It’s a humbling and educating experience to raise money, whether you’re a volunteer, philanthropist, startup or VC. Hunter and I are thrilled to announce that we’ve concluded our fundraising process and closed Homebrew II, a $50 million seed venture fund. More details on the Homebrew blog. And now back to work.
Local offline-to-online marketplaces are just beginning to impact the lives of individuals and small businesses, enabling them to save time and money and generate new revenue streams. Where there was previously friction, opacity or scarcity, local marketplaces are providing convenience, transparency and abundance. Homebrew is focused on supporting seed stage companies like these that are building the Bottom Up Economy. Our prior experience working with and investing in companies such as OpenTable, Angie’s List and several less successful marketplaces has helped inform how we evaluate and support investments in this segment. Here are some of the other key things we look for in startups employing a local marketplace model.
Focused use case: We believe that scale is the outgrowth of doing one thing really well. Accordingly, we prefer to see local marketplaces that nail a specific, focused use case rather than take a broad platform approach from the outset. Homejoy is a great example of a company that has had relentless focus on a single use case, cleaning your home. An early competitor, Exec, offered a platform where all kinds of services, including home cleaning, could be requested but suffered as a result. One of the primary benefits of focusing on a narrow use case is that customers don’t need to think about how or why to use the marketplace. Focus makes that abundantly clear.
Premium experience for sub-premium price: Great local marketplaces enable customers to have a new experience that is magnitudes better than the old. But the best marketplaces deliver that new, better (i.e., premium) experience for a sub-premium price. Uber and Lyft are the prime examples of delivering infinitely better experiences than hailing taxis and typically at only modestly greater costs (even cheaper in an increasing number of cases). One of our Homebrew family companies, Shyp, is similar in that it delivers an incredible shipping experience at standard retail rates.
Necessities over luxuries: There are local marketplaces for all kinds of products and services, but we prefer marketplaces that are focused on necessities rather than luxuries. Necessities tend to have higher transaction frequency, greater word-of-mouth and less susceptibility to economic downturns. Everyone needs to eat, wash their clothes and get to work. But not everyone needs to fly in a private jet, rent a yacht or hire a Michelin star-winning chef. Those can be wonderful services and they can be delivered in compelling ways, but our view is that products and services that are truly need-based lead to more vibrant. liquid marketplaces.
Organic distribution: Word of mouth is the best marketing. But there are other forms of organic distribution that can be just as powerful and cost effective. For example, when Uber launched, taking a ride with a friend introduced many others to the experience. When Shyp sends a package, the recipient is exposed to the delightfulness of the service. Many of the most compelling local marketplaces have dynamics where the same person can be both customer and supplier over time. Dog owners on DogVacay can be hosts in one transaction and customers in the next. We love to see marketplaces that have these types of organic distribution opportunities embedded in their services.
Few emerging replacements: While we always tell startups not to fixate on competitors, in today’s world where switching costs and barriers to entry are often low, we prefer to invest in local marketplace startups that are solving problems that few others are addressing with new solutions. For example, for better or worse, we’ve avoided investments in the various types of food delivery companies because while frequency is high, there are many replacement products available. This makes it hard to to acquire customers cost effectively, to protect margins and to maintain significant market share over the long term. Many markets have room for more than one “winner” but very few have room for more than two or three.
The above characteristics may be unique to Homebrew, but we also like to see things that others have recognized as important to marketplace businesses. Many of these are well-documented by Bill Gurley in his excellent posts on marketplaces and platform transaction fees. In the past year, we’ve seen local marketplace startups in countless areas, including tech support, parking, home services, cleaning, laundry, food, labor, property rental and transportation. We’ve made investments in several verticals, including shipping with Shyp, legal services with UpCounsel and property management with an unannounced investment. But we believe that there are many more use cases for which compelling products and services can be delivered via a marketplace model. If you’re starting a local marketplace company, especially in specific labor verticals or providing B2B services, please contact me at satya at homebrew.co.
