Thoughts on Closing Loup Ventures Fund I

We’ve got a long way to go, but we’re excited to report our early progress towards building a leading investment platform pioneering frontier technology. In late December, we closed on Loup Ventures Fund I, a $25 million multi-stage venture capital fund focused on investing in frontier technology companies.

Now, Loup Ventures’ mission is a shared one.

We’re honored to work for the team of limited partners that invested in LVI. We’re grateful for their belief in us as we build something from the ground up. That trust has given us a deeper level of respect for the opportunity ahead of us: to create a portfolio of entrepreneurs we believe in.

Thanks also to everyone that’s been willing to connect with us as new VCs and support us on that journey. We’re looking forward to returning the favor and paying it forward.

Every VC Should Have to Raise a Fund At Least Once. We liken raising a venture fund without a traditional VC track record to raising a seed round as a first-time founder. We had to sell investors on our team and our vision vs what we’ve done in the past. Asking someone to write you a check to do something you’ve never done before is incredibly hard. The weight of that responsibility does not sit lightly with us. Hopefully it doesn’t sit lightly with any other investor or entrepreneur that’s gotten the same vote of confidence. Our experience of raising money has given us an intimate understanding of what it’s like to sit on the other side of the table and be the ones asking. We try to be respectful of this process by moving quickly and giving clear feedback about whether we are interested in investing or not.

Finding Product Market Fit. Much like new companies, new venture funds need to find product market fit, too. We started Loup Ventures as a research-driven venture fund, publishing regular analysis on frontier tech. Some of our approach has resonated really well. Some of it hasn’t. We’ve tried to take the feedback from the market on what is and isn’t valuable and use it to inform our strategy. We plan on being around for a long time. The only way to do that is to keep iterating to make sure we’re providing value to all of our key stakeholders.

Raising Money is an Achievement, But Not the Achievement. While we’re appreciative of the congratulations we’ve gotten on raising the fund, that’s only the first step for us. Success for us isn’t raising money or even an exit in our portfolio, it’s building a team that consistently backs transformative frontier technology companies to generate great returns for our LPs. That achievement will take much more time than it took to raise Fund I, but we’re looking forward to the journey.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

What a Venture Win Looks Like

We met with a prospective LP recently to talk about investing in a specific company. This LP had a successful business career in a traditional industry where operating profits are the bar, so he had a hard time getting his head around how to value a business based on more abstract concepts like daily active users, platform engagement, and IP. To that end, he posed a simple question, “What has to happen for us to win in this investment?” A simple, but powerful question. It forced us to reflect on our experience as public market analysts and now VCs about why tech companies have liquidity events. We concluded that nearly every tech company that we’ve seen exit does so based on the promise of profit, not actual profit. There are rare exceptions like Google, Facebook, and Alibaba who were operationally profitable at their IPOs. It’s no coincidence that those companies also happen to be some of the best performing, and now biggest, public stocks of the past decade. But most exited tech companies, whether via acquisition or even IPO, do not generate an operating profit. Most don’t even generate an EBITDA profit. We analyzed 20 tech IPOs from 2017 to put some data to our observations. We found that 75% of those companies did not generate a net profit in 2016, a year prior to IPO. 65% are not expected to generate a net profit in 2017 based on consensus estimates (only 17 companies have 2017 estimates), and 67% are not expected to generate a net profit in 2018 (18 companies have 2018 estimates). Much like venture investors, growth seems to be the more important near-term metric. Of the IPO companies for which we found data, they grew an average of 78% in 2016 and are estimated to grow 46% in 2017 and 35% in 2018. But what does this really mean about a win for venture investors? In lieu of net profit, public market investors are looking at growth to help them build a case for profit tomorrow. A small survey of buy side investors from earlier this year corroborates this. When we asked 12 buy side investors to rank tech IPO traits including short-term profitability, short-term growth, long-term profitability, long-term growth, and visibility of revenue, long-term profitability ranked first, followed by long-term revenue growth. Even for exits that happen through acquisition, profitability factors heavily. When a Google or an Apple or a Facebook buys a company, it’s preceded by a careful analysis of what the expected return of the investment may be. That return may be very short-term in nature, or it may be long term. When Apple bought Beats, they were buying a music platform that they could quickly leverage into its own streaming service. Apple Music launched two and a half years ago (one year after the Beats acquisition) and now has 30 million subscribers. That business generates a run rate on the order of $3.5 billion per year gross, which should net enough to quickly pay for the $3 billion purchase of Beats. A similar calculus is possible for YouTube or DoubleClick or Instagram even WhatsApp, although the last still needs time to come to fruition. We’re sharing this because it’s easy to get hung up on user growth, media mentions, and other startup vanity metrics. Wins require profitability, or at least the potential of it. It’s something both VCs and companies should both remind themselves of frequently.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Do You Have What It Takes to Be a Great Founder?

