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VC Fundamentals Part 1: Sourcing

Limited Partner Episode

June 9, 2020
June 9, 2020

Despite many advances in industry transparency over the past ~10 years, much about the actual "jobs of a VC" remains locked inside firm/institutional knowledge and venture's apprenticeship model. With this new series we aim to change that. Our goal is to draw back the curtain on what the actual tasks are that VCs do day-to-day, how you can learn them, and ultimately what's required to succeed. We hope this series will be helpful both to anyone looking to break into the industry and to those who are already practicing, and also for entrepreneurs and consumers of venture capital to understand more about the motivations and activities of those across the table!

In this episode we start with sourcing: what it is, why it's important, who does it and when, and -- most importantly -- the brass tacks of where to look and how to do it.

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
June 9, 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
June 9, 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
June 9, 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
June 9, 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
June 9, 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
June 9, 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
June 9, 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
June 9, 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
June 9, 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: Hello Acquired LPs and welcome to another episode of the LP show. Thanks, again as always for joining us. David, we embark on a new journey. A new mini-series today for the LP show that captures a lot of the other things we talked about in the show but we wanted to do a little bit more formalization, so what are we doing?

David: A first [...]. Thanks to all of you as LPs; it means the world to us. We are formalizing our VC Fundamentals Series here on the LP show. We think about this kind of stuff all the time. It's probably obvious and for me, it's all Acquired Episodes. What does it mean to be a VC? How do you be one? What are the jobs that you do as a VC? How do you get better at them? How are you constantly learning? 

We know many of you think about the same thing, too, whether you are an investor, an inspiring investor, or like Sun Tzu says, “Know yourself, know your enemy.” Even if you're an entrepreneur working at a company, it behooves you (I think) to know some of the mindset and jobs to be done for VCs as well.

Ben: Or in a less enemy framework way. Know the incentives and the jobs to be done by your upstream, whatever it is. In this case, Upstream Capital. It's like if you're making sales, know what your customer motivations are. The best salespeople are the people that just solve problems for customers, and if you're an operator you can figure out what a VC is optimizing for and deeply understand that. You'll have at the very least a better time pitching, but probably a better working relationship with Upstream Capital.

David: I think a higher success rate, too. Here's how I’m thinking about it on the outside. Today's episode is going to be about sourcing. The first and natural cycle of activity for VCs. The rough outline we're thinking is sourcing today. The next episode will be on picking and “winning.”

Ben: Is that winning the deal, David?

David: Yeah, winning the deal and trying to avoid the winner's curse but really all about judgment. The next episode after that will be on company building. What happens in your relationship with companies after the [...] deal and you wake up the next morning. I'm really excited about the one after that which is portfolio management. This is something that for the first seven-plus years in my VC career, I spent literally zero time thinking about and now I think it's at least equally important with all the other aspects of being a VC. 

Ben: These first three, sourcing, picking (and obviously winning), and company building are sort of front office for a VC. It's what the founder sees a lot, what the job of the VC is. Then, the rest of them, starting with portfolio management—I won't spoil the next two—are kind of back office. 

David: Believe me, all our listeners are in huge suspense waiting for the last [...].

Ben: For sure, but portfolio management, we did a great deep dive with Charles Hudson on what portfolio construction looks like in seed and pre-seed, but I think it will be a good chance for us to go more formally into it.

David: The last two we're thinking are going to be fundraising for VCs themselves. Every couple of years they have to subject themselves to the gauntlet with LPs just like you all and then the last one, firm management. How do you think about building, managing a firm, people, human capital, all aspects of a brand? It will be super fun. Should we dive into…?

Ben: Before we dive in, David, I should give a quick update to you. We have a lift-off with Falcon. Here we sit recording, Wednesday, after the Demo 2 mission. Falcon is away with I think 60 Starlink satellites in the fairings in a very underpublicized launch for SpaceX, which is crazy given how much publicity there was for a launch just a few days ago. Here they are shooting another Falcon 9 rocket with no fanfare routine.

David: Just a few days after the Dragon 2 crew test, right? Is that the official name?

Ben: I know that mission was Demo 2.

David: Demo 2, that was it. Super cool. All right. Should we lift off? 

Ben: Let’s do it.