Additional posts on Homebrew investment themes:
Homebrew’s first fund focuses on what we’re calling the “Bottom Up Economy.” The Bottom Up Economy thesis states that as technology becomes more affordable, flexible and accessible, many industries that have not benefitted from or been impacted by technology historically will finally do so Software is eating the world in many cases but also enabling the world in others. Accordingly, we spend a great deal of time getting to know entrepreneurs and companies building software solutions that disrupt industries or enable the existing industry players to compete more effectively. And we’ve already invested in companies serving several different areas, including legal services, mental health, logistics, communications, financial services and commercial construction. Given our focus on vertically oriented software, I wanted to share a little bit about the attributes we like to see in those startups.
Teams with a unique POV: As my partner, Hunter Walk, has written, we’re excited by teams that aredisrupting industries with love (and just enough greed 🙂 ). Teams that have experience in the domain tend to have a strong POV about what’s broken and how to fix it. But often times the most unique insight can come from teams outside of their target industry who are approaching things with fresh eyes. So we prefer to work with teams that can demonstrate domain expertise without the stagnation of assuming status quo is just the “way things are done”. What’s critical is that the teams we invest in have an insight that many others either have not seen or don’t agree with.
Distribution focus: We tend not to invest in software companies that are 100% dependent on selling into theC-level via a direct salesforce. Instead, we prefer a bottom-up entry point via individuals or teams within the enterprise or small business. The startups that intrigue us have a well-articulated plan for how to get distribution of their software in the industry they are targeting, and most often that includes a strong likelihood for organic or viral growth. No matter how slick and easy-to-use your software is,if you build it they probably won’t come.
Long-term advantage: Nearly all software is replicable, so we look for companies that are likely to have long-term differentiation, ideally via customer or data network effects. Network effects mean that the value of the software grows as more people use it either because it allows them to interact with more people in the context of their work or it helps collect and aggregate data that informs and improves their work. The strongest network effects enable customers to benefit from product usage that occurs even outside of their companies (i.e. industry-wide).
Acute pain: VCs are notorious for categorizing things as an aspirin versus a vitamin or need-to-have versus nice-to-have. But there is a good reason for this. Unless software is helping addressing an acute pain or delivering value that can’t be ignored, it likely can’t attract the attention it needs to be used or purchased given the limited time of people and budgets of companies. We like to see software that is addressing what is likely to be one of the top 3 hair-on-fire issues. This kind of software has a better chance of drawing attention and dollars.
Widespread pain: In addition to the pain being acute, the pain needs to be felt by a lot of people. This is important because companies need to be able to reach “venture scale”, usage and revenue that allows for a company to be valued many times higher than the value at which a VC firm invests. For Homebrew, our goal is to invest in companies where we can see a path to returning the value of our entire fund ($35 million) from an investment in that company. Both the total dollars invested and the price of investment have an impact on that math, but it generally means that we need to believe that the company can eventually generate $100 million in annual revenue. That kind of scale requires a widespread feeling of acute pain.
Painless path to first dollar: It’s obviously easier to get someone to use something that is free than it is to get him or her to pay for something. So we like to see products that are likely to have a painless path to the first dollar payment. It becomes much easier to extract more economic value once the customer is convinced to pay for something because at that point she clearly sees some value in the product that is greater than what she is paying. This typically means that there is a single person who has three characteristics: 1) she feels the acute pain personally 2) she has the budget needed to buy (can just put it on her company credit card) and 3) she can pilot the product easily (self-service sign-up, no IT involvement).
While we don’t have hard and fast rules or a checklist approach to evaluating investments, we always think about the criteria above when looking at opportunities in vertical software. If you’re taking a vertically focused approach and have a story to tell that fits with our preferences and approach, don’t hesitate to get introduced to us or to reach out directly.
