cost provider let’s say that’s a strategy right? Understanding, okay, how do they maintain the low cost and is that sustainable? Is that defensible? That’s the really important set of questions that, yeah you could look at intellectual property. You could look at also to other aspects of the business.It may be completely irrelevant if they can’t maintain a low cost provider mentality, okay? So, if you have new technology you have to understand. Does it work? Can it be defended? Do people care? I mean, there’s a lot of great technologies that are superior technologically. #Betamax is superior technologically. You know look at #Token Ring versus #Ethernet. Token Ring is a much better algorithm.You’d think that’s pretty stupid how it works.

So you look at those kind of things but there are lot of other factors that make technology businesses successful and so for us it’s understand those key value drivers and also taking a holistic view of value too. It’s not always revenue. It’s strategic relationships, it’s other things too.

Nick: I love to read a book that talks about standard protocols and how they became the standard even when they’re not the best protocol.

Jason: Yeah. I mean, you could you could even make the argument for Windows. I mean, Windows… If you look at UNIX especially X Windows which is you know, an older product or even you know, even look at the NeXT machines that #Steve Jobs did.They had multitasking inherent in the operating system really, really early. Multithreading and everything where you could run two piece of software at the same time. Microsoft Windows,I mean that didn’t come until much later, I think it was ’95 maybe even ’98 when it was truly implemented. So if you look at that and say, “Boy, how is that possible?
I mean the answer was, there was more software. That was it. Period. You know, Microsoft had a very open system and engage the developers an Apple was pretty closed and Unix was very complicated in most Unix machines didn’t have a graphical user interface for some time and so it often is a lot of extra nowadays and network effects that make the difference. There not so much better technology.

Nick: How things have changed.