Every VC says they only invest in great founders, but the majority of venture-backed businesses still end in relative failure. Does that mean we as VCs are just bad judges of founders or do we not know what great founders look like? This is a question we’ve obsessed over since we started Loup Ventures — trying to define what makes a great founder and how to test for it. It’s hard. Great founders come from a host of different backgrounds, educations, genders, ethnicities. We’ve identified 10 traits across two categories that make great founders at the seed stage: Innate and Dynamic.

Innate Qualities of a Great Founder

Innate traits are character elements that are difficult to impossible to learn — either the founder has them or they don’t. Regardless of the type of business a founder starts, there are five imperative innate traits for all great founders:

  • Intelligence
  • Integrity
  • Commitment to suffering
  • Focused curiosity
  • Resourcefulness

Warren Buffett has talked about a few of these traits as things he looks for in his managers. Naval Ravikant has also talked about a few of them, so they shouldn’t come as much of a surprise. Intelligence is probably the most obvious of the innate traits. To start a valuable company, a founder must have some kind of smarts because intelligence leads to interesting insights about a market (see the next section). These insights translate into vision, which is the only truly defensible element and most important asset of any startup business. Vision is how an entrepreneur attracts talent and creates strategy.

 

Pure book smarts matter, but emotional intelligence is important too. A founder has to deeply understand his or her customers to deliver products they want, not just products the founder wants to build. A founder also has to deeply understand his or her employees and what motivates them to sustain high levels of productivity.

Integrity is the current buzz word in the startup world. We used to think about integrity as honesty, but that doesn’t seem to fully encompass the spirit of the trait. Honesty is a requirement because it means the founder learns from his or her mistakes. Dishonesty assumes problems are someone else’s fault, which means it’s impossible to learn. Ownership is a popular modern term for honesty – taking responsibility for things that happen whether they’re purely in your control or not.

The interesting component about integrity as it relates to startups is that great founders need to be willing to break rules to build valuable businesses. However, there’s a line between what’s acceptable and what’s not, and sometimes it’s blurry. Salesforce.com hired fake protestors to disrupt a Siebel conference in its early days. Clever guerilla marketing. The cases of Hampton Creek, Theranos, and Zenefits are clearly in the unacceptable camp. The ride sharing legal disputes are blurrier, although we agree that the laws are outdated and ride sharing is a significant net positive to the world. In any case, dishonesty and unethical behavior are contagious, so integrity must come from the top and be a guiding light for any startup.

The third quality of great founders is a commitment to suffering for at least five years. This might sound more extreme than necessary, but starting a company is a rollercoaster of suffering. You need to be comfortable with hearing no over and over and not let that destroy your will. You need to be able to withstand low periods that are inevitable — unexpected customer or employee losses, investor rejections, tax bills, fights with cofounders. Entrepreneurs don’t necessarily need to revel in difficulty, but it helps. We like to track the number of times we hear no during the week to reduce the negative reinforcement of it.