Most VCs spend a significant amount of their time generating and evaluating new investment opportunities. When Hunter and I started our Homebrew seed fund last year, one of the common questions from potential LPs was “How will you generate deal flow?” Our hypothesis at the time was that we would generate investment opportunities from four primary sources: our personal networks, other investors, inbound thematic leads and proactive outreach. Now that we’ve closed out 2013 we thought it would be useful to share our data in hopes that entrepreneurs who want to get in front of us or other VCs can learn a few lessons about how VC deal flow works. So here’s a look into our pipeline for 2013 (note: this isn’t 100% accurate as we certainly missed tracking every single opportunity we reviewed and every meeting we took).
First, the high level funnel metrics:
- 885 opportunities evaluated (100%)
- 399 first meetings or calls (45%)
- 71 further diligence, defined as second meeting or greater (8%)
- 11 investment offers made (1.2%)
- 9 investments closed (1.0%)
Let’s breakdown where our opportunities came from:
- 55% from entrepreneurs and executives in our network
- 16% from other investors (includes angels, VCs, accelerators, etc.)
- 4% from service providers (legal, finance, etc.)
- 25% from other sources (inbound, proactive outreach or ideation)
And what about the 71 opportunities where we dove deeper?
- 41 from entrepreneurs and executives in our network
- 25 from other investors
- 5 from other sources
Finally, here are the sources for the companies we wanted to invest in:
- 9 from entrepreneurs and executives in our network
- 1 from another investor
- 1 from another source
When we reviewed this funnel there were a few things that jumped out at us. First, our hypothesis about where opportunities would come from was largely confirmed. Second, we were surprised by the percentage of our opportunities that come from “Other Sources”. However, upon reflection, we realized that the 25% came about by design. At Homebrew, we actually review and respond to nearly every opportunity that comes to us via a credible or thoughtful email. Why do we do this even when the data suggests that those opportunities tend not to become investments? Because we appreciate that Silicon Valley is a tightly networked community and that not everyone has access to that network. While we focus on SF and NY, we understand that innovation and talented entrepreneurs can emerge anywhere. That belief is embedded in our Bottom Up Economy thesis. The other reason for the high percentage is that given our thematic focus, we try to be proactive about reaching out to entrepreneurs thinking about or companies operating in markets that we are excited about. We are thrilled to work with entrepreneurs who are early in their thinking. For us, it’s incredibly rewarding to help formulate, refine or even test ideas. And we anticipate doing even more of that going forward. The final takeaway from the data for us was that we aren’t yet seeing as many high quality opportunities from other investors as we would like. We’ve participated in syndicates with many notable institutional and angel investors but it’s also possible that we haven’t done enough to educate other investors about who we are and how we can be great partners. We have a plan for tackling this in 2014.
Lessons for Entrepreneurs
Warm introductions are critical. Unfortunately, the reality is that most VCs can’t or aren’t willing to spend the time needed to review opportunities that come over the transom given how few ever turn into investments. So it’s not new news, but your best bet as an entrepreneur is to find some way to get a warm introduction to potential investors.
The best cold intro has data or a demo. If you’re going to send an email to Homebrew, we’re most interested when you can share data or a demo. Talking about an idea that you have or seeking general advice about entrepreneurism doesn’t give us enough context to engage.
Expect to hear “no”. As the data suggests, somewhere around 1% of companies we see receive funding from us. And that number (1%-2%) holds true for most venture firms we know. As an entrepreneur raising capital, it can feel like the world is against you and you alone. But the truth is that everyone hears no and everyone hears it often. It’s not personal, so keep fighting for that “yes”.
No second chances for first impressions. We end up speaking to or meeting with less than 50% of the companies we are introduced to. And we spend more time with less than 20% of the companies we meet or speak to once. What message you deliver in that introduction or first interaction matters a great deal (admittedly unfairly so). Seek feedback on your messaging or your pitch before sharing it with potential investors. Prepare for meetings by listing and answering all of the questions you have about your business, because investors are likely to ask the same ones. Research your audience by using their website, social media posts and their existing portfolio to understand more about how they might think about your business. While we’ll share more of our thoughts in the future, Mark Suster has an oldie but goodie on how to prepare for a VC meeting.
