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Everything you need to know about Pre-Seed (with Charles Hudson of Precursor Ventures)

Limited Partner Episode

March 23, 2020
March 23, 2020

Charles Hudson of Precursor Ventures joins us to illuminate everything Pre-Seed -- not just what it is and how founders/companies should navigate it, but also and more deeply:

- How he came into this corner of the venture world
- How he started Precursor as a solo GP and raised his first/subsequent funds, and what that journey was like
- How he manages the firm, its overall strategy, and especially portfolio construction within this relatively new asset class (spoiler: it's different!)

Note: we recorded this episode in the days right before it became clear that the coronavirus was going to become a major global crisis. While the world has obviously changed since, nothing in this episode is fundamentally different and -- if anything -- Pre-Seed rounds are going to be more relevant for entrepreneurs and investors going forward as valuations and check-sizes contract. We hope you enjoy and find the discussion as useful and illuminating as we did!

We finally did it. After five years and over 100 episodes, we decided to formalize the answer to Acquired’s most frequently asked question: “what are the best acquisitions of all time?” Here it is: The Acquired Top Ten. You can listen to the full episode (above, which includes honorable mentions), or read our quick blog post below.

Note: we ranked the list by our estimate of absolute dollar return to the acquirer. We could have used ROI multiple or annualized return, but we decided the ultimate yardstick of success should be the absolute dollar amount added to the parent company’s enterprise value. Afterall, you can’t eat IRR! For more on our methodology, please see the notes at the end of this post. And for all our trademark Acquired editorial and discussion tune in to the full episode above!

10. Marvel

Purchase Price: $4.2 billion, 2009

Estimated Current Contribution to Market Cap: $20.5 billion

Absolute Dollar Return: $16.3 billion

Back in 2009, Marvel Studios was recently formed, most of its movie rights were leased out, and the prevailing wisdom was that Marvel was just some old comic book IP company that only nerds cared about. Since then, Marvel Cinematic Universe films have grossed $22.5b in total box office receipts (including the single biggest movie of all-time), for an average of $2.2b annually. Disney earns about two dollars in parks and merchandise revenue for every one dollar earned from films (discussed on our Disney, Plus episode). Therefore we estimate Marvel generates about $6.75b in annual revenue for Disney, or nearly 10% of all the company’s revenue. Not bad for a set of nerdy comic book franchises…

Marvel
Season 1, Episode 26
LP Show
1/5/2016
March 23, 2020

9. Google Maps (Where2, Keyhole, ZipDash)

Total Purchase Price: $70 million (estimated), 2004

Estimated Current Contribution to Market Cap: $16.9 billion

Absolute Dollar Return: $16.8 billion

Morgan Stanley estimated that Google Maps generated $2.95b in revenue in 2019. Although that’s small compared to Google’s overall revenue of $160b+, it still accounts for over $16b in market cap by our calculations. Ironically the majority of Maps’ usage (and presumably revenue) comes from mobile, which grew out of by far the smallest of the 3 acquisitions, ZipDash. Tiny yet mighty!

Google Maps
Season 5, Episode 3
LP Show
8/28/2019
March 23, 2020

8. ESPN

Total Purchase Price: $188 million (by ABC), 1984

Estimated Current Contribution to Market Cap: $31.2 billion

Absolute Dollar Return: $31.0 billion

ABC’s 1984 acquisition of ESPN is heavyweight champion and still undisputed G.O.A.T. of media acquisitions.With an estimated $10.3B in 2018 revenue, ESPN’s value has compounded annually within ABC/Disney at >15% for an astounding THIRTY-FIVE YEARS. Single-handedly responsible for one of the greatest business model innovations in history with the advent of cable carriage fees, ESPN proves Albert Einstein’s famous statement that “Compound interest is the eighth wonder of the world.”

ESPN
Season 4, Episode 1
LP Show
1/28/2019
March 23, 2020

7. PayPal

Total Purchase Price: $1.5 billion, 2002

Value Realized at Spinoff: $47.1 billion

Absolute Dollar Return: $45.6 billion

Who would have thought facilitating payments for Beanie Baby trades could be so lucrative? The only acquisition on our list whose value we can precisely measure, eBay spun off PayPal into a stand-alone public company in July 2015. Its value at the time? A cool 31x what eBay paid in 2002.

PayPal
Season 1, Episode 11
LP Show
5/8/2016
March 23, 2020

6. Booking.com

Total Purchase Price: $135 million, 2005

Estimated Current Contribution to Market Cap: $49.9 billion

Absolute Dollar Return: $49.8 billion

Remember the Priceline Negotiator? Boy did he get himself a screaming deal on this one. This purchase might have ranked even higher if Booking Holdings’ stock (Priceline even renamed the whole company after this acquisition!) weren’t down ~20% due to COVID-19 fears when we did the analysis. We also took a conservative approach, using only the (massive) $10.8b in annual revenue from the company’s “Agency Revenues” segment as Booking.com’s contribution — there is likely more revenue in other segments that’s also attributable to Booking.com, though we can’t be sure how much.

Booking.com (with Jetsetter & Room 77 CEO Drew Patterson)
Season 1, Episode 41
LP Show
6/25/2017
March 23, 2020

5. NeXT

Total Purchase Price: $429 million, 1997

Estimated Current Contribution to Market Cap: $63.0 billion

Absolute Dollar Return: $62.6 billion

How do you put a value on Steve Jobs? Turns out we didn’t have to! NeXTSTEP, NeXT’s operating system, underpins all of Apple’s modern operating systems today: MacOS, iOS, WatchOS, and beyond. Literally every dollar of Apple’s $260b in annual revenue comes from NeXT roots, and from Steve wiping the product slate clean upon his return. With the acquisition being necessary but not sufficient to create Apple’s $1.4 trillion market cap today, we conservatively attributed 5% of Apple to this purchase.

NeXT
Season 1, Episode 23
LP Show
10/23/2016
March 23, 2020

4. Android

Total Purchase Price: $50 million, 2005

Estimated Current Contribution to Market Cap: $72 billion

Absolute Dollar Return: $72 billion

Speaking of operating system acquisitions, NeXT was great, but on a pure value basis Android beats it. We took Google Play Store revenues (where Google’s 30% cut is worth about $7.7b) and added the dollar amount we estimate Google saves in Traffic Acquisition Costs by owning default search on Android ($4.8b), to reach an estimated annual revenue contribution to Google of $12.5b from the diminutive robot OS. Android also takes the award for largest ROI multiple: >1400x. Yep, you can’t eat IRR, but that’s a figure VCs only dream of.

Android
Season 1, Episode 20
LP Show
9/16/2016
March 23, 2020

3. YouTube

Total Purchase Price: $1.65 billion, 2006

Estimated Current Contribution to Market Cap: $86.2 billion

Absolute Dollar Return: $84.5 billion

We admit it, we screwed up on our first episode covering YouTube: there’s no way this deal was a “C”.  With Google recently reporting YouTube revenues for the first time ($15b — almost 10% of Google’s revenue!), it’s clear this acquisition was a juggernaut. It’s past-time for an Acquired revisit.

That said, while YouTube as the world’s second-highest-traffic search engine (second-only to their parent company!) grosses $15b, much of that revenue (over 50%?) gets paid out to creators, and YouTube’s hosting and bandwidth costs are significant. But we’ll leave the debate over the division’s profitability to the podcast.

YouTube
Season 1, Episode 7
LP Show
2/3/2016
March 23, 2020

2. DoubleClick

Total Purchase Price: $3.1 billion, 2007

Estimated Current Contribution to Market Cap: $126.4 billion

Absolute Dollar Return: $123.3 billion

A dark horse rides into second place! The only acquisition on this list not-yet covered on Acquired (to be remedied very soon), this deal was far, far more important than most people realize. Effectively extending Google’s advertising reach from just its own properties to the entire internet, DoubleClick and its associated products generated over $20b in revenue within Google last year. Given what we now know about the nature of competition in internet advertising services, it’s unlikely governments and antitrust authorities would allow another deal like this again, much like #1 on our list...