David: Disclaimer upfront before we jump into sourcing. Really this applies to everything in venturing in life, but I think especially here, there's no one right answer to how to source investments. There are a lot of rules, some of which we'll talk about. All of those rules exist to be broken. It reminds me of actually two mentors at various points and times of my career giving me some version of this advice. 

One was Andy Rachleff, one of the founding GPs at Benchmark. He retired and became a professor at GSP. I was lucky enough to take one of his classes when I was there and I asked him how to be a great VC. He gave me a bunch of answers that we'll talk about later on the show. At the end of the day, you have to figure out what works for you and what works for you is going to work for you. It's not going to work for somebody else.

Ben: Yeah, and David, when you say rules are meant to be broken, a friendly reminder to everyone, the Venture Capital is an asset class that is wholly made by outliers and non consensus bets. In a lot of ways, the purpose of learning how things have been done before and how other people do the things is that you can selectively choose when you want to be different and why.

David: The other great piece of advice was from a former Sequoia partner. He basically said the same version of the same thing that the best advice that Don Valentine ever gave him was what led Don to Cisco and what led Mike Moritz to Google isn't going to be the same thing that leads him to whatever his big one is going to be. Always a good thing to keep in mind. 

With that disclaimer, why is sourcing important? I thought this would be a good place to start because I remember back when I first joined Madrona as an associate in my first gig in VC. I don't know if you ever felt this way, Ben, but I remember thinking the real fun stuff and the real work is working with companies after you've already invested in them, being a board member, helping with strategic decisions, hiring, and that feels meaty. 

Sourcing is important and new investments (of course) are important, but that's just top of the funnel, it feels like sales, you have a lot of conversation, a lot of them go nowhere. I just remember feeling like it was the least interesting part of the job for me when I first started in VC. 

Ben: It also can be soul-crushing because a lot of the times a lot of the companies that you want to get into rebuffing you, and then a lot of the people you, unfortunately, have to say no to you're rebuffing them and trying to do so in a way that is not incredibly off-putting and crushing to the incredible journey that they're on. It creates a negative emotion for everyone or at least for you in both scenarios except for that very rare one where you're shooting the gap and you're both like, yeah, let's do this together.

David: And that happens so rarely. Whereas, once you start working with a company, then you're on the same team. You're in the foxhole together. I'm not saying I'm right, but I think this is a pretty wrong mindset and an important myth to dispel. There are a couple of reasons for this, but I think it said no more eloquently than what Sequoia says all the time and what Doug Leone (I think) said in our episode which is, “We're only as good as our next investment.”

That is fundamentally the mindset you have to have as a venture investor especially somebody focused on building a firm. No matter how much success you've had in the past, there's always change in this industry. Success in the past may afford you the opportunity to see good investments going forward, but if you get lazy and if you take your eye off the ball, you're going to miss some of those and somebody else is going to come up and get them, then you're going to start to fall behind. This is an industry of aggregating returns and very quickly disaggregating returns if you start to miss one or two. 

Ben: The other important thing is ultimately what is the fund? A fund is a set of 30-40 investments and the thing that determines what those investments will be is what the top of the funnel is. It's a gigantic funnel and there's no way that something's going to come out the bottom of the funnel that isn't at the top of the funnel so the top of the funnel is crucially important because it is the governing factor on the whole world of things you could invest in.

David: Totally. Then the other final point on this that I'll say, which I guess is a good reminder to always keep SVC which is the raw materials of our industry are entrepreneurs. This is where you get your hands dirty and interact with entrepreneurs, [...] large, and you can't take for granted the fact that, Ben as you're alluding to, you're going to end up not getting there on most of these, investing in most of the entrepreneurs, but that doesn't discount the fact that they're still on an entrepreneurial journey. And they're giving you their time. You need to respect that. As I said, it can be easy to get really jaded about this, but it only takes being proved wrong a couple of times which if you spend anything more than 6–12 months in the venture industry, you will get proved wrong very quickly. Just start to change your mindset around this. 

Ben: David, I do have to give you an update. We are looking at a drone ship right now. The camera feed stayed on. A Falcon 9 is coming down and it's a little left of center, but it is stable. 

David: Will we give it an 8.5 on landing?

Ben: Yeah, 8.5. The judges are a few 8.4s in there, but it's about right.

David: I love it. I love these real-time updates. 

Ben: Happy to provide.

