20 VC 095: How VCs Find Startups and How To Add Value Once Invested with David Teten @ ff Venture Capital

David Teten is a Partner at ff Venture Capital and is also Founder and Chairman of Harvard Business School Alumni Angels of Greater New York, the largest angel group in New York. David is currently co-leading the first study on “how to disrupt the investing industry.” He led the first-ever study of best practices of venture capital and private equity funds in originating new deals (#1 all time most-read study in the Journal of Private Equity) and the first-ever study of VCs in creating portfolio company value. He has published in Harvard Business Review, Institutional Investor, and other leading publications. David's blog is one of the most extensive and actionable blogs there is, seriously you have to check it out and it can be found at teten.com. I would like to thank Mattermark for providing all the data and analysis for this interview and you can check them out here! CLICK TO PLAY In Today's Episode You Will Learn: 1.) How did David make the move into the world of vc and technology? 2.) What is David's approach to deal sourcing? What strategies would he recommend to other VCs to find the best startups and entrepreneurs? 3.) What does David think are the most effective ways that VC and PE funds are helping to increase portfolio company value? 4.) How should an entrepreneur evaluate how value-added a VC can be? Are there any signs that one VC has more value add than another? 5.) Is VC moving to the operational model in terms of headcount, with the moves of firms like a16z who provide extensive services as additional value add? 5.) Why did David and ff invest in Indiegogo? Is it not an alternative finance method that is competing with VC? Has David notice a loss in deal flow to AngelList? Items Mentioned In Today's Episode: David's Fave Book: Edward Tufte: Graphical Communication of Quantitative Data David's Fave Blog: PandoDaily David's Most Recent Investment: Skycatch As always you can follow Harry, The Twenty Minute VC and David on Twitter here! If you would like to see a more colourful side to Harry with many a mojito session, you can follow him on Instagram here!

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Harry Stebbings?

  You are listening to the 20 Minute VC. I am your host, Harry Stebbings, and today I'm thrilled to welcome a true thought leader of the industry, David Teten. David is a partner at FF Venture Capital and is also founder and chairman of Harvard Business School Alumni Angels of Greater New York, the largest angel group in New York. David is also currently co-leading the first study on how to disrupt the investing industry. He also led the first ever study of best practices of venture capital and private equity funds in originating new deals, and it's the number one all-time most-read study in the Journal of Private Equity, what an incredible stat that is, and the first ever study of VCs in creating portfolio company value.

• 0:44Harry Stebbings?

  He has published in Harvard Business Review, Institutional Investor, and other leading publications. And I've seen thousands of VC blogs in my time, and I can safely say David's is one of the most extensive and national blogs there is. Seriously, you have to check it out, and it can be found at teten.com. That's T-E-T-E-N dot com. I would also like to say a huge thank you to Matamark for providing all the data and analysis for today's episode, and you can check them out at www.matemark.com. They really are awesome. But there is more, there is an exclusive just for you. The amazing team at LawTrades are giving you the opportunity to schedule a free 20-minute

• 1:26Harry Stebbings?

  strategy session with a top attorney, and all you have to do to schedule is choose a practice area that you'd like to speak about, so incorporating a business, choose a time slot that works well for you, and then you'll receive an email confirmation and calendar invite confirming your session. It really is that simple, and you can check them out at www.lawtrades.com, or you can follow them on Twitter at LawTrades. But now it's time to jump into our interview with the legendary David Teten, partner at FF Venture Capital.

• 2:03Speaker 01

  You have now arrived at your destination.

• 2:06Harry Stebbings?

  David, welcome to the 20 Minute VC. It's a huge pleasure to have you on the show. Thank you so much for joining us.

• 2:12Speaker 02

  Thank you.

• 2:13Harry Stebbings?

  Now, I'd love to get the ball rolling today by delving into how you made the move into the world of VC and technology as a whole.

• 2:21Speaker 02

  I grew up in Marin County, Northern California, so I was playing with computers from a very young age. I was earning money through computer consulting and teaching people how to use Excel when I was a kid. My bar mitzvah project was making a test of your knowledge, like a true false quiz on my Atari 800. And so that was something that started very, very early. I got fired when I was about 16 because I was working at a very prominent financial services firm and I wrote a memo to IT saying I've uncovered some very weak security in your IT system. It seems the password password is getting me in. And that got me fired because I didn't like 16 year old admins.