1. Instagram

Purchase Price: $1 billion, 2012

Estimated Current Contribution to Market Cap: $153 billion

Absolute Dollar Return: $152 billion

Source: SportsNation

When it comes to G.O.A.T. status, if ESPN is M&A’s Lebron, Insta is its MJ. No offense to ESPN/Lebron, but we’ll probably never see another acquisition that’s so unquestionably dominant across every dimension of the M&A game as Facebook’s 2012 purchase of Instagram. Reported by Bloomberg to be doing $20B of revenue annually now within Facebook (up from ~$0 just eight years ago), Instagram takes the Acquired crown by a mile. And unlike YouTube, Facebook keeps nearly all of that $20b for itself! At risk of stretching the MJ analogy too far, given the circumstances at the time of the deal — Facebook’s “missing” of mobile and existential questions surrounding its ill-fated IPO — buying Instagram was Facebook’s equivalent of Jordan’s Game 6. Whether this deal was ultimately good or bad for the world at-large is another question, but there’s no doubt Instagram goes down in history as the greatest acquisition of all-time.

Instagram
Season 1, Episode 2
LP Show
10/31/2015
March 23, 2020

The Acquired Top Ten data, in full.

Methodology and Notes:

  • In order to count for our list, acquisitions must be at least a majority stake in the target company (otherwise it’s just an investment). Naspers’ investment in Tencent and Softbank/Yahoo’s investment in Alibaba are disqualified for this reason.
  • We considered all historical acquisitions — not just technology companies — but may have overlooked some in areas that we know less well. If you have any examples you think we missed ping us on Slack or email at: acquiredfm@gmail.com
  • We used revenue multiples to estimate the current value of the acquired company, multiplying its current estimated revenue by the market cap-to-revenue multiple of the parent company’s stock. We recognize this analysis is flawed (cashflow/profit multiples are better, at least for mature companies), but given the opacity of most companies’ business unit reporting, this was the only way to apply a consistent and straightforward approach to each deal.
  • All underlying assumptions are based on public financial disclosures unless stated otherwise. If we made an assumption not disclosed by the parent company, we linked to the source of the reported assumption.
  • This ranking represents a point in time in history, March 2, 2020. It is obviously subject to change going forward from both future and past acquisition performance, as well as fluctuating stock prices.
  • We have five honorable mentions that didn’t make our Top Ten list. Tune into the full episode to hear them!

Sponsor:

  • Thanks to Silicon Valley Bank for being our banner sponsor for Acquired Season 6. You can learn more about SVB here: https://www.svb.com/next
  • Thank you as well to Wilson Sonsini - You can learn more about WSGR at: https://www.wsgr.com/

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Transcript: (disclaimer: may contain unintentionally confusing, inaccurate and/or amusing transcription errors)

Ben: All right LPs. Welcome to The LP Show. I’m here up in Seattle and not traveling. I’m fine but adhering to regulations to not travel when necessary. David is down in San Francisco right now with our guest, Charles Hudson of Precursor VC. Welcome, Charles.

Charles: Hi, thanks so much for having me.

David: I’m the lucky one. I get to be here in person.

Ben: Yeah. Listeners, if you don’t know Charles already (and I’m sure many of you do), he is the managing partner and a founder of Precursor Ventures, an early-stage venture capital firm focused on investing in the first institutional round of investment for the most promising software and hardware company. Prior to founding Precursor, Charles was a partner at Uncork, formerly known as SofTech VC, and he’s a lecturer at Stanford University’s Graduate School of Business and was formerly the founder and CEO of Bionic Panda Games.

Charles, I didn’t really know that about you until I made sure to keep hitting view more, view more, view more on your LinkedIn. That’s awesome. I didn’t know you ran a gaming company.

Charles: It was really fun. I really enjoyed. I had a long run in games. You want to talk about market timing, I had the misfortune of deciding to build an Android-only games company with a good friend of mine in 2010, thinking that Android-iOS parity was just around the corner. Suffice it to say, we got the timing a little bit off.

Ben: It was probably three or four more years before it globally really caught fire, but still not domestically, right?

Charles: Still not.

I could talk about that forever. It’s such a great learning experience as an entrepreneur and I carried a lot of lessons from running that company with me as an investor.

David: You went to DSP as well, right?

Charles: I did, yeah.

David: Did you start that right after DSP?

Charles: No. It’s interesting. I worked for a startup called Serious Business that was started by Siqi Chen and Alex Le. Siqi is now running Sandbox VR. At that company, we ended up selling it to Zynga. There was a handful of the management team that did not go work at Zynga. I was one of those folks, and so was our VP of Engineering. He and I had become friends at that company.

We were hanging out one day just talking about ideas and we tried to build this product that I rarely talk about, but I’ll tell you here. We’ve tried to build a professional social network for job sharing on top of Facebook as our first product.

David: Oh, BranchOut?

Charles: Like BranchOut. It was called Job Circles and we got unanimous feedback from our friends that like, “We do not want this content on this network.” On arrival, our target customers told us—this was back in 2010—that they did not...

David: That’s like the same time as BranchOut, right?

Charles: Yeah. Rick is amazing at distribution and he is a really talented entrepreneur. He was able to scale that thing way faster than we were. We ran a little side experiment for us and for our audience. It just didn’t work and the people were just telling us, “We don’t want to commingle personal and professional.”

We had tried really hard to run away from games and we said, “Well, is there a games platform that would be interesting to build on?” and Android just felt really attractive and interesting. So, we stopped working on that Job Circles company and that’s how Bionic Panda got started.

Ben: It’s a great name. You got to reuse that for something again in the future.

Charles: I can’t take any credit for it. My co-founder came up with it and it also has (I think) personally, one of the coolest startup logos ever, which was also designed by our team. My old co-founder, Mike Jimenez, is a super talented guy.

Ben: That’s awesome. Well, the main focus of the episode today is the work that you do in pre-seed and seed investing. David and I, LPs as you know, pontificate as often and as lengthy as we possibly can about seed investing.

Charles, you run a fund that has a specific focus around pre-seed. We thought it would be really interesting to talk about how you think about that. We’ll get into some fun strategy stuff later, types of companies you like to invest in. My first question to you (to set the stage here) is how do you define pre-seed?

Charles: It’s a really good question. I feel like every quarter, internally, we have to revisit this and say it’s still accurate. The way I think about it is right now, a pre-seed round is a round of a million dollars or less for a company that we say is pre-everything, which is a little tongue-in-cheek. What we really mean usually, pre-revenue, pre-traction, oftentimes pre-launch where the goal is really to give the team enough time and space to build and launch a product.

Ben: It’s interesting that if you think about probably 25 years ago, maybe 20 years ago, we didn’t really even have seed. We had Series A and that was the first institutional round. You’d get friends, family, and fools before that. Then, we started to see some institutions doing that, participating in that angel round and the professionalization of angel funds was the canonical name for awhile.

Charles: Super Angels.

Ben: Yeah. And of course then, institutionalized seed, so seed now is a post-traction but pre-product/market fit round for most people (or at least that is my mental model of it). There’s evidence that something’s happening but it’s not gangbusters, so you’re not ready for your Series A yet.

So, when do you think that it emerged and how do you think about the professionalization of the class?

Charles: I think pre-seed is still really small as an industry in terms of people that are really (I would say) practitioners of primarily pre-seed. I think in a lot of ways, what happened with pre-seed is a re-run of what happened with institutional seed. When I first started working with Jeff at Uncork (it ended 2010)—this sounds probably crazy to the audience—a million dollars was considered a large seed round and if you’re raising $1½ million in the seed round in 2011, there’ll be a lot of conversations, “Okay, that’s a lot of money. Are you sure you need that much? Can you do it for less?” with one big caveat. If you are a successful repeat entrepreneur, that conversation didn’t happen. You are probably going to raise $2 or $3 million, which at that time was an exceptionally large amount of money.

Ben: Today, when people talk about skipping the seed and going right to A, it’s the same phenomenon but with just one—

David: One more zero.

Ben: Yeah.

Charles: Yeah, and I think what happened is, I remember being in those meetings with that sort of generation of seed managers that are now on fund 4, 5, and 6 that are the established leaders. Those funds were all small. There was sub-$50 million. It was unclear that you can even raise more than $50 million for that strategy. I think what happened is those folks all, whether it was Floodgate, Felicis, Uncork, Freestyle, Cowboy, or Forerunner, that TVPI started turning into DPI, the funds started to work, and I think LP said, “Wow, this is an asset class.” I don’t think anybody knew how big seed funds could get before they lost their essential nature. So people—

David: For our audience, TVPI bidding (Total Value to Paid-In Capital) includes paper mark-ups. But then, you won the DPI, that’s the liquid distributions.