David: That's why it's important. We're going to talk about broad strategies. This is mostly firm-driven, although I think many VC firms do have room for different styles amongst partners and investors within them. There's some drift here, but it's mostly going to be aligned with what your firm strategy is. Then we're going to get into actual brass tactics of sourcing but at a higher level. 

Ben, jump in if you feel there are others. I think there are three wide buckets of strategies that you can have for sourcing as a VC firm and those range from one end of the spectrum being completely generalist and opportunistic. I will invest in whatever interesting stuff comes across my plate.

Ben: Which is pretty synonymous with network-driven because the things that come across your plate if you're a generalist and not doing proactive work, you're going to be inbound-driven. You can be a good generalist investor and do outbound work, but then you have to have an additional thing on your thesis that says we're generalist investors and the way that we find companies is and define if you're a marketer or think about it as a gigantic funnel, what your omnichannel strategy is. We're on Facebook. We're doing content, but we don't have a Twitter approach. For a generalist fund, this might be, we are proactively meeting with senior execs at these two companies, to figure out who the great people are at those companies that we may want to fund, but we're not going to meetups. Pick your battles there. 

The thing I would say about generalists is it then requires one more level of what's the way in which you intend to meet people? A way to do this is lots of great people are going to start lots of great companies, so I might invest in them. That's been the legacy of the venture industry for a long time.

David: It's a little bit different partner to partner, but generally I would classify Founders Fund as a generalist fund. Grew out of the PayPal mafia and Peter Thiel. I think it was Brian Singerman who was on the best of the best with Patrick and he talked about his primary sourcing strategy as he just asks everybody he meets to send him companies. Then, he just starts to tune like who sends me good companies? Who sends me less good companies? If you start sending me good companies, I'll pay more attention to you. If you send me less good companies, I'll pay less attention to you. But I'm open to anything.

Ben, like you're saying, that can work because he has an incredible network, as do all the folks of Founders Fund. That's one end of the spectrum. Why don't we go to the opposite end of the spectrum then we'll talk about the strategy in between? The opposite of the end of the spectrum is being completely thesis-driven as a firm. The classic example for me of a thesis-driven firm is Union Square Ventures (USV). They've kept evolving their thesis, but I always think in my mind, classic USV which was the mid-2000s, late 2000s, when they were investing and they're doing early rounds in Twitter, in Tumblr, in Foursquare, in Zynga, in these first real, real, big, big breakout new internet companies after the smaller exit, Internet 2.0 of Flickr and the like.

Their thesis at that time was that they invest in “large networks of engaged users, differentiated by user experience, and defensible through network effects.” They have a very specific point of view on the world. This is not saying (which we'll get to in a minute) the middle bucket which I call thematic investing, which I think digital media is going to be a thing.

It’s not even, I'm looking at a specific sector. It's that I have this very specific point of view and anything that jives with my point of view is what I'm going to do even if I see things that are in a sector I'm interested in. If it doesn't meet that point of view, then I'm not going to invest in it. 

Ben: Do you know how good of a job they did sticking to that? Because when you get really tight like that where you put more than two constraints on something, where it has to have network effects. It has to have engaged users. It has to differentiate through user experience. Every time it's an encubed problem where you're zooming in and every time chopping off a large percent, 90% of the possible ones that fit within all the previous criteria. 

David: I think they’re pretty disciplined, too. Fred Wilson actually has written a lot about this and I really respect his thoughts on it. He's pretty funny. He says like, if you are right about your thesis and disciplined, that is probably the way that you are going to have the most success to make the greatest returns. And it's the right timing. The thing is, when they had this thesis, all of this sounds duh now, like investing in large networks of engaged users, differentiated by user experience, defensible through network effects.

Think back to (I think) 2006 maybe, when they invested in Twitter, 2006 or 2007 around then, same time for Zynga. People weren't thinking about this. Network effects, if you said that to most people on the street, they'll look at you like you had two heads. You're talking about ABC and NBC, the big broad networks.

Ben: Now it's like, so you're a tech investor?

David: Yeah, exactly. They were right and at the right time with this. Even as a very small partnership, I think it was just Fred and Brad during most of this time. They were able to source and lead investments in these huge, huge companies that would drive massive outcomes for them. You need to be very certain of your point of view on the world to do this. 

Ben: Yeah, it's like the more you zoom in, the more high conviction you have to be in your thesis. 

