We had an incredible day last Thursday as we got together with our LPs, founders and advisors for our 3rd Annual Meeting to review Homebrew’s progress over the past year. Hunter already wrote about what we said we know and don’t know after three years of Homebrew. One of the things we talked about was being eager partners to other investors and also hungry competitors. But the opportunity to partner or compete is predicated on the lifeblood of any fund: deal flow.
Picking great startups and winning the opportunity to invest in those companies is clearly critical to the success of any VC fund. But it all starts with seeing the best opportunities in the first place. Potential investment opportunities can come from known connections like operators, investors, or service providers. But they also come in cold based on reputation and are generated actively via outbound outreach. And we do our best to provide an answer (almost always a “no”) to every single company. After year one, I wrote about our deal funnel. It’s time to revisit the data after a couple of years of refinement.
Here’s how our overall investment opportunity funnel broke down in 2015:
- ~1600 opportunities evaluated (100%)
- 476 companies with first meetings or calls with either me or Hunter (30%)
- 64 companies that then had a meeting with both or the other one of us (4%)
- 14 investment offers made (0.9%)
- 10 investments made (0.6%)
Of the ~1600 opportunities we saw, here is how those opportunities were sourced:
- 35% from entrepreneurs and executives in our network
- 27% from other investors (includes angels, VCs, accelerators, etc.)
- 3% from service providers (legal, finance, etc.)
- 35% from other sources (inbound, proactive outreach or ideation)
Coopetition and our seat at the table
It might be surprising to some to see that over a quarter of our opportunities come from other investors (up from 16% in our first year) but the VC ecosystem at the seed stage is very cooperative. Seed rounds seem to range from $1.5m-$2.5m nowadays and most seed firms don’t write checks that large (larger funds are a different story). As a result, nearly every financing round has a syndicate structure with several VCs and angels participating. Our approach is to be the investor of record in the round. To us that means being the lead or co-lead investor (writing one of the larger checks, from $500k to ~$1m) for only 8-10 companies each year, typically taking a board seat and then working closely with the founders to help them build the company that they envision.
We’re very transparent about this approach with both companies and other investors. And we work hard to make sure that they see a clear seat at the table for us based on our approach, experience and potential contributions to the company. Often times we’re able to work with other VCs in supporting a company. Sometimes it means that we beat out other VCs for the opportunity to invest and sometimes it means that we get beat (4 times in 2015, of which two were originally seed rounds that became Straight to A’s). But it’s super important to us that irrespective of the outcome with any particular investment opportunity, we treat other VCs with respect and honor their potential contributions to a company. It’s one reason that we’ve had the good fortune of seeing so many wonderful opportunities from our fellow VCs.
Hustling to find the best opportunities in areas we care about
The percentage of deals that come from other sources has also increased (up 10% from year one), driven largely by our outbound efforts. While not exclusively thesis-driven, we do spend a lot of time thinking about markets or trends we liked to invest in. We then take those interest areas and try to identify and contact companies or entrepreneurs doing innovative work in line with our theses. Not coincidentally, 3 of the investments we made in 2015 were the result of outbound efforts.
Open to inbound
We get a lot of cold inbound emails from founders asking us to invest. The form emails that are clearly being sent to a large number of investors get rejected quickly. But on occasion, a truly thoughtful, personalized email appears in our inboxes and grabs our attention. The sender has clearly done his or her homework on our investment approach and areas of interest. And the email contains data or a demo that tells a compelling story.
We respond to all cold inquiries because of emails like those and because we want to be at least somewhat helpful to founders who take the time to express interest in working with us. We believe that there is an opportunity to grow the pie and impact founders beyond just our portfolio given the platform we have as VCs. And every so often, this “extra” work yields a match.
Just as in Fund I, we have one investment in Fund II that is the direct result of an inbound email without a warm introduction. You’re much more likely to have success getting any VCs attention if you’re referred to him or her, but if you’re going to send a cold email, make it clear why your company is a potential fit for the investor and back up that story with data or a demo.
Tightening our filter
Since we started Homebrew we’ve continued to refine our investment criteria and judgment to make quicker decisions so that we don’t waste founders’ time and so we can allocate as much time as possible to our existing portfolio companies. Our goal is to take a deliberate path to conviction rather than circle an opportunity to see how things play. Our diligence focuses on the questions that we think are appropriate for a seed stage company that hasn’t yet obtained product-market fit, not endless data requests and busy work for founders.
We only take a first meeting or call when we see something about a team, product or market opportunity that signals it could be special. While we reduced the percentage of companies with which we take a first meeting from 45% to 30% in the past two years, we’d like to continue to drive that number down, probably in the 20-25% range. Every meeting can be educational or lead to an important relationship, but we err on the side of getting to “no” (and once in awhile “yes”) as quickly as possible. And usually that means even before a first meeting.
Sticking with unanimous decisions
Every single investment we make is one that both Hunter and I are excited to put sweat and reputation behind. There’s no such thing as Satya’s investments or Hunter’s investments. There are only Homebrew investments. It’s been this way since we started and only if we someday have 3+ partners do we expect that to change. In the meantime, every company we invest in spends time with both us of during the diligence process. If after a first meeting (and usually some preliminary diligence) one of us believes that the team, product and market collectively represent a strong candidate for investment, the other partner is brought in to dig on the 2-3 key outstanding questions.
At the end, we believe we need to be early or contrarian (and eventually right!) when making investments. There has to be something unique about the combination of the team, the product and the problem being addressed that compels us to write a check. We tend to be less interested when there is a market where a dozen companies are doing effectively the same thing. Unless we see a very clearly differentiated approach that has long lasting differentiation, we’re likely to pass.
That’s not to say those companies won’t be successful or won’t be able to raise seed money (in most cases they do). They’re just not the right opportunities for Homebrew. Many times we feel very confident that those companies will likely be successful in raising capital beyond the seed round. But we’re very comfortable foregoing short term write-ups to avoid what we perceive to be long-term pain. The net is that we’d like to get more efficient in this process as well, decreasing the percentage of companies that meet with both us from 13% of companies that have a first meeting with us to 10%.
For the curious, our average core investment in 2015 was $799k. We invested in four Bay Area companies, 4 NYC companies and 2 LA companies. Three of the companies had female members on the co-founding team (including two female CEOs) but none had founders from underrepresented populations. We’re working diligently to try and address the last issue because we know that to be a top-performing fund we need to back a diverse set of founders. We also emphasize with our companies that diversity within the first 20 hires will make for better startups. Finally, we’re doing our best to stay on top of our own unconscious biases. It’s early, but we hope to make real progress here in the coming year.
Based on the opportunities that we see, we have great confidence that a very successful fund can be built by investing in the right subset of those companies. Ultimately, we won’t know for many more years whether our picking will yield an incredible fund. But we do already know that we’ve invested in incredible people. People who we are so proud and excited to be working with. It’s these people and the ones we’ll back in the future that lead us to work every morning. We’re so lucky they’ve chosen to partner with us. We try to remember that every day, but it’s never more apparent than on the day of our Annual Meeting. As Hunter and I said after the meeting “How. F’in. Lucky. Are. We? Very lucky.” Hoping we’ll continue to be as lucky until our next Annual Meeting!