Charles: That’s the real money. And what ended up happening is I think a lot of people said, “Well, how elastic is the seed model? Can it go from $25 million to $50 million?” A lot of people did that and said, “Well, that seems to work pretty well. Can it go from $50 million to $75 million?” A lot of people ran that experiment and said, “Well, it seems to still work.” And then the big experiment I think was going from $75 million to $100 million.

What ended up happening is, if you think about, “How do you model out the returns for a $100 million seed fund?” I think the answer is you have to be relatively concentrated and you have to be in really big companies. And you also have to write fairly large checks. What ended up happening is that a lot of the seeds funds have hmm.

For the entrepreneurs who are raising $750,000 pre-launch/pre-product, I met them in the morning. In the afternoon, I met a team of six people that have been working on their product for 1½ years, have $10,000 in monthly recurring revenue, and some things I can analyze and they want to raise $3 million. In that morning case of $750,000, you’d have to be the whole round. Even then, it probably wasn’t enough. What ended up happening is the kind of investments that seed firms had made their living on just didn’t fit the fund size. 

Ben: And when you say even if you have the whole round, it may not be enough. Is that because they’re selling less of the company when a company’s raising $750,000 than somebody would be selling when they’re raising $3 million?

Charles: That’s right. Also, the two things I think about, the old, I think it was the Mike Maples trope, “If you tell me your fund size, I can tell your strategy,” it’s really true. If you think about one of the challenges you had at a $100 million fund size, it’s not just ownership, it’s also you have to get enough dollars to work.

If you could buy 15% of a company for $300,000, you would check the ownership box but you would be nowhere near the dollars deployed box that you need in order to make that model work. I think what ended up happening is, seeds have just become a different thing. To your point, it is this larger round for companies that are more mature. For me, the light bulb went on is that the VC industry at seed figured out that their model had changed before entrepreneurs figured it out.

As at Uncork, as our fund sizes got larger, the same type of entrepreneur kept coming in to present to us. I would tell them, “Hey, three years ago you would have been perfect for us and now I can’t write a check as part of your round. It’s just too small.” They would say, “Where do you want to send us? Do you have any ideas?” I’m like, “Well, no because all of the people I co-invest with have been equally successful and are doing the same thing,” which is raising more money and becoming more concentrated over time.

Despite that, there was this hole in the bottom of the market that if you weren’t a repeat entrepreneur, a Lycee grad, or someone with a really high signal resume, and you wanted or needed less money, they’re just weren’t great places for me to send them. This was when the days when Angelus was still relatively new and I remember telling founders in 2011 and 2012, “Go put up a profile in Angelus. Maybe you’ll catch the eye of some really smart angel and maybe that’ll help you get on the block for these little rounds because I don’t know great institutions that are doing them.”

Ben: One thing to give the non-VCs in the audience a little bit of VC empathy and how hard it is to return that $100 million, can you walk us through the math a little bit of the opportunities you’re looking for, the ownership, and what has to happen and the outcomes for you to get a good return for your investors on that fund?

Charles: Oh boy, it’s scary. I knew I should definitely jump in if you want to modify this. I would say, if you’re going to go try to raise a $100 million fund, your story to your LPs is that you’re going to do a forest growth 3X net fund, which means that $100 million that you raised is going to give them back $400 million, which will be $300 million net of the original $100 million.

And if you want to get super technical, depending on the recycling policy, you’re probably only going to invest that $80 million of that $100 million, so that $80 million has to turn into $400 million. That’s pretty scary. Let’s say a typical seed fund. Let’s say you do your job right and you end up with terminal ownership, i.e., the ownership at that time of exit of 10%, which is possible at seeding and you start off at 15% you could end up at 10%.

David: You could. Even that’s hard and it’s not a given.

Charles: I’m going to make this easy. I think you would probably end up at 10%. But let’s assume it at 10%. That means you need $4 billion in exits to get to a 3X net fund, which is a very good but not out-of-this-world exceptional fund. If you think about it that means you would need four unicorns in your portfolio. My guesses are if you’re a $100 million seed fund, you probably have 45 or 50 companies in that portfolio (at most), which means basically 1 in 10 companies you back has to become a unicorn at a minimum for you to meet your returns hurdles. That’s really hard.

Ben: Yeah. The only thing I’ll add to that is that 45 is with great portfolio diversification and with the amount of money most funds are saving now for a follow-on to be able to protect their investment if they have pro-rata rates or something like that, you’re probably looking at 20–25 investments that you’re making out of a fund like that. The hit rate has to be quite high.

Charles: I think that totally influences people’s behavior as it should, which means that you are looking for companies that even at the seeds stage look like they have the potential to be huge home runs.

David: I’m curious if you started to see this, even back when you were at Uncork, the traditional big [...] venture capital firms didn’t ignore everything that was happening either. They started to unseed as well. They would argue they have always done seeding, that would be accurate but for a while they kind of ignored this part of the market and then they came back in a big way. 

Charles: I think that’s been the single biggest disruption I’ve seen in the last six months. It seems to me that every three years, big Series A funds rediscover seed. I don’t know whether that’s because some of the newer investment professionals on their team like a seed is a good way to learn the business. It doesn’t cost you as much or whether it’s just because they look at the mark-ups and say, “We could do this, too.” 

The big difference is in the early 2010s, this argument that you didn’t want a big Series A firm on your cap table at seed for signaling. It was a very powerful argument. I think it’s partially because two things were happening. One, some of these big funds had these almost “spray and pray”-like seed programs and people didn’t know how to interpret what it meant when a big Series A fund that has spent no time with your company declined the ledger series A. People would just say, “Well, it’s probably not good so we won’t touch those companies.”

I think those big series A funds realize, “Okay, this probably isn’t good for our brand if we’re writing 100 seed checks and we only do one or two.” I think maybe it was in the [...] that spark, who published a chart a while back that showed seed-to-Series A conversion by a firm and there are actually relatively few firms where that conversion was really, really high.

And I think the biggest difference now is the entrepreneurs that I meet have zero concern about signaling risk, of having these people on their cap table. I have examples even on our portfolio where a very large tier 1 firm did 75% of a given company’s seed round did not lead the A and an equivalent tier fund came in and led the A and there was no conversation at all about signaling. 

It is new and it’s changed the pricing dynamic because a lot of those big series A firms are, I wouldn’t say they aren’t price-sensitive; that wouldn’t be fair. They can afford to pay a higher price because they have more ways to get to their ownership target between seeds and series A than your typical seed fund does.

David: My hypothesis would be in the account of what I have seen of [...] case if you’ve seen the same as that a big part of this shift is that entrepreneurs have just gotten smarter, too. If you have a big series A fund in your seed, (a) probably good to get a couple of them in there, and (b) you keep building relationships with other series A funds. You don’t stop talking to them. Then you say, “Yeah, XYZ firm has been great to work with but we’re going to raise them. If you want [...] you can go right ahead.” That’s how you can get dynamics as you described happening.

Charles: I also think that for the most part—this is not a [...]—I feel like most of these series A firms coming down to do seed, it’s with high signal people. To your point is with people who have access to relationships where they say, “Hey, even if I take your money, my professional/social network is going to expose me to lots of other equivalent VCs. I don’t feel bound or captive to you just because you did my seed.” Those people are more sophisticated.

I also think some of those entrepreneurs are just capable of handling more money, more pressure, and larger teams earlier in their lives because of their previous experience. I tell people, this whole pre-seed thing is a weird moniker. I just think there are two-seed markets right now. There’s a seed market for high signal experienced people. If you’re employee number five at Stripe, you’re probably not going to come to Precursor, to be honest.

David: You should.

Charles: You should. I would love to meet you. You’re probably going to go to General Catalyst. You’re going to go to a big brand, you might even be friends with the [...]. You’re going to have a really different journey. If you’re employee 500 at Stripe, my hunch is you probably will end up in my office because of the odds, that benefit of that low employee number count, access to the founders, to the early employees and investors. In general, most people even in [...] don’t have that in their back pocket and I think that’s really the role that pre-seed can play even in functional venture markets like San Francisco and New York. 