David: That brings us to the middle bucket, the manic investing. It's not a smiling curve or an inverted smiling curve because you can have great success as an investor and as a firm with all three of these approaches. But most large venture firms (I think) fall into the thematic bucket. Thematic and generalist. There are a fair number of generalist firms out there but I think most are on the thematic bucket.

As we alluded to earlier, the thematic bucket is like there are swim lands and these swim lands might be as broad as enterprise versus consumer. It might be developer tools. It might be the future of work. You can get as specific or as wide as you want, but we as a firm have these buckets, these teams, different partners and different teams, subteams within the firm focused on different of these buckets. Then we all aggregated up all together into a firm.

Ben: David, you're the only one who can see any put, but the reason I’m [...] over here is because I don't want to blow his or her cover so I won't say which VC it is, but a great top returning VC told me they’re absolutely thematic. They have 5–7 themes that they invest in. But really, that's so we can say no more easily. If we like something, we'll invest in it. 

We definitely believe in this handful of themes over anything else. We came up with them because that's the things we think are going to be the future, but they're broad enough intentionally to let us squint or not squint to count something in that theme.

David: That's funny. I actually hadn't quite thought about that, but I suspect there are a lot of firms and even more investors within firms who say they're thematic driven, they even believe they're thematic and they're investing, but really they're generalist. They're just looking for intellectual justification to stand behind.

Ben: When you think of these themes, there are things like future of work or computing at the edge. Is this boom arm on this mic? If I invested in that boom arm company, could I call that the future of work? Maybe. I wouldn't have classified it like that a year ago, but the world has changed enough that you can squint your way into saying that to the extent that I can make a hardware investment, I don't know maybe there's something special about this boom arm. It's kind of a bad example, but you can illustrate how far you can squint in these thematic areas.

David: Yup. That's kind of a high-level strategy. As we said, they tend to be said at the firm level.

Ben: What did Jake call them in our interview with Jake Saper from Emergence Cap? Do they have three priority themes? 

David: Yeah. I can't remember what he called them. 

Ben: You keep talking. I'm going to look it up.

David: I'm sure Jake is yelling into his AirPods right now at us.

Ben: Jake, go to sleep.

David: He probably needs it. Then in tactics, I would say we’re going to cover a whole bunch of sourcing tactics here. Broadly, you can put them into four buckets and they're applicable. No matter what your strategy is, you can apply all of these tactics to different strategies. 

The first one is inbound. This is entrepreneurs are coming directly to you either as a firm or as an individual investor. Second, obviously is outbound. You are going directly to entrepreneurs and there's a great, great quote from Kathryn Gould who was one of the legendary VCs from a few generations ago, was one of the co-founders of Foundation Capital. Sadly passed away a few years ago from cancer, but she has this great quote which basically boils down to, in her belief, it was not the calls you take as a VC that make your career. It's the calls you make. 

She had a great way with words, but I don't have the exact quote in front of me but she said if you catalog the ten smartest people you know and you just make a habit of always regularly calling them, at any given point of time, one or two of them is going to be starting a company and you can just roll with that and do very well in your venture career.

Ben: I would describe us as thematic at PSL where obviously we're Pacific Northwest-based because there are a few key things we believe very strongly that this region will be good at. We have these three themes within there, so I wouldn't call us fully generalists. I would put us like most people you are alluding to, David, somewhere in the middle of being thematic. 

When people ask how do you find founders for the studio, and I know I'm probably jumping ahead a little bit here, but the question that my partner, Greg, who David obviously know very well from Rover and Madrona always responds with is, who is the person that if they came to you and said I'm starting a company, you would say I'm in with my personal cash to be an angel investor before I know the idea.

It's a very similar concept (I think) to keep up with those 10 people regularly. At some point catch them when they're starting a company. It's this idea that years before they start a company, you want to know in your head, like who do I think is going to be a founder of an amazing company and how can I just keep up with them?

David: Yup. Hang around the hoop and a bunch of other different tactics we'll go into. I always think of Kathryn when I think about outbound.

The next bucket is the referral. This is somebody referring you to a deal. Could be another entrepreneur, could be another VC, could be somebody else entirely, but I bucket that separately from inbound and outbound. 

Then the last one that, Ben, you're a world expert on and is in many ways the most always highly desired yet elusive form of deal flow and sourcing for LPs is the homegrown/proprietary deal flow. Classically, this was done with things like entrepreneur and residence arrangements, although today that's not even proprietary. But it could range all the way from that up to you're running a venture studio in-house which Ben has lots of experience with.