• 3:06Speaker 02

  It's about security vulnerabilities, particularly highly embarrassing messages. So when I finished, when I was in college, I ran a computer consultancy. And when I graduated, I worked briefly in strategy consulting and then moved into investment banking for the tech industry. Working with Mike Grimes, who later went on to lead the Facebook IPO. Then went to business school, was CEO of a number of startups in Israel and in the US. And joined FF Venture Capital in 2011 when we were three people. We are now 10x as large by headcount with over 27 people. FF Venture Capital is, we believe, the largest by headcount seed focused VC on the East Coast.

• 3:49Speaker 02

  We invest across the US as well as abroad with investments in Canada, Israel, the UK, Amsterdam, and potentially elsewhere, depending on what deals come through.

• 3:58Harry Stebbings?

  And then does geographic specialization play a core role to you or are you much more sector specialized?

• 4:06Speaker 02

  Neither, actually. So the philosophy of FF Venture Capital is that as seed-stage investors, we should be generous. We should keep our doors open wide to the broadest possible array of companies. We do not invest in life sciences because we don't have any domain expertise there, but we have invested in drones, in software, in food companies like Plated, and a whole host of other sectors. We believe that the growth areas of 2019, we cannot predict in advance, so we don't like to label ourselves a content VC or a social media VC. Instead, we're just a VC that invests in interesting companies with high-growth potential, and we think that that helps account for the diversity of our

• 4:48Speaker 02

  portfolio and their relatively good performance. We are, we have invested in, about 40% of the portfolio is in the New York tri-state area. The remainder are scattered across the US in both major and minor geographies, and as I mentioned, quite a few international investments as well.

• 5:09Harry Stebbings?

  And talking of these great companies, one of your main jobs as a VC is to find them, and so deal sourcing plays a huge role of your job. So how do you think about deal sourcing, then? How do you source entrepreneurs as a VC?

• 5:24Speaker 02

  So I wrote the first research study on this topic, so I have written tens of thousands of words on it, so that's a long answer. The short answer is-

• 5:33Harry Stebbings?

  For the 20-minute VC.

• 5:34Speaker 02

  The short answer is, I admire the outbound approach of a TA or Summit. A more sophisticated version of that is something like Signalfire, which is a new VC started by my co-author Chris Farmer, which relies on mining publicly-available data to identify growth companies. That, however, is not the model of FFVC. Our approach is, we devote very disproportionate resources to support our portfolio companies and lower their failure rate. We have a 1 out of 6 write-off rate, which is well below industry norms, and that attracts to us over 2,000 inbound companies per year, and we filter through them for the approximately one dozen

• 6:16Speaker 02

  new companies per year in which we invest. So we think that you can invest until you have attractive deals through which you can filter, and we prefer to invest our calories in doing good work with our companies and then making people aware of it, as opposed to the outbound model. Where you're trying to get people interested in your firm when they don't know if you can actually help them when you in fact invest in them.

• 6:40Harry Stebbings?

  And do you think in the future we'll see a lot more algorithmic sourcing like with Signalfire?

• 6:45Speaker 02

  I think that that is not a proven thesis as a way of investing, but it is one with a significant chance of success. So there's a very small number of people are actually experimenting in this area. Google Ventures also is doing work in this space and more people will do work on it. However, there is certainly a paucity of data available about private companies. There's a lot by historic standards, but low relative to say, public companies. And even the public company universe, there's still plenty of room for fundamental analysis. So it will be an increasingly important tool in the VCs toolkit, but it will never be the only tool.

• 7:26Harry Stebbings?

  And is there an individual or firm that you think particularly excels at deal sourcing?

• 7:32Speaker 02

  So I am, I'm biased of course, but I really like the FFVC model because I think it's a much more efficient model. One of the great frustrations of our friends who work at most other VCs at our stage is they spend 80% of their time talking with companies with whom they can't consummate an investment. It's sort of like going to a lot of parties, but never meeting anyone that you actually want to spend time with. In our model, we have no one at FFVC, despite our large headcount, whose job is origination. Our team spends most of their time either in the office or in our portfolio companies' offices. They're not spending lots of calories going to conferences trying to hustle attention because they don't need to. So I think this is a more efficient model, but it takes years to build up to because

• 8:17Speaker 02

  we've had to build our portfolio acceleration infrastructure and also make sure the market is aware of it.

• 8:23Harry Stebbings?

  So what would you suggest then to funds which don't have such large volumes of inbound coming in as you do through your branding you've built up over a few, over a number of years? So if you had a new fund which doesn't have 2000 coming in, would you suggest that it's brand building first and then watch the inbound come in?