Ben: All right. Talk to me then about your philosophy there. This is a founder that doesn’t have this super high signal in the club, of the people who are friends with it, the GPs that—

David: Wait. To be clear, too, we talk about this on the show all the time. That signal may or may not be worth the paper it's printed on.

Charles: Totally! I’m glad you said that and I didn’t have to. I think that’s true and I think there's safety in buying signal. In a world where more investments don’t work out, and people will say why did you back this company, the ability to point to whether it’s educational or professional credentials is a very nice crutch and it’s a nice safety blanket.

David: It’s reassuring.

Charles: That’s right.

Ben: Then how do you absent that easy snap decision-making, “No one will ever fire me for buying IBM here.” Absent having that safety, what’s your decision-making process? How do you evaluate founders? I’m so curious.

Charles: It’s an evolving process. I will say one thing. We’re very volume-oriented at Precursor and I think one of the things that help us is we see and meet a lot of companies and we have a large portfolio. We’ve made about 175 investments across our first 2 funds. That has given us an interesting perspective which is we have every type of successful founder that you could imagine. We have a solo, non-technical, female founder. We have a male-female co-founding team. We have all-female co-founding. We have every permutation.

David: You have a large data set.

Charles: We have a large data set. I think we have every permutation which has convinced me that just about anything can work. I would say when you meet a couple of thousand teams a year, the ones that really stand out to you tend to really stand out to you because most of them are good and then you meet ones that you go “Wow!” 

The big thing for me is my fear is always that whatever the hypothesis the company has about why they’re going to be successful it’s just not durable. For me, durability matters because most of the companies we meet it’s funny. The number of times people tell me, “Instagram can’t do A, B and C thing.” I’m like, “No offense. You haven’t done it either.” You’re starting from zero and your product won’t be done for some period of time. Who says that the competition’s going to stand still? 

When I look at a lot of the companies that we’ve backed—I’m not a technical person by any means—we end up finding a lot of companies where I think the innovation of the insight tends to be around the business model or the market segmentation. We were very early investors in athletics and they had a really strong thesis that building a subscription-powered sports service was going to be a fundamentally different endeavor than what you would focus on if you’re building something that was ad-supported.

That difference was not cosmetic. It was actually fundamental to the business. All these interesting ripple effects about how much you could afford to pay talent and what you do with the proceeds, there’s just really different ripple effects that I find. It took me probably three or four years to realize that for us, these business model innovations have all of these ripple effects that are hard to quantify at the front, but it means you end up building a different product because your business model dictates that you do things differently. That ends up being a big chunk of what we look for. I guess I am an optimist, so my view is you really don’t know how good of a founder someone’s going to be until they do the job.

David: That’s so true, by the way. So true.

Charles: Yeah. Even being a senior executive at a company is really not the same. I’m an optimist and I think most people, to experience being a founder, it brings things out of you that maybe you didn’t even know that you possess the skills and if you give yourself the chance to make 25-ish investments a year, you can have a spectrum of people where you say, “I have a really high confidence that this person’s going to be successful. They are repeat entrepreneurs. They’re in the same domain.” This person ought to be able to figure it out and some people have never done this before. By this, I mean a venture-backed startup.

Again, when you have a portfolio of 175 companies, a lot of the stuff you can learn from your peers. I lean heavily on our existing portfolio companies to help each other and they’ve really cultivated on their own the spirit of helpfulness. I always ask myself, “With $500,000 and a million dollars and 12 months of work, do I think this founder can tackle the number one problem facing their business?”

Oftentimes, the number one problem is the product simply doesn’t exist. We’re very much in hypothesis land. That’s why I ask myself if they can get the product out or they can take the alpha or beta version, ship something, and we can learn, there’s a good chance we’ll know whether the hypothesis is right in a year.

I never showed these stats but I am happy to tell you guys. About 60% of our portfolio companies get from pre-seed to seed and that’s been really consistent over both of our funds and roughly an equivalent percentage slightly more go from seed to series A.

David: Has anybody ever skipped the seed and go pre-seed day?

Charles: Yes, and he is becoming more popular. I think it’s the aspiration of all the company corners

David: Anytime you can skip around, that’s simple math. It’s good.

Charles: That’s right. It is so good and it’s becoming more possible and weirdly it’s easier for our consumer companies to do it than for our B2B ones just because if you have a really breakout consumer product and a small team, a $750,000–$1 million seed can actually take you to the place where a Maveron or a consumer-focused VC can say, “I know how to interpret attraction and this is sufficient.” Harder to do in beta B enterprise.

David: Wow. A couple of follow-up questions. Going back from many tier decision making processes, I would imagine, as opposed to a lot of firms that have more concentrated approaches, are like fewer—what we’re talking about whether how I see [...] goes—you start running into this issue, like I interned at Mary Tech Capital growth. They are the best and they are fantastic, I love those guys. They are the best. 

At the stage they invest in, one of their core tenets is don’t lose money, and that makes sense at that stage. That mindset starts creeping in at seed and then you are like, “Don’t lose money at seed.” That is the wrong approach. So, I am curious about your approach to being wrong, losing money?

Charles: I worry more about our conversion rate being too high than too low. I sometimes wonder and I have talked to a few people that I consider mentors in the business, I have talked to them, “Hey, given our risk profile, is 60% graduation too high? Is that evidence that maybe we’re not taking enough risk either on people or markets or both?”

Mostly because the way I’ve modeled that we haven’t really dug deep in portfolio construction but I can tell you all, what I’ve pitched our LPs is we’re going to make 75 or so investments per fund and my expectation is the top 4 companies will do at least 2X as a group. That means 2X on the whole fund. Without getting too deep in the math, that basically means I need those companies for our first fund to be in 1% or 2% ownership in companies that are $500 million–$1 billion in valuation, so we don’t need decacorns or multicorns. We can do just fine.

For our second fund, you need companies to creep a little bit closer to $1 billion for that math to work. I was asking myself, but I don’t want to end up with is an entire basket of really mediocre, uninteresting, no offense to B2B SaaS companies but the B2B SaaS companies that are doing $20 million in ARR and can’t grow at a rate to get 3Cs attractive and are big enough to sell the PE.

I’m paranoid that by doing middle of the road stuff that’s too safe, we’ll end up with a portfolio that has no outliers and I spent a lot of time asking myself like, “Are we meeting the kind of founders that we think and produce really interesting breakout companies and are we taking enough risk on the business model or marketing people to give ourselves a shot at finding four or five outlier companies?” It’s funny LPs always asking me like, “Oh, what’s your conversion rate?” I’m like, “I’m worried that [00:26:15] pre-seed is a little too high.”

Ben: I have had many friends pitch me on this idea in the past that why do VCs need these,” and they say, “10X returns?” It’s not 10X. It’s 50X returns on your initial invested capital to become these top-top 4 that you’re thinking about in your fund that are going to 2X the fund and the growth spaces.

Everyone’s got this idea that everyone goes through this cycle of like, “Why don’t you just make a bunch of investments in companies that will all be 3X, 4X, maybe the potential for 5X, and have a more distributed return profile?” The way I’ve always thought about that is no matter how much you bring down the ceiling on how breakout these companies could be, it doesn’t track with that startup getting easier to execute. For a pretty similar amount of risking the whole thing going to zero, you have to be able to have a huge return versus being able to have a ceiling of a 5X on it.

Charles: To your earlier point, though, if we had fewer companies—this is what are my core arguments when I pitched LPs—if we had a more concentrated portfolio, I think it would squeeze out companies on the high risk, high return. I would naturally gravitate towards companies where the founders are—

David: Oh, employee number five?

Charles: That’s right, all day long.

David: Sure thing.

Charles: I think we spent a lot of time thinking about what’s the right number. What I’ve decided is, 25 is a good balance. We’ve done tons of internal analytics on this, 13–18 months after pre-seed. You sort of know what you have in your hands with the company. It’s either raised money, sold, shut down, or it’s in a stage where they are figuring stuff out that’s ambiguous; very few companies are in that ambiguous bucket of 18 months.

So, it’s okay. If we do 25 a year, most of them are going to turn over in time onboard the next wave. Also, 25 is enough that you can get to know people, through monthly or slightly more than monthly check-ins and build the relationship and get to know them as people. More than that, and it’s passive. It ends up being more. At that point, you might as well just do as many good companies as you can, but I think if you mull that out, you start diluting your returns too much if you do, 120. I haven’t seen them all, but I believe in what you can do to 120 companies.