Ben: That's absolutely one of the benefits to being an investor in PSL Ventures is David, as you alluded to, the studio creates a handful of companies a year. I think last year was eight and the fund has some ownership in every single one of those and can participate in their earliest financing rounds. While the venture fund is not leading those deals, the studio companies have exposure by default to proprietary channels of companies as you just described.

David: Anybody whose anywhere been close to private equity investing in any form is going to smile. Proprietary deal flow, the holy grail. Good work if you can get it. 

All right. Let's jump into brass tacks here. A tactic of how within these broad categories and strategies, how to go about sourcing. As part of when I talked to Andy Rachleff back when I was at GSP going hand in hand saying please, give me some knowledge, he gave me six tactics right off the bat. 

He said look, you should try all of this. You'll figure out which ones you like, which ones you're good at, which ones you're not, but here are broadly accepted paths. One, he said, was PR and public presence. Back in his days and even this time, kind of the 2010s when I was talking to him about this, that really meant PR. Blogging was around. Fred Wilson was blogging, but there's been a lot of development since then. 

Ben: Yeah, the explosion of the venture ecosystem has also meant the explosion of marketing as a core competency of venture capital firms. It's assumed now that when you look at these enormous platforms like Andreessen Horowitz, that thought leadership and marketing is a piece of what the job of a venture capitalist is. That's only recently true. It may not be true of the investing GP, but it may be a core competency of the firm broadly.

You think about the a16z Podcast as this great example of it where it's not Fred Wilson blogging. It's a program that's developed by a person at the firm as a competency of the firm, but David, you're right. It wasn't that long ago that it was literally to see if you can get quoted in the Wall Street Journal.

David: Yeah, maybe hire an outsourced agency to help you do that or go on CNBC. Although actually it came a full circle. Going on CNBC now, look at [...] and Jason, they're making a career out of it. When Jason started, they brought on, I don't think she was a full-time employee of the firm to start but quickly she became a partner, Margit Wennmachers, who was the founder of the OutCast PR. A super famous PR agency. 

They brought her [...] to architect this whole strategy around blogging, having part of it being written in other news outlets. The Marc Andreessen Software Is Eating the World, [...] Wall Street Journal, [...] around the world. The podcast, all of that.

Ben: So brilliant. Has become synonymous with the firm. 

David: Totally. 

Ben: And to go meta for a minute, anytime you have something moving from a differentiated product to a commodity, marketing is going to become more important. Without demeaning ourselves too much here, in the commoditization of startup capital, you have a tremendous abundance of it. A lot of money is just as green as a lot of the other money, so what do you do to differentiate?

In the very same way that in the jewelry business or in the consumer package brands business. This window cleaner is the same as that window cleaner, but the very minute difference is probably won't be known by consumers so the thing that becomes crucially important and how P&G built their entire company is the marketing of these things and the ability to appear differentiated. 

Many, many sources of capital are truly differentiated from others. The person you're working with at a board level is crucially important to a company, but as it becomes more commoditized than it has been in the years passed, it makes sense that the 2010s were the year where you need marketing to create the perceived differentiation of capital.

David: I think what's been super cool on this, a lot of people dismiss this whole idea of marketing venture capital firms. It feels tasteless and when Andreessen started, old school VCs were throwing a lot of bombs and it was very controversial. What's super interesting now (I think), to foreshadow some of the modern sourcing tactics we'll get into including things like podcasting in this very podcast, it actually has become a self-fulfilling prophecy that I think having a strong—I'm going to characterize it differently in a minute—marketing and everything around that competency as a firm actually helps the companies you invest in because you amplify them.

Ben: You both amplify them and you gain access to resources that you otherwise wouldn't have gained access to make those companies better.

David: Totally. Back in the day, this was—

Ben: Also, did you just imply that this podcast can be content marketing for a venture firm? David, how dare you?

David: No. We're going to talk much more about that.

Ben: I will come at you hard in a minute.

David: Okay, you come at me hard. This is definitely not content marketing because I have a whole different category for it. 

The next one that Andy told me is that you can be a lab rat (as he called it). Today, people would call investors like these deep tech investors, but you want to hang around scientists, you want to hang around computer scientists, whatever your jam is. Whether it's physical sciences, engineering or whatever. Just be a technology sponge and hang out around the people that are at the bleeding edge because probably some of them are going to be entrepreneurial and want to start companies.