Why five years of suffering? It usually takes at least two years before you have any reasonable traction to show that your business might be working, then another few years of driving growth to create something that looks like a moat. Then you can afford to breathe. A little.

Focused curiosity might seem like an oxymoron, but curiosity that is targeted at a specific market leads to a commitment to testing new things. Testing new things leads to new business opportunities and products. Curiosity may be particularly necessary for seed stage founders (our focus) because their businesses are so nascent and require constant iteration. A lack of curiosity at the early stage leads to stagnation, which leads to death.

An early stage startup is an unending series of challenges. This is doubly true for first time founders who not only have to figure out how to deliver their specific offering to market, but how to operate a business in general. The final innate trait, resourcefulness, gives founders the ability to thrive in the face of persistent tests. A great founder is not one that says he or she couldn’t do something because they didn’t have enough capital or it was too difficult. They figure it out and keep figuring it out.

Dynamic Qualities of a Great Founder

Where the innate traits are binary and fixed, the dynamic traits of a great founder are five qualities that exist on a spectrum and evolve over time:

  • Market insight
  • Operational capability
  • Product sense
  • Growth
  • Leadership

Market insight is our term for the popular “founder/market fit.” What we want to see from a founder is that he or she has spent a lot of time thinking about and experimenting on a problem they’ve identified. In that sense, market insights are a byproduct of the innate intelligence trait being applied to a specific problem over a length of time. Founder/market fit to us implies that the founder has spent time involved in a market, thus the fit; however, prior market experience isn’t necessary for great founders. Jeff Bezos didn’t have founder/market fit when he started Amazon. He never ran a bookstore before, but he had a market insight about the Internet changing the way people shopped. The founders of Uber never worked in the livery business, but they had an insight about mobile changing the way people arranged transport. Airbnb is another example, and there are many others.

The other four traits are relatively straight forward business-related qualities. Operational capability is the founder’s ability to deliver their product or service and serve customers. Product sense is the founder’s ability to create a product or service that unexpectedly delights consumers. Product sense is what enables a founder to reach product/market fit. Growth is the founder’s ability to market and sell the product or service. Leadership is the founder’s ability to organize his or her team to meet objectives.

All five of these traits work in conjunction with one another, and all five are necessary for an early stage founder to possess in some degree. However, numerous factors influence the relative importance of the dynamic qualities of a founder. In other words, some of the dynamic traits need to be more developed depending on type of the founder’s company. For example, in a highly social company, a founder’s product sense seems to matter more than any other trait because user growth will have to be organically rapid for the company to service. The immediate experience of the users will be what keeps them engaged and sharing the product with others. An enterprise founder should require stronger growth capabilities to directly sell their B2B product, software or otherwise. Hardware companies tend to need stronger operational capability given the manufacturing requirements of their product.

The above observations were specific to seed stage companies, but stage of the investment also impacts the relative importance of the dynamic qualities in a founder. At the A/B round, product should be somewhat established, so market insights and growth might matter more as the founder tries to leverage his or her unique vision into some sort of durable advantage. In a pre-IPO or public company, the importance of leadership matters significantly more because of the likely larger number of employees at the company.

If You’ve Got It, Go for It

It’s boring to hear every VC say they only fund great founders, but it really is true, and their criteria probably isn’t much different from ours. Early stage companies are extremely fragile. VCs obsess over the quality of founders because it’s one of the few variables we can control. Recognizing these qualities in oneself is also an important variable an entrepreneur can control. Whether you’re running a small business or hoping to build the next Google, you must have all the innate traits and the correct balance of dynamic traits to be great. If you know you have them, then focus on your goal and be great. Hopefully we can help you along the way.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Swinging for Grand Slams

If we had to sum up our investment approach in one word, it would be non-incremental. Venture capital is a power law game: the vast majority of venture returns come only from a few investments. We believe we have to have the chance to hit a grand slam on every investment we make. Therefore, we look for great teams doing something a little more out there than most. Things like brain-computer interface, or connected fabrics, or creating the future of retail. And we actually think that investing in non-incremental businesses is safer than investing in incremental ones.