David: Well, Y Combinator is the only way you can make it work, which is you, your valuations are just so low because of your whole bargain what you do. That’s the way you make it work. If you’re paying marked evaluations for 120 companies, that’s not going to work.

Charles: Any of the forcing functions with YC that you have cohorts that graduate, and you have graduated—

Ben: You’re out of the nest.

Charles: That’s right.

Ben: Charles, give listeners a sense. What was the size of fund one and fund two for Precursor?

Charles: Oh man, this is taking me back. Our first fund was $15.3 million. It took almost two years to raise and that was so brutal.

David: At two years, I was raising for a little over one year and I can’t imagine going for another year. How do you keep going through that?

Charles: I had a lot of really rough, rough moments. Part of it was I didn’t have a Plan B. I felt like the only way LPs would take me seriously was if I had already made the decision to move on from Uncork if I had one foot in and one foot out. If I were an LP, I don’t know if I would fund somebody in that position, and I felt like having to make it work would push me through the hardest times.

I also just had a lot of other experienced GPs. I don’t even think they know, just tell me really important things along the way. That help picked me up. Every time I got to the point where I couldn’t do it anymore, somebody said, “Yes.” That was just enough to keep up.

If you zoom out when I raised our first fund (it was 2015) I think Manu at K9 has been doing pre-seed for a while. Tim Connors was doing concentrated pre-seed. I don’t think he really talked about it that way, and I’d say Notation was probably the one person who was out there talking about.

David: They were starting right at the same time.

Charles: Usually the same time. They were a little ahead of us and I think they had just a different model. There just wasn’t a lot of LP vocabulary around pre-seed. Definitely, there weren’t LPs who said, “Oh we have an allocation for pre-seed.”

David: And keep in mind [...] we talk about the other. It’s natural that Charles and [...] we talk about LPs, we know the LP animal. There are a lot who listen to this show, they’re great, they’re wonderful but these are folks who allocate capital across public equities, real estate, fixed income. Venture is a tiny piece of what they do and when they think about Venture, they think Sequoia. They don’t think pre-seed.

Charles: The irony is that most of the LPs I met who were sophisticated enough to have a seed program when they showed me the roster of managers, I was like, “Wow, you’re in the best, and it’s probably in the best cause you were there early, but you’re in the best. I can’t really sit here and argue that you should fire one of those people to hire me if I’m honest.” Then a lot of people had issues with single GP and that was all, but that’s a binary fork in the road.

I don’t think I convinced anybody that a single GP was a good idea. If they didn’t think it was I found a tribe of people who by far the hardest thing for us was our portfolio construction. Because our portfolio construction of 75 companies per fund, relatively low ownership is unorthodox at best compared to the current viewpoint of most institutional LPs, which is the way you return a seed fund in high concentrated ownership and a relatively small number of breakout companies.

That works great. Roger Ehrenberg does that super well. Tim Connors does that super well. There are a lot of people who are successful at that strategy and candidly, there aren’t as many proof points outside of YC and accelerators for the kind of model that we have, so I totally don’t blame them for being skeptical.

Ben: One thing we haven’t talked about is this “one stage earlier than seed.” When you’re out pitching those LPs, did you get this question of, “So, am I going to have to be another year or two more patient with my capital than I would be with seed managers?” How do you address that issue? What’s the fund lifetime?

Charles: The fund lifetime is 10 years plus 2 one-year free extensions, so think about it as 12 years. The sophisticated LPs (as well as my seed managers) are telling me 8–10 years, so should I assume to add 12–18 months on top, that’s a safe assumption? With one caveat, one of the nice things about being a relatively small owner in these businesses is, nobody really gets bent out of shape if we decided to do a secondary in a late-stage company. This was a hypothesis when I started the fund.

That would not be an issue with the other entrepreneurs or the other investors, and it’s proven to not be an issue we get presented with those opportunities routinely at the B and C. Also, I told the LPs is because we’re probably going to have the lowest dollar cost entry point relative to anybody else in the cap table, some of those Series B and Series C secondaries could be substantial.

It could be, 10%, 15%, 20% of the fund, which I will have the ability to provide you early distributions if we choose to do so, but I will not do so at the expense of long-term returns. We are not going to sell out of our winners at low prices just to generate distributions. That was a hypothesis. It has turned out to be true, but it was speculation when we started the fund, and I told LPs, “Yes. It is even worse than that because, by the time I come back to you for the next fund, the set of facts that we are going to have about the previous fund are going to be limited.”

David: You really take a page from the [...] playbook of like, “I am going to tell you exactly what’s going to happen here.”

Charles: I will tell you all of the bad news upfront and this is going to be a long hold, but I think a lot of sophisticated LPs I talked to, I said,”Go back and think about some of the best returning funds you have in your portfolio, where they look like.” And I said, “Well, they were relatively small fund once.” I think it’s just easier to generate high cash-on-cash multiples when the total capital base is lower and their entry point is lower. 

Ben: Yeah, you hear the rumors of what was Chris Sacca’s fund one, that was [...] Twitter and obviously massive. I think multi-dozen multiples on that fund. Charles, then fund one was (I think) you said 15.1. What was fund two?

Charles: 31.3.

Ben: So, you doubled for fund two. Is there a fund three in the works?

Charles: There is a fund three. We actually just filed the form D for fund three yesterday.

Ben: Congratulations!

Charles: Thank you. So, really excited. It was a really different fundraiser. This is the first time I think I met LPs that have a prepared mind about pre-seed, who were specifically looking for people doing this work. We have a handful of really strong companies that have performed well and that helped but it was really different. 

Our fund two was really the same as fund one mostly because we didn’t have any data. It was still really speculative and I was asking existing LPs to double down and new LPs with not done fund one to take a bet on us. Fund three was much easier. We had 80-some companies in fund 1; we only have 1 company left at pre-seed.

I can tell you what happens to the majority of the portfolio because we only have one company that is still at pre-seed. They just happen to be really capital-efficient and haven’t had the need to raise. I think more than anything, I have more confidence and clarity around our model, 175 companies that I did in the beginning, so it was much easier for me to talk about why what we do works and why I think it is a good investment. 

David: It was just like a company right? Fund one is a pre-seed, like you have a hypothesis, but you are pre-everything. 

Ben: All right. Let’s talk about scaling the fund then. Fund two was twice as much as fund one. How do you keep from just becoming a seed fund? What needs to stay consistent in your strategy? What needs to change? And operationally, how do you scale SLOGP fund?

Charles: I have (again) something I think is probably atypical of most managers. I believe there is a very hard dollar cap on our strategy. It’s probably somewhere between $40 and $50 million is the most that I could see [...] the point in a world where I’ll just tell you what the tensions are in the models will get bigger.

One simple solution would be we will all raise more money and just increase our initial check size. It should be an easy solution. The problem is in a $500,000 round when I do $250,000, that leaves another $250,000 for great angels and other people who can do awesome value at things for the company and be a support system. It’s not just my voice. It also means that the company has more human resources to go to when they have problems and challenges. If we were to double our check size and go to $500,000 I would just squeeze out all these amazing angels because I would need [...].

Doing 25 companies a year where you’re basically the soul of it, I don’t think I could manage that. I think it would be too much for me and the team. Some were like, “Okay, we can’t do that. What are the other releases [...]? What do you do about this?” “Oh, we will just raise a bigger fund. You can live with your company longer and pro-rata.” Theoretically, that’s a good idea. After fund two that we raised an opportunity fund after doing 15 SPVs. Yeah, we have 15 SPVs.

David: You’re a busy man. 

Charles: We’re very busy. We will get to the scaling part in the second. I just want to set the stage. We raise an opportunity fund to have a dedicated pool to double down. I think what I’ve concluded is this is the hard thing that we are wrestling with today, we reached the point of view on this, and I reserve the right to change my mind. Our typical entry point is called five posts. Our typical seed round is mid-teens post. I can argue that those are similar assets and they should be bundled into the same fund. We will call that the core fund strategy.

The harder question is we’ve had some Series A’s in the high 40s and low 50s, and those are really competitive rounds. Our best, strongest company (from a fundraising standpoint) are raising at a price that’s maybe six to seven XR cost basis and I’m going to have to fight like mad to get an allocation. Why should we do that? 

David: Is that what LPs, to go give you capital for?