Thanks to all of the entrepreneurs who gave us the opportunity to know them in 2013! We’re able to share this data because of your interest in working with Homebrew.
We think of Homebrew as our startup (it just happens to be one that writes checks instead of code). And we’ve definitely had to deal with the typical startup challenges while getting Homebrew off the ground, including fundraising. While cloud services, open source software and engineering outsourcing/offshoring have driven down the costs of starting a technology company, I’ve been dismayed at how little impact technology has had on aspects of company-building that have nothing to do with the the traditional technology stack, such as obtaining credit, finding office space and buying insurance. There is still tremendous opportunity to improve the costs and efficiency of creating businesses, especially small businesses that are part of the Bottom Up Economy. We’ve learned this first hand over the past few months.
I thought it would be interesting to outline all of the things that we had to do and the dollars we had to spend to get Homebrew to a point where we could focus on our “product”, investing in entrepreneurs who are enabling the Bottom Up Economy. I found that with each of the items, there is room for startups to provide a better, faster, cheaper solutions. If you’re working to address any of these opportunities, we’d love to hear from you. Here is a long but not completely exhaustive list:
– Fund formation. Legal work, including for our fundraising (akin to company formation and fundraising for startups), took us 100 days, required countless state and federal forms and cost us about $125k in legal fees (yikes!). And because we’re a VC, we had to purchase a special type of insurance called Venture Capital Asset Protection, which protects us in case we get sued while performing our duties as board directors of the companies we invest in. We obtained our policy through a broker and pay about $15k annually to cover us. Finally, we conducted a trademark search and registered our name, which required using a separate trademark lawyer and incurred about $3k in fees. While fund formation is clearly a high class problem, small businesses usually need to complete similar steps when starting up. They need to incorporate, register the business, seek trademark protection and get liability insurance. While we had the benefits of time and resources, most startups don’t. Yet, beyond a now dated LegalZoom, little seems to have been done to decrease the cost and complexity for new businesses.
– Office space. It took us two real estate agents and about 7 months to find and move into our offices (3200 sqft at a bit over $10k per month). The good news is that in most commercial real estate markets, San Francisco included, tenants don’t pay broker fees (lots of startups don’t seem to know this….hire an agent!). However, landlords can make you jump through hoops, including providing financial statements, certificates of incorporation, etc., to sign a lease. As a startup much of this is hard, if not impossible, to provide. But it doesn’t end there, once you find office space you need to find a real estate lawyer to review your lease agreement (cost us about $2000) and get lease insurance ($2700 through an insurance broker). In both cases, we relied on our real estate agent to recommend a service provider as there wasn’t any good way of “shopping” for one. Is there anyone out there working on a Zillow or Trulia for commercial real estate?
– Office outfitting. Furniture, internet service, janitorial service, utilities, electricians, movers, painters, food and drink. These things add up, even if you’re just opting for IKEA and Costco. And they take time because there are no good sources for identifying providers, for comparing pricing and quality or for scheduling. Even with the help of friends, all of this took countless hours, appointments and emails. The most frustrating was furniture, which took 4-8 weeks (and counting!) for delivery with no regular visibility into a delivery status. And we know we’re not alone in struggling through these items because we hear about them regularly from founders and small business owners we meet.
– Hiring. For small businesses, hiring is still done through personal networks, walk-ins or Craigslist. Given that we were looking for more than just an employee, a true founding member of the Homebrew family, we relied exclusively on our personal networks. The process didn’t cost money but it took 5 months of interviews, reference checks and social outings to vet candidates. We were fortunate that all of that time and energy resulted in finding a great Director of Operations. Unfortunately, for small businesses, they rarely have the luxury of that much time to find a qualified employee.