Ben: Yup. You see a lot of studios actually doing this. A great example is Andrew Ng's AI fund, or up here in Seattle AI2, both have deep connectivity either in their organization or outside their organization with AI researchers and are actively seeking to start companies and invest in the work that those researchers are spinning out. 

David: Yup. The next one is pretty specifically tied to the thematic investing strategy which becomes known as the investor or the firm in a given space. What would be an example of this?

Ben: Bill Gurley in Marketplaces.

David: Exactly. Bill Gurley in Marketplaces. There are whole firms around this now. I'm thinking of Bolton Hardware or great FinTech firms out there, Ruby Capital or others. Not only are you narrowing the universe for your sourcing but you're also broadcasting out to the world this is what we do. We're the experts. If you are an entrepreneur working in the X sector, you need to come talk to us. It's actually amazing how well this works.

Ben: Yeah. The thing that must be occurring to all listeners now is, this sounds like that thing we're talking about earlier around firm strategy. Yes, of course, listeners, you are right. This is something that requires a tremendous amount of alignment. Figuring out from your strategy to your tactics, picking the way in which you are going to create a deal flow for yourself to do this top of funnel sourcing that completely matches up with your chosen strategy that you like to invest in, and why you think that will generate outsiders returns for your investors.

David: I think that's really actually a good point, Ben. I'm not going to name any names but there are certainly firms out there that have a strategy around being thematic on certain [...] but who are not good at the tactic that matches up with that, of making it known to the world that that is what they do, either because they don't see the value in it or they're just not good at it.

The next one, tap into specific talent networks. I would say, this is what founders fund. In many ways, I think Sequoia had done this too. There's a certain population of people where, for whatever reason, there's fertile DNA for entrepreneurship. PayPal Mafia, obviously. For whatever reasons, we've covered it a bunch in the show, a whole slew of former employees and other people involved in PayPal went on to start really great big companies.

Ben: David, this doesn't have to be just like the big firms that have hundreds and millions or billions under management. I was talking recently with one of the founders of Backend Capital. It's a super small pre-seed fund that's in their first fund right now. One of the founders there, I think both the founders were involved in MHacks, one of the biggest—I hate to say the University of Michigan; that kills me as a Buck guy—and most successful college hackathons in the world that started 5–8 years ago.

The talent network that they have there is organizing thousands and thousands of college hackers to build products, prototypes, and side projects. Some of them are going to go and create big companies, and be an existing leader within a community where the people who are in that community are rising to the top. You know them already. They trust you. You're an authority figure to them. It makes total sense that they would want your capital and relationships.

David: Yeah. I wonder if you could argue that this was actually Y Combinator’s primarian most successful tactic as they were starting, which was talented engineers who were still in college especially in the Boston area in the first couple of years, but then quickly venting out all over the country and then the world. They pretty uniquely, amongst investors, were going at that time, [...] 2000s to that group of people, and saying you can be entrepreneurs. We'll fund you.

Ben: Yup. I think that's a great example. This has been huge for me, personally, growing up in the Startup Weekend movement and being an organizer there. There have been billions and billions of dollars of market cap and/or private company valuation, if you sum up all the companies of people that actually started companies at Startup Weekend like Rover or people that were very involved in Startup Weekend that teamed up with other Startup Weekend people and started things. Hightower is a great example of this that merged with VTS, a big multi hundred-million-dollar merger a few years ago. There's a lot of those types of companies.

David: Branch Metrics which is a company that I invested in, both because they were my classmates at GSP and because we started at Startup Weekend. There was a bunch of stuff that happened between the Startup Weekend and the actual company. 

Ben: But you know the people built those relationships by participating in those programs together. I think doing 30 Startup Weekends over the course of my 20s, that was a meaningful part of how I know the people and get to invest in the people that I do.

David: Totally.

Ben: The other thing, David, I’ll point out there, is you mentioned knowing them from GSP. Business school is a great talent network. I think at some point we'll do a whole episode on whether I should do business school or not. That's just a fantastic example of a talent network that I know you've leveraged over, and over, and over again in your investing career.

David: Not just a talent network but also just a network, period. But that's an episode for another day.