Charles: Is that what you gave me capital for? Or would I better off taking that $300,000 or $400,000 that we are going to try really hard to squeeze into that company? Or do I think I could generate a better risk-adjusted return by adding another company to the portfolio? Or by doubling down on the company that’s in between pre-seed and seed, where we have unique inside or proprietary information and performance?

I concluded that it is also not consistent that we are going to get into those really large competitive Series A because, remember, at best we are third in the stack. You have the Series A lead which is a big billion-dollar fund, has both a capital deployment, a capital allocation challenge, and ownership challenge. Then you normally have an ownership-conscious seed fund, that’s larger than us, [...] will absolutely exercise it, and because their ask has gone from about 10% when I started Precursor but closer to 15%, there are just fewer points of ownership to go around.

I told the LPs, “Do you really want me to have this theoretical pool of reserves that we probably won't get to deploy? And if we do, it will probably be only in the Series A’s that are more difficult? Which doesn’t mean they are the worst companies. It’s just that the facts are, that’s how it's probably going to work. Or could I segment the pool?

Could I say, “Look, at the core strategy at topside at 40 or 45. I really can’t do more than that”? But in the event that we get opportunities at the A and the B, we have a different vehicle with a different fee structure, different returns expectations, and I would be happy to take almost a limitless amount of money into that other vehicle because it’s just a function of what becomes available to us.

That’s the way we are moving us a fund. I don’t think we can get bigger than at solo GP and with our strategy. I struggle to see how more than 50 plays to our advantage.

David: In terms of valuation?

Charles: In terms of valuation, in terms of model, I'm just really nervous about tinkering. I think what we do right now works great. $250,000, I'm very comfortable giving that to people that I don't know that well, because I feel like it's enough for me to learn how they operate. It's enough for that to make a difference for them, and the bar to saying yes to me is low enough that I don't agonize over it. I'm like, "This is a good person. They're consistent with the other founders that we've backed, we should give them an opportunity." When it doesn't work, it's not that painful.

At 500, there are people in our portfolio that are very strong performers. I don't know if either: (a) I would have been allocated 500, and (b) I'm not sure I would have trusted them with that much money from scratch.

David: When you start to get into this fear of losing money mindset.

Charles: Absolutely. I guess, the trick is we have a team of three, we'll add a fourth.

Ben: I was going to say [...] saying we, so tell me about the crew.

Charles: We have a great team of three. I'm the one GP. We've got an associate, Sydney Thomas who's been with me for almost four years now since the very early days of Precursor. A year ago, we added Ayanna Kerrison as our analyst, so we have a team of three people. Right now, I do all of the non-fun to admin operations at Precursor around wiring, audit. We're going to fix that.

David: We know how that works.

Charles: You guys know how that works. We're going to fix that. That's too much for me to have them.

David: Good for you. I can only imagine with as many companies as you have, too. That work scales with the number of companies that you have.

Charles: It does. A lot of our portfolio companies provide us with like written updates. Fortunately, I'm not in the workflow of getting that into Airtable. I do primary portfolio, company support, primary company selection, initiation of wires, tracking down closing. It's a lot and we've got to the point now where I don't need to do that work anymore, so we'll fix that.

Ben: And for listeners who aren’t writing regularly writing checks, there is a shocking amount of stress and time around the initiation of wires where, when it’s closing day for a company, your productivity is shot for potentially a third of the day by making sure that you’re getting that company the money on the exact day that they need it, making sure that all the boxes are checked.

David: That it's not going to some bank account in Russia.

Ben: Yeah.

Charles: Yup. So, we'll fix that. The nice thing, though, is because we're going to be, I'd say permanently boutique. I really admire what Initialized and some of my other friends who are building multi-generational franchise firms. That's not my current aspiration. I think what we do has a cap. It also means that with a small team, the 2–2½% management fee that we get is actually sufficient to cover most of what we need to do. If we can sort of stabilize on a fund size of 40 on a go-forward basis, it'll be sufficient; but it means we'll probably never have a team of like five or six people. It'll probably be three or four of us at all times.

David: When you’re maybe not raising, for instance—forget the LP perspective—just in practice. What's it like being a single GP? Probably when you started this, everybody was like, "Solo GP. I'm very, very skeptical." Now there are a bunch out there, but how's it really been like?

Charles: It's such a funny question. People always go, "Well, tell me about your thought process." I was like, "There wasn't one." It never occurred to me to not start Precursor if I didn't have a partner. I'd meet a lot of first time or new fund managers. I could never imagine starting a fund on my own. I go, it never occurred to me that starting Precursor was gated on having another person to go on the journey with me for a couple of reasons.

One, I just did the math on our hard cap for fund one when it was $25 million, and we fell short of that. Even in that world, how do I get another me? How do I get another person like me who's an experienced GP to come work here for this amount of money to split to carry? That person could do the exact same thing that I'm doing, and basically have total control over the brand and style of the firm, and all the economics. I don't think anybody I know who would fit that bill is going to decide that teaming up with me is better than doing on their own.

Sort of more from a practical standpoint, I feel like if you're going to evaluate, let's call them zero data companies, we really don't know anything about them. You're going to write relatively small checks, what's the benefit of a second set of eyes?

David: Right. Doing it by committee is probably not going to lead to good decisions.

Charles: No. Also, it's just not going to lead. From a process standpoint, I think it's really going to slow you down. If I'm like, "Okay, you've got to go meet my two partners and the three of us have..." I don't think entrepreneurs are going to wait around and run that process for 250. The best ones won't, they have other options.

One thing I learned from Uncork is if you're going to build a new firm brand, you only have (as a solo GP) so much time to incorporate others before the market perception is the founding GP is the brand. It's nothing about the level of effort that you as the founding GP exert to uplift and—

David: Take Tim Connors at PivotNorth.

Charles: That's right.

David: Take Steve Anderson at Baseline. Yeah, exactly like—

Charles: Manu Kumar.

David: Manu, yeah. I think Manu, I think K9. I think K9, I think Manu.

Charles: That's right. I think what ends up happening is that the market just associates the firm with you. It takes a tremendous amount of effort to reset people's expectations that that's not how it works anymore.

Ben: Yeah. I feel like it took Lyft going public for Floodgate to become Mike and Ann.

Charles: Yeah. Ann's been doing great. She's been doing great work.

Ben: [...] unbelievable investor, yeah.

Charles: That's right. I'm sensitive to that. We probably have one more fund cycle where I could make a decision on that. It's a little different with internal promotions. That's a different lane, but that's something I think about a lot.

Some LPs were just like, "Hey, we really want to know what your strategy is here." I can be a little tongue-in-cheek sometimes. I said, "Tell me about all the problems that you have with your multi-GP partnerships." Or, "Let me tell you about the problems you have that you don't know are problems." I just decided really early that (for me) I was very comfortable.

This is a really good question. The worst part about my initial fundraise, and I give credit —I don't even know if I've ever thanked them publicly—to Michael Dearing, who's run every permutation of solo GP with a partner, with a junior person by himself. In this very Michael Dearing way, he said, "Do you feel comfortable as a solo GP?" I said, "Yeah." He's like, "Well, then you have to stop being defensive about it."

I realized my answers to LPs about our long-term plans was a 5-minute answer for what should have been a 30-second answer. I'm sure they picked up on the fact that I wasn't clear in my own mind on that.

David: That's such a good piece of advice from Michael. So not shocking. Michael would be blunt like that and have a piece of advice like that.

Ben: I have a quick Michael Dearing story. A friend a couple of years ago told me that they were flying down to the Bay Area to meet with Harrison Metal about an investment in their company. I knew Michael’s name but I never knew the name of his investment entity. I was like, “Oh, but you’re not a metals company. That wouldn’t be strategic…”

Charles: I'll be the first to admit, I absolutely benefit from the work that Manu and Tim, when it was just Roger and not the full team. There's a bunch of people before me who've done the really hard work of Steve Anderson, Chris Sacca. The really hard work of proving to LPs that this can work, which doesn't mean that every LP believes it. But also, those individuals have been extremely generous to me in terms of just helping me navigate how do you do this as a single GP? When do you know that you've done enough on apps and you should hire someone else? When do you know that you need help? What do you think about sort of junior investment professionals, and developing them, and giving them space? Those individuals have been extremely helpful to me. I just try to pay it forward for the next wave of people that are trying to do this.