– Health insurance. Our Director of Operations is an employee so the State of California requires us to carry workers’ compensation insurance. Again, we worked through a broker and obtained a policy that costs us $240 annually for one employee. We also needed health insurance for our team. This was possibly the most painful experience that we had even though we worked through a broker. The list of reasons why is too long to delineate but it includes: 1) not being able to obtain insurance without 6 weeks of payroll 2) needing to provide proof of insurance for one employee who opted out of coverage (?!?) 3) completing over 16 different forms for only two covered employees 4) having to provide partnership agreements, ownership structure and our Certificate of Formation for who knows what reasons 5) requiring a paper check for payment of the first month’s premium to initiate coverage and 6) taking over 3 months from start to finish (our insurance finally kicked in on 8/1). And all of this is for a process that is completely opaque and results in what we hope is good insurance given the $2500 per month to cover two employees and their families. The vast majority of small businesses rely on insurance brokers for finding and maintaining health care coverage and no doubt face the same questions and frustrations we did.
– Banking. As a startup in Silicon Valley there are plenty of banks that will service you, so finding a bank is not a problem. However, the process of actually opening an account takes countless paper forms and hours of back and forth with the bank. And if you want a business credit card, good luck. Homebrew is a $35 million fund with large institutional investors and we still couldn’t qualify for a credit card with reasonable limits and fees from a number of banks. After six weeks, we were finally approved for a card from Amex on the back of my personal credit card history. Imagine the pain if you’re a small business on Main Street!
– Payroll. Maybe the easiest thing we did because of our outsourced CFO and ZenPayroll (wish we could have invested but Homebrew didn’t exist then!). Most small businesses still rely on ADP or Paychex but it’s great to see a better solution available.
– Web Presence. Finding and negotiating for a web domain, designing a logo, building a website that works well on mobile, choosing a web host and setting up various online identities (blog, Twitter, Facebook, LinkedIn, AngelList) takes time and can cost significant amounts of money. We have the benefit of having worked in technology for years (and it still wasn’t painless), but for a small business that wants to have a meaningful online and social media presence, the resources available to help understand its needs, find options and learn how to use them, are still incredibly disparate and unclear. The number of options available are limitless but the information needed to make intelligent decisions is rarely available.
– Infrastructure. We’re a completely cloud-based company so we use Google Apps for email, Google Docs for document creation, DropBox as our file system and Base for CRM. Selecting a CRM system was the most difficult of these choices because there are so many options in the market and no good way to compare them. We also chose to buy a printer/scanner/copier because as much as we want to be a paperless office, it’s hard to avoid paper completely in our business. Fortunately, we didn’t need a POS system, merchant account, accounting system (our outsourced CFO uses Xero), etc. like many small businesses do because I think I would have pulled the little that remains of my hair out trying to figure all of that out.
As a fund, we had the luxury of raising our money upfront and having ample time to work through these issues as there was no clock ticking. But for small businesses, the costs and the time taken away from selling and serving customers can mean the difference between success and shutting the doors. There is so much friction involved in the process of establishing a new business and relatively little has been done to make it easier. We hope that Homebrew can play a part in changing that. Over the past few months, we’ve put in place a lot of the foundation to support entrepreneurs participating in the Bottom Up Economy. We’re going to share as much as we can along the way – both the good and the bad – to be transparent about our work and to encourage more innovation in support of the Bottom Up Economy.
I’m thrilled to launch Homebrew today. And even more excited to be doing it with my dear friend and now work-wife Hunter Walk. Homebrew is truly the outgrowth of our experiences, observations and passions. Maybe surprisingly, after Twitter, it wasn’t easy to decide to return to investing when there is so much startup activity and there are so many fast-growing companies. But with Homebrew we saw the chance to construct something of our own design that blends the best of investing and operating in support of creating companies of lasting value. The combination of an opportunity to serve entrepreneurs differently (and hopefully better) by working with them very closely on product, organizational and strategic issues and the ability to do it with a great partner made the decision for me.
Homebrew is our startup and our goal is to establish product-market fit with entrepreneurs as our customers; helping them build the companies that they envision. We’re creating a long-lasting platform for people who care about the Bottom Up Economy. And we hope you’ll do us the favor of sharing in what we brew.
Homebrew is open for business.