Before we get to why, let’s define the difference between incremental and non-incremental.

Incremental companies build for obvious or established markets. They create products and services that are 10% or 50% or even 100% better than what’s on the market now, but they don’t create products that are 10x better. They don’t create products that transform industries and change how consumers interact with the world. And that’s ok! Incremental businesses are important to the progress of the overall ecosystem and see good exits all the time.

Non-incremental companies create products and experiences that are 10x better; those that revolutionize, not merely improve. They establish new markets that are obvious only in hindsight. They create entire ecosystems of companies trying to play in the sandbox they built. It takes a founder with a big vision and a dedicated team to build something non-incremental.

With that distinction in mind, we see three reasons why investing in non-incremental companies is safer than investing in incremental ones:

First, it’s just as hard to create a great non-incremental company as a great incremental company. Either way, the entrepreneur has to convince talented people to take a risk and come work for him or her. The entrepreneur has to retain that talent as other companies come calling with better offers. The entrepreneur has to convince skeptical customers to use his or her new product. The entrepreneur has to persevere through the rollercoaster of survival as a new business. We think that last point is the death knell for most incremental companies: the entrepreneur is beaten into submission and loses interest in the business. It’s easier to stay engaged working on non-incremental ideas than incremental ones.

Second, non-incremental companies tend to have less relative competition than incremental ones. It’s red ocean/blue ocean strategy. Since incremental companies are attacking obvious problems, the market will be full of other businesses trying to solve the same thing. A non-incremental company will have less direct competition because they’re focused on something less obvious. This means that non-incremental markets look smaller than incremental ones at first, but the early non-incremental markets tend to morph into new markets that encompass larger legacy markets over time. Airbnb is an example. Air mattresses on a stranger’s floor is a weird, non-incremental market, but a platform to rent unused housing space competes with the legacy hospitality market.

Third, non-incremental companies tend to develop things that the world needs most. What’s truly valuable about the 5th food delivery company? Or the 10th ride sharing company? Or the 100th photo sharing app? Yes, there are great potential markets there, but they’re obvious markets with lots of competition and, for the most part, undifferentiated technology that creates modest incremental value. We believe that companies tend to get rewarded in proportion to the value they create in the long term. This means that some companies can be overly rewarded in the short term (see many social plays). These short-term wins are harder to predict and are more driven by luck through rapid user adoption than true value creation. Investing in things the world really needs gives us a tangible reason for future reward.

Our downside is still zero when we invest in non-incremental businesses, but the probability of zero is lower for the three reasons mentioned above, and the potential for a unicorn-sized return is greater. Even better, and cliché as it might sound, non-incremental companies are the ones that actually change the world and shape it in our vision of the future. That’s why we swing for grand slams.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio. Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.

Building a Startup Is Like Launching a Rocket

I read about 80 books a year and am always looking for new suggestions from people in technology (email us your recommendations). A number of VCs and technologists recommended Failure Is Not An Option by Gene Kranz, flight controller for the legendary Apollo 13 space mission. After reading the (audio)book, I see four reasons why the book is so beloved among the tech set.

1. Parallels of Launching a Rocket vs a Startup

“Going to the moon was more art than science because they were doing something that had never been done before.”

To boldly go where no man or woman has gone before was the mission of the US space program in the 70s and is the mission for all great startups today. Kranz retells stories of many space missions and preparations that faced calamitous error because they were doing something that had never been done before, but flight control and the astronauts persevered and found solutions. Startups also face frequent, calamitous problems because they too are building a business that does not exist, and they too must persevere. Most startups (aside from SpaceX) aren’t launching rockets into orbit, but they should treat their mission just as seriously.

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