David: That's one thing. Also, you on the show are so good. It's been such a nice thing. I think both of us found being in the seed ecosystem is, as we both came from Madrona beforehand. Not that there wasn't camaraderie in the big farm ecosystem, but the stakes are a lot higher as we were talking about.

Ben: Elbows a little sharper.

David: Yeah. It's just everybody, a lot of the same people you mentioned have been mentors to us, too. It's just so generous that people are willing to be generous.

Charles: It is. I mean, I think that's the one thing that's striking to me. In a lot of ways, sort of 2020 pre-seed reminds me of 2007 seed. 2007 seed, you had five or six firms. You could probably put them all around one kitchen table, super collaborative.

Ben: Or backward, like a VIN-38.

David: I love that you remember that.

Charles: I was like, "Is he going to go VIN-38?" I mean, I think he probably will, but I think it was very collegial because also everybody's fund size and strategy meant that you could do two-handed in some cases, three-handed deals or three firms would all get together and do around. Pre-seed right now, it's funny. I'll be just like, "Who's your competition?" “My competition is the founder who doesn't do a company, and goes and gets a job.” That's a little facetious but is also true.

Our true competition at pre-seed (and I think this is true for all pre-seed managers) is a company that you find that you think should raise pre-seed, catches the eye of a bigger seed firm, and what would have otherwise been one on three or four, becomes three on seven. And generally speaking, you can afford to pay that. You can't maybe afford to pay 3 on 12.

Our real competition is the seed funds that have an eye for talent and give themselves permission a couple of times a year to dip down and do something really, specifically novel. It's not a repeat founder. It's somebody who's really at zero, but is a compelling person, giving themselves permission to do those rounds.

The ones that we lose that I would say are regrettable losses tend to be those. Or ones that just run away from us. We meet them, and they're raising one, and they end up raising seven in the goal, which happened three times in Q4 last year.

David: Wow. We would be totally remiss if we didn't switch gears to the more important side of the equation before we wrap up. Tell us about the entrepreneur side of things for Precursor. How do you meet entrepreneurs? How do you interact with them?

Ben: And I should say before you answer that question, I do want to say this last close to an hour that we’ve been talking, I don’t think we’ve really done this on the LP show, like really dissect fund strategy and think about the ecosystem, at least not in the last six months since it’s evolved, maybe not in the last year, either.

For founders out there or for people who want to know more about this, I hope it’s valuable. I think it’s super “inside baseball” information and now I’m super excited to talk about what you’re interested in and founders in a bit. This is not widely available off to bated dissected stuff in the public.

Charles: It's funny. I feel like seed has gone totally micro. All of the decisions you make in seed right now are about your fund, your strategy because the macro environment for seed is pretty well-understood and pretty well-established. You got to have ownership, seed deals are getting more expensive but so are Series A's.

I think pre-seed is still very macro. We're still figuring out macro. There's not that many pre-seed funds out there. There's also for Bloomberg Beta. There's a handful of people out there that do this work as a primary activity. I think we're all still very macro, which is what does it mean to be a pre-seed firm in a world where seed firms are under pressure from the top.

Increasingly, the nice thing about fund one is there was no sophistication on the entrepreneur side around pre-seed because it was brand new. No one had the flashy pitch and the vocab. No one really came in and told me they're raising a pre-seed round. Like, "Hey, we were trying to raise a million-dollar seed round. Everyone told us that that's too small. So here we are."

Now, entrepreneurs understand that pre-seed is a thing. The quality and the insight that they have around what a pre-seed round looks like is much more sophisticated even in five years. I suspect at some point, pre-seed will become more micro than macro, but the weird thing is when you're a bar has no traction, smart person, the universe is your oyster. You can literally meet with anyone. When you have 300 portfolio company founders in your network, if I were to say what's the biggest learning I've had from Precursor? Everything that LPs thought, for the most part, was a bug about our model that I thought was a feature has turned out to be a feature.

For example, I talk to people all the time, "Oh, we have a Slack channel, but nobody uses it. Tell me about your portfolio." "Well, we have 45 companies." Okay, I know where it's going. "We have three pre-IPO, a couple of…" I’m like, “Look, you just don't have enough people, period.” Slack works well when it's liquid and what makes the liquidity, you need people asking for help and people providing help.

The best way to create liquidity is if you have a bunch of people that are at roughly the same stage of company building. You have a lot of them, you will have liquidity. When people post and see that a question gets 15 replies, they go, "Oh, this isn't shouting into a well. I should post my question here." You get liquidity and it just feeds on itself. You’re probably better off with a Google group. Email might be a better mechanism for you because it's easier to manage.

A lot of people said, "Oh, how can you help all these companies?" I'm like, "Well, it turns out when I look in Slack, a lot of the questions that people are asking, I have no business answering them." For example, two weeks ago, someone's like, "What's the market rate for penetration testing?" I don't know. Fifteen people chimed in, "Oh, I use this vendor. This is what they charged us." In an hour that person had a pretty good set of market cops.

David: Yeah. That's so funny. Literally, I remember back in Madrona getting that question and trying to pretend like I knew and try to find the answer on questions like that.

Charles: I think that's turned out to be a feature. To be clear, about 25% of the investments we make are seed as an entry point. But when you take seed-stage companies and mix them with pre-seed companies, you get people who are slightly more experienced, slightly farther along, helping people who are close enough in a phase that you can actually have a real conversation.

Even little things like we do this thing a couple of times a year called The Seed to Series A Dinner. I think there's so much on Medium, Twitter, other podcasts about what does it take. I feel like founders are getting overwhelmed. I was like, "You know what we'll do? We're going to take four or five people from our portfolio who successfully raised Series A, and eight or nine people who I think are on track, and we're going to have dinner. We're going to have the people who actually did it, tell what actually happened, and how it actually worked in an off-the-record private dinner, where the founders who are thinking about raising can ask every single question, including 'Hey, how'd you use Charles in your process? Was he helpful?'" I want them to have that forum because I think there's so much content out there about what works. It can be overwhelming.

When you have a big portfolio, anything, any theme, anything you want to do, you're going to get 10 or 15 people to show up, which is the long-winded way of me saying that the way that we meet entrepreneurs is we try to keep the bar for a first meeting really low, and the bar for a second meeting really high, which enables us to meet a lot of people. We've got 300 great founders out there who I'd say, by and large, are happy with the experience they've had working with us. My basic view is, we are not the most central character in their story like they are, as some like, "Look, I'm probably not going to come to your office and sit down on the whiteboard with you for five hours on Friday and fix your product. I don't have that skill. I can totally help you fundraise. If you think about our founder profile, most of them are fundraising for the first time."

Fundraising is a skill that we think we can teach, but also because we get so many reps across the portfolio, I think we have a pretty good sense of the market. I can tell someone, "Based on your deck interaction, on a scale of 1–10, 10 being slam dunk, 1 being a possible, your fundraiser is going to be a 4. It's going to be really hard." By the way, because we have 175 companies, there are very few good seed or series A firms out there with whom we do not have at least one co-investment. I think it's not glamorous to help people with a deck behind the scene and send a bunch of email intros.

Ben: It’s the job, though.

Charles: It is. It's less, I'd say, sexy and glamorous than whiteboarding on product, but I'm just like, "This is what the companies we backed. These are the areas where they need help."

Ben: And this is the unique place where you can really add value. They can get another smart founder or another product manager at their company to do that whiteboarding stuff as the fund is for us.

Charles: That's right. The other weird thing is when you have 175 companies, there's basically a 100% chance that somebody is having a dire emergency every day. So, you just book time in your calendar.

David: Do you have an emergency block time?

Charles: I have a couple of blocks a day that my admin knows that if this comes in, stick it in this block. Honestly, part of this job is just availability. That's something I learned from Jeff really early on when I worked with him at Uncork is availability is a superpower in the venture. I wish I could say we're always available for every founder, that is an untrue statement.

What I can say is I'd like to think that when founders really have time-sensitive or pressing issues, whether it's a one-day thing or two-week thing, we're able to make time for them because I know at any point in time, a predictable number of our portfolio companies are going to need (by our standards) an extraordinary amount of support and help. As long as we stay within a band and we've studied this, we just finished a study which shows we're actually pretty good ex-ante at predicting how much help a company is going to need.