• 8:43Speaker 02

  Brand building is a bit of a farce unless you have something underneath it to sell. So there's an old Jewish proverb that the coin box that rattles the most has the fewest coins. And there's certainly some investors I know who are very, very noisy, but lack underlying returns or empirical ability to add value to their companies. So I would focus on figuring out your differentiation. There is, Angel List is very, very clearly working to disrupt the generic VC, meaning the GC that doesn't have an edge. And the conventional VC that doesn't have something special that they bring to the table will, I suspect, find themselves challenged in the next two fundraising cycles.

• 9:27Harry Stebbings?

  And we spoke there about VC value add. So now we've sourced the company and we've invested in it. Based on your research, what are the most effective ways then that VCs and PE funds in actual fact are helping to increase portfolio company value? What can they do?

• 9:45Speaker 02

  So we, I published a large research study on this. I will highlight for you the top three most important ways that we have found to support our companies. First is capital raising. By definition, our companies are virtually all losing money, I'm embarrassed to say. So we have to either invest in them ourselves or help them raise capital from other VCs in the ecosystem.

• 10:09Harry Stebbings?

  Is that not very normal though, at your stage, for them to be losing money at the seed stage?

• 10:13Speaker 02

  It's totally normal, but it is ironic by historic standards, right? That's not the normal state of a business.

• 10:19Harry Stebbings?

  Yeah.

• 10:20Speaker 02

  That is the norm in our space. And I have to acknowledge that and then address it by focusing on figuring out ways that they either get profitable or raise their next round. So we have worked with over 200 other VCs who have written follow-on checks in our companies and our relationships with them are critical to our company's continued growth. Number two is our finance and acceleration team. We have a team of nine accountants who provide outsourced CFO services to our companies. Our companies usually don't have their own CFO until they hit about 30 employees. And this gives our companies a lot of comfort that the numbers are in order and it makes it easier for Kleiner Perkins and Google Ventures and other later-stage VCs to invest

• 11:04Speaker 02

  in our companies because they know that the numbers are in order. Third is recruiting. We have built out a set of resources to help our companies identify appropriate talent and bring them on board.

• 11:19Harry Stebbings?

  And how should an entrepreneur then evaluate how value-added a VC can be? Is there any signs that maybe the investor is rather value-add light? And you know, their coin box does have very few coins in it, as you said.

• 11:33Speaker 02

  Number one is reference check, and number two is do the math on their resources versus their portfolio. In our case, we have about 60 active portfolio companies. We're highly significantly involved with about two-thirds of them. The other one-third are companies that are either way outgrown us or they're somewhat less active. And we've got over two dozen employees. So I would look at other funds and say, how many folks do you have in your team? How many portfolio companies do you have? How many checks do you write per year? And you can do a rough calculation of how many person-hours you can expect to get from the firm. Of course, that's not the only measure. You also have to look at what sort of technology platform they have to support your company.

• 12:18Speaker 02

  But I think that's a really important test. It's easy to talk about value-add, but it's harder to deliver, particularly given the limited scalability of the VC model.

• 12:28Harry Stebbings?

  And you said there about kind of headcount of VCs. And we've seen with A16Z, they have a huge headcount. And they've moved very much towards the operational side of kind of having a huge marketing team, which obviously offers assistance, huge finance team. Do you think VC is moving to that very operational additional value-add in order to attract the top talent from startups?

• 12:51Speaker 02

  So that is certainly a trend in the VC world. But it's actually a relatively short list of VCs who do this. The reason is it's really, really expensive. So I would highlight, besides us and Google Ventures and Andreessen Horowitz, First Round Capital, OpenView does some work in this area. A lot of other firms talk about it, but they've hired one or two people, right? They don't have a whole set of resources. Because what that means is they're foregoing current management fees in the hope that 10 years later, they're going to have greater capital gains. That is a very long-term bet. Of course, VCs are supposed to make long-term bets, but unless this is a difficult bet, because it means your current cash compensation as a partner at that VC goes down.

• 13:33Speaker 02

  So it requires a certain level of self-confidence to pursue this model. That said, at this point in the cycle, there are certainly more VCs who are trying to do this because competitive pressure motivates them to do so. When the market turns down, which it will, I think you will see some shrinkage in this model by the people who are not fully dedicated to it and who haven't built it out as a core part of their business.

• 14:01Harry Stebbings?

  And how do you then maintain the right timeframe in your head with regards to managing kind of the short-term LP desires and the kind of desires of your portfolio companies versus the long-term investor return rate that happens at the end of the fund?

• 14:19Speaker 02

  We educate our LPs that this is a highly illiquid asset class. We have collected 12 different academic studies on angel investing, which show median returns of 18% to 54%. So it's the highest-returning asset class out there. Of course, there's a cost, which is it's highly liquid, most of your investments blow up, and in the best-case scenario, it can take 10 years to actually see cash returns. So as a result, this is an asset class which is highly unattractive to most institutions. We're one of the few institutional VCs who focuses on this early stage of companies. So our LPs are fine with our model because by definition, they wouldn't have invested if they weren't comfortable with this, the illiquidity of it.

• 15:03Speaker 02

  In the institutional investing world, one of the most famous investors is David Swensen, the head of the Yale Endowment, who has amazing returns over the past two decades and has argued that there is a very, very powerful, long-lasting liquidity premium to people who are willing to countenance investing in an illiquid asset class. Our view is that's true, and even the liquid asset classes tend to get illiquid when you really need liquidity. For example, in 2008, when lots of people wanted to get out of different things and found that the doors were closed.

• 15:34Harry Stebbings?

  And then delving deeper into kind of the finance sector. In a recent article of yours, you mentioned on corporate venture capital, you stated the challenge is how to disrupt yourself, or at least invest or buy the disruptors. Now, is that why FF have invested in Indiegogo? And how do you view the crowdfunding sector?

• 15:54Speaker 02

  So we invested in Indiegogo at the seed level when it was not as apparent as it is today how they might impact the broader ecosystem. Right now, we, of course, wouldn't invest in the crowdfunding space defined as competitive with Indiegogo because we don't invest in competitive companies. There are also over 500 crowdfunding sites and most of them will fail, so we're glad we invested in one of the clear winners of that game. We are certainly monitoring AngelList because there is no question that they are working up the food chain to make themselves the fundamental operating system of this asset class. We, as a firm, are not significant users of it, but we might, possibly, over time,

• 16:39Speaker 02

  get more engaged in using their services.

• 16:44Speaker 02

  We are certainly interested in other variations of this, marketplace lending and other versions of crowdfunding.

• 16:51Harry Stebbings?

  And at your stage of the investing cycle, you know, the seed stage, have you noticed deal flow being lost then to AngelList?

• 16:59Speaker 02

  So, the...

• 17:04Speaker 02

  Let's put it this way: our cash, we believe, is greener than the cash from other sources because it comes with a brand, it comes with the resources. And so I think our firm is well positioned relative to AngelList, but I would say that, wouldn't I, right?

• 17:18Harry Stebbings?

  Absolutely.

• 17:19Speaker 02

  But I think that the modal VC, two partners and an admin and maybe an analyst, is under threat from AngelList because it can't possibly have the level of granular knowledge of different sectors that individual angels do. In my role as founder of HBS, Harvard Business School Angels of New York, which is now the biggest angel group on the East Coast, I've been very involved in encouraging our member base to get more involved in angel investing, to leverage their intellectual and financial capital to invest in the next generation of great companies. And we think that by creating educational materials for them and by exposing them to this ecosystem, we are not only helping them make more money, but we're also promoting economic development, which I think is also important.

• 18:04Harry Stebbings?

  So do you think AngelList will work its way up the food chain then to the Series A and Series B? I know Gil Panchina's got now, I think, an eight million syndicate, which could comfortably do a Series A in some cases. Do you think that will be happening?

• 18:17Speaker 02

  Absolutely.

• 18:18Harry Stebbings?

  And then what do you think the white space is then for entrepreneurship in fintech?

• 18:23Speaker 02

  So I'm currently leading a large research study on exactly this topic. The website is disruptinvesting.com. I'll highlight a few areas. First is security. I think that even now, people don't realize just how vulnerable we are. Just in today's paper, I read that Russia's Russian submarines are cruising around the undersea cables where most of our internet traffic travels. You could see a lot of very bad things that they could do. So we're an investor in companies like Secure, which does identity verification, Distill Networks, which just raised a large round from Bessemer, which blocks bots that steal data from websites. Ionic Security out of Atlanta, which has raised over 75 million since we initially

• 19:05Speaker 02

  invested in them, which allows for secure use of cloud-based services. So we're certainly interested in that area. We're also interested in taking manual processes and making them more efficient. We were an early investor in Atapar, which is started by Joe Lonsdale of Palantir and PayPal fame, now Formation 8. And Atapar was started because Joe was setting up a family office for himself and realized that family offices usually run on Excel and PDF. And said, this is sort of ludicrous, there should be a more seamless way to do it. So he set up a company to do that. We not only invested, but became a client. We run part of our back office on Atapar because we, of course, own interests in about

• 19:49Speaker 02

  80 different companies with lots of different types of securities and amounts and so on. And we need some mechanisms to track all of those holdings. I'd also point to the data space. I used to run an investment research business, so care a lot about that. We're an investor in Earnest Research, which is a company that takes non-traditional data sets like credit card data or email receipts and mines them to sell actionable trading information to hedge funds and other institutional investors. They provide really insight that is not available through any other means to their clients, and that is something that justifies a very strong competitive position.