We get it right most of the time. We have some far outliers and we have some, what I call temporal outliers, especially if it's co-founder separation, major pivot, M&A, difficult fundraising. Those are temporal spikes, but we can absorb those as long as everybody doesn't have one at the exact same time.

David: Yeah.

Ben: Though it’s not a run on the bank.

Charles: Yeah, that will be overwhelming; there is no answer. The LPS go, "What happened?" I go, "There's no answer. Will we just be overwhelmed?"

Ben: You need uncorrelated crises.

David: Yeah. I just want to highlight. I think there's really a lot of insight in what you said, you're less than about availability, and that you learned that from Jeff. It's so true. I think about the very best investors I've ever interacted with. Paradoxically, they are the easiest to get a hold of, the most you send them anything, they will take any meeting, and they will take it within three days. It's the ones who are like, "Oh, yeah, let's schedule this for next month."

Charles: Truthfully, the biggest tension we had in last year was we had a very prolific 2018. By my count, we went at 150% of our normal investing pace. Also like any good founder, sometimes you only learn certain lessons by doing them. We made too many investments in 2018. The ripple effect is that portfolio company support in 2019 started to crowd out availability for people who are not already in the portfolio.

I think when you live through something like that, you're just like, "I don't ever want my fund to run that way again." The pacing and cadence of making new investments, we have to be mindful of it if the goal is to continue to provide people with a high level of access and support. That was one of those things to your point where I was like, "Hey, I can feel that our accessibility is under pressure. It's just because we sort of bid off too much." It takes us 12 months to reset and work through all that.

Ben: All right, we’ve got some grab-bag questions here at the end. Do you have any particular spaces or trends that you’re excited about right now?

Charles: I'm terrible at answering this question because we're a generalist intake-oriented venture fund. I can tell you we're probably doing more consumer investing than just about anybody who's not a pure consumer fund right now. I just have been meeting great people who have really interesting consumer focus. That's everything from transactional and subscription services to just pure, attention-oriented apps.

Ben: Cool. What are people not talking about right now, but they should be?

Charles: I'll tell you what I think people are not talking about right now, but they should be. We're seeing some cracks in some late-stage portfolio companies; write down, shutdowns, unexpected. I don’t think anybody (at least) I know was talking about what's the scale of this, in this post-WeWork fundraising environment where things are more difficult and the expectations around a unit. I was like, "What's the real exposure?"

I don't really hear people talking at the industry level, what does the exposure look like there? That's going to have a really profound impact even on seed firms because I think a lot of seed firms are carrying some of these positions at probably appropriate but important marks.

David: Well, to your point about TVPI versus DPI. If you're going out to fundraise as a seed fund on TVPI that looks really nice and then all of a sudden, that doesn't look really nice. Yeah.

Charles: Totally.

Ben: Yeah, and underscores the fact that these are multi-fund relationships between a GP and LP. You need to preserve those.

Charles: That’s totally true.

Ben: You can not answer this if you prefer not to, but what is the craziest pitch you’ve heard of in the last year?

Charles: Oh, wow. Mind control. A mind control startup, like control other people's minds.

David: Wow.

Charles: Yeah.

David: So not even Elon's do stuff with your thoughts. This is other people's stuff. Wow.

Charles: It was a serious pitch.

David: Did you do it?

Charles: Nope.

David: It's good for the world that you didn't.

Charles: Yup.

Ben: What were you most wrong about in your investing career?

Charles: When I started Precursor, I had this thesis that there's this balance between founder and market. I was like, "You know? It's not 50-50 because you'll never make a decision." I said, “I think it should be 60-40. I think we should be 60% focused on the founders and 40% focused on the market,” which caused me to pass on some really good companies, where I had misinformed but slightly strong views on the market they're in. So, we've revised that now to 70-30 in favor of the founders and the 30% means I have to not hate your market.

I can be neutral, I can be skeptical, I have to just not hate it, and it's very liberating. It's actually gotten me to invest in a handful of categories and companies that I would not have otherwise done. There are some markets where I have very strong feelings, because I've done a bunch, but there's others where I don’t, and we should give ourselves permission to.

David: Almost always when I have a very strong negative visceral reaction, I'm wrong. I have a very strong positive visceral reaction, I may be right, I may be wrong; but if I'm like,
There is no way this is going to work,” I almost always look like an idiot.

Charles: I remember the first time I heard about Airbnb, I'm like, "That's dumb." No one's ever going to let people stay there. I can name 100 other companies that I've met, whereas I was like, "That just seems like there's no way." I even think about when I heard the pitch for Firefly, the guys that have the...

David: Oh, the ads on—

Charles: On top of that... I was like, "That seems to be working a lot better than I would have suspected," so I've just concluded that whether or not it makes sense to me or not, it's not necessarily a predictor of success.

Ben: You may have just answered this but what’s something that you’ve wished you have learned earlier?

Charles: I think when I was a younger investor, I think I was more focused on trying to have an impact on companies than being a good listener and figuring out what does this company need. I think I was like, "Well, how do I add value? How do I show impact?" and now I'm much more focused on listening more and maybe doing less.

My LPs always ask me, "Why do you need to talk to these companies once a month?" I'm like, "Because companies are a collection of peoples and founder psychology, founder outlook on the world has an outsized impact on how the companies run." I'm like, "I don't know how to advise a company well if I don't know how that founder processes and absorbs information about their business in the world. The only way I know to learn that is to actually spend time with them."

I wish I had learned earlier that volume of contribution and impact are not the same. We have some companies that might argue I probably did two things for them over the course of all of the year. One of them told me like, "Hey, you did two things for me this year. Those two things were incredibly important for the business. You helped us close a really important candidate. You talked us out of doing something that was really dumb." I think the younger me would have said, "Well, why didn't you do 10 things?" but those two were the ones where I think we had unique insight in the ability to help, so we capitalized on them.

Ben: All right. The last question is what’s something we have talked about that you’d like to share or use this opportunity to say?

Charles: This is a weird one. We're also running a human capital experiment here at Precursor, which historically there’s been pretty well-defined paths for how you get into venture. The Product Manager of Dropbox probably went to HBS or GSB statistically. Both of the people on my team are incredibly high intellectual horsepower people, neither of whom came from startup land or venture land.

I have this hypothesis that because Precursor is a little bit of a weird firm, in terms of our portfolio construction and what we look for. I think I'm happier with people who come to the table with maybe less traditional venture experience. What I found is if you enjoy management and you're willing to engage with people, you can take people who are smart with a lot of horsepower of curiosity and drive, and you can actually teach them most of the mechanical basics of this job in a fairly short period of time.

It's really changed my philosophy over time as we add people, where are we going to look. I just really wish more venture firms would entertain the idea that the funnel of people who could be really exceptional at this job is a lot wider than we often admit. It's not just race and gender. It's also where did they go to school? What personal and professional social networks do they bring?

For our analyst hire, we did sort of an intentionally very broad open call. We got 400 candidates. A lot of my friends are like, "That sounds like a lot of work. Why wouldn't you just go pluck?" I was like, "Because I really want something different." Our analyst Ayanna worked in finance in New York. This brings a really different perspective to the table. Sydney comes from a really different background, too.

I get so much energy, and I learned, and they pushed me because they're not mini me's. They push me and they push our firm in ways that wouldn't happen if I had like two of my buddies from the GSB working here. It feels like a very homogenous firm. I just really would encourage some of my peers to think about expanding the spectrum of people that you think can be really good at this job, and I think you’ll be pleasantly surprised by what they can contribute.

David: That's awesome. I think that applies to founders, too.

Charles: The same. Maybe that's why a specific part of our cultural values in terms of who we hire also broadly reflects who we fund.

David: Yup, awesome. Thank you, Charles.

Charles: Thank you so much, guys. I really appreciate the opportunity.

Ben: If listeners want to either read the stuff you’ve written or engage with you, where do you want to direct them on the Internet?

Charles: Twitter's probably the best, @chudson. I used to write a lot. Now I feel like there's so much VC content being produced that's written. I've basically shifted to basically using podcasts as my outlet for sharing my thoughts. I find that I enjoy it more than writing these days.

David: Yeah. We do too.

Ben: Awesome. Well, you are welcome anytime.

Charles: Thank you so much, guys. I really appreciate it.

Ben: Awesome. Thanks, listeners.


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