• 20:31Harry Stebbings?

  And if it's okay with you, we're going to delve into a quick fire round now. So VCs use of social media.

• 20:38Speaker 02

  Yeah, I think VCs are aggressive in use of social media, certainly compared with the private equity and hedge fund world. I think that it is easy to spend too much energy in marketing as opposed to doing your job. So I am judicious in my own use of social media and don't tend to tweet about what I have for breakfast.

• 20:57Harry Stebbings?

  Okay. Amazon, buy or sell?

• 20:59Speaker 02

  I would probably sell on the grounds that it's not clear to me if, when they eventually turn on monetization spigot, it will be impossible for other people to compete with them. In other words, the whole theory of Amazon, not unlike a lot of early-stage startups, is build lots of infrastructure and then at some magic point in the future return on monetization. But if tomorrow they raise their prices 15% to turn on monetization, it's not clear to me if there wouldn't be new competitors like Jet that emerge. Right now, Jet is, I think, challenged because they're competing head-on against a company that keeps its margins very low. But if tomorrow Amazon raises its prices significantly, someone would create Jet number two.

• 21:43Speaker 02

  So I'm a little skeptical of them on their traditional side, but that said, on the Amazon Web Services side and other parts of their business, I think they've got great customer lock-in and a very powerful position.

• 21:54Harry Stebbings?

  And then what are your best tools for deal sourcing and analysis?

• 22:00Speaker 02

  We use a combination of RelateIQ, Salesforce, one of the data vendors that sells data about private companies. We use Bottelos, which we're also an investor in, to track industry information, and those have been helpful to us. We also have three in-house engineers who are building tools for us that are not broadly available.

• 22:23Harry Stebbings?

  Your favorite book and why?

• 22:26Speaker 02

  I am a huge fan of Edward Tuftey, T U F T E, who is a professor at Yale and the world's leading expert on graphical communication of quantitative data. Anyone who prepares presentations to investors must read his book on this topic, and you will be much more effective.

• 22:46Harry Stebbings?

  And then what's your favorite blog or newsletter?

• 22:49Speaker 02

  Pando Daily, I give a lot of credit to for being willing to write about controversial topics and make enemies. There are not enough journalists out there willing to do that.

• 23:00Harry Stebbings?

  And then finally, your most recent investment and why you said yes?

• 23:06Speaker 02

  So, most recent investment that I can disclose, I'm actually double checking the status of the most recent one to make sure that I can share it with you. So, talk about Skycatch, which is a company that we invested in not long ago. Skycatch is a drone technology company, which provides a set of tools for collecting data via drones. Their current main use case is for construction. So, they have a very large scale partnership with Komatsu, which is a massive Japanese construction company. And their technology allows Komatsu, and behalf of their clients, to monitor the exact status of a construction project.

• 23:50Speaker 02

  Particularly given that Komatsu uses robots heavily in their work, it's imperative that you understand exactly where all the parts are, the elevation of the ground, etc. And Skycatch allows Komatsu to do that much more effectively than they could do by any other means. So, we think drones are underhyped, and are going to have impact on many different industries, and Skycatch has taken a leadership role in this area.

• 24:12Harry Stebbings?

  Well, David, thank you so much coming on the 20 Minute VC. I've hugely enjoyed chatting with you, and it's been an absolute pleasure to have you on the show. Thank you so much. And I'd like to say again a huge thank you to David for giving up his time today to be on the show. And I would like to say if you are loving the 20 Minute VC, sign up to our newsletter on the site at www.thetwenty minute vc.com or you can follow us on Twitter at 20minutevc. For both of those, the 20 is all in letters. But before we leave you today, do not forget to check out Law Trades. The incredible team are offering 20 Minute VC listeners a free 20 minute, ironic I know, strategy consultation session with top attorneys.

• 24:53Harry Stebbings?

  And you can discuss anything from company incorporation to funding to IP protection. It's such an amazing service and it's perfect for all startups and entrepreneurs. So check them out at www.lawtrades.com or you can follow them on Twitter at Law Trades. Thanks so much as always for your continued support. I really am so grateful. And if you ever have any questions or feedback, feel free to email me harry@thetwenty minute vc.com. All in letters again. And we cannot wait to bring you our interview with Ryan Hoover at Product Hunt on Friday. Thanks so much.