The last two tactics that Andy gave me are funny in that sort of like the first one, the PR, at that time. Less so now, but still now. They were viewed as sort of unseemly in the industry, but man, they absolutely work. The first one is to make late-stage investments in brand name companies to kickstart your reputation and become affiliated and associated with those successful companies that you paid up for to get into once it was already clear they were a success, and then start to migrate into early.

Ben: Logo shopping.

David: Yeah, logo shopping. Exactly. It's funny. The VC industry can be so insular. It's like middle school in a lot of ways. Kind of petty and mean to its own. I think it's getting better. I think it is getting significantly better. I think the newer generations are less like this. That's viewed as you're cheating or you didn't earn it. It absolutely works, though.

Ben: Well, because you can't walk around with a per company IRR on your website, but you can work around with your logos on your website. Sure, you can do some research and figure out what round if it's mentioned in a public forum when they invest. But if it wasn't announced that you invested, who knows what stage? Who knows what check size? Obviously, their investors will know if you try to use that for a track record, but you can build hype long before you have to show a track record.

David: Right. That's talking about fundraising with LPs. That's an infrequent activity. If you're a junior VC, that's something you don't need to worry about at all. What you really need to worry about is your reputation with entrepreneurs. They're not going to know or care that much. What's actually valuable about this is certainly the reputational brand halo from the successful companies is huge. If you do that, you also get to actually learn from the experiences of those companies.

Ben: There is real intrinsic value there. 

David: There's real intrinsic value. You get to learn. You get exposed to the people within them which can help build your talent networks, especially for newer, younger VCs. I think it's a really great way to jumpstart your sourcing strategies and tactics.

Ben: Yeah, totally.

David: The last reason on this, why it's a good strategy, especially for younger VCs, is not only are you going to get the learning from the company and the access to the talent networks, but if you get to join the board either as a member or a board observer, you're going to get to learn from the other venture investors on the board. This is actually something that I hugely benefited from so much in my career and continue to that I don't think has talked about enough. You learn a lot from other members of your own firm who you spend a lot of time with, but you can learn just as much, if not more, from all the board members of other firms who you share boards with because you get exposed to different types of thinking.

Ben: Yup. I think we heard this straight from Chetan's mouth on the Enterprise Investing LP episode. I think he was on the Elastic board with Peter Fenton or maybe still is. This was when Chetan was in his former firm NEA before he had joined Benchmark. Obviously, that mutual learning from each other led to something much more than just learning where they actually joined forces later at Benchmark. That's a very common thing, especially in this mutual context.

David, I think you're pointing out for younger VCs to get to learn from more experienced partners, but I think it's a pretty commonplace thing for people to want to co-invest together to get to work on a company together.

David: Totally. If you're doing late-stage investment, you get a multiplier effect on this. Every investment you're making that's a late-stage investment, there might be three, four, or five great early admit stage VCs already on that board. You've just got to build relationships and learn from all of those all at once.

The last one that Andy told me tongue-in-cheek but also absolutely works is beg. He used the example of another famous VC, his vintage, who he said derisively begged to get into all of his early hits and then build a reputation. Really, what I think this means is some combination of begging the entrepreneurs and also just paying up. Related to the previous tactic, but this can also work in early stages, which is if there's a hot deal and you're willing to pay the highest price, well, there's a good chance you're going to win that deal.

Ben: David, we're getting to our next section here. Listeners, we wanted to include this section. I hope we would've included this section before everything that's been brought to light, all the protesting that's been happening, and rightfully so, this last week. Across all these tactics that we've just mentioned and across all of them that'll come in our next section, I'm sure many of you have listened to us talk about this and go, oh my gosh, it's so insular. It's such an echo chamber. Wow, what another great way to fund white males, talent networks from existing successful tech companies, or “top tier” schools.

I'm putting top tier in quotes here. There's so much fishing in the same pond over, and over, and over again because: (a) no one gets fired for buying IBM, and (b) everyone just has a tremendous amount of bias, different amounts buried, and lack of desire of getting outside their comfort zone at the very least is the most charitable way to describe it. Every single one of these tactics has ways to break outside of these networks. When you think about the way that you make money and invest is being non consensus and right. 

A lot of the things we just described are ways to be consensus. I think if you go do that same stuff as everyone else, if you're going to try and go blog about how software is hitting the world but doing it worse, or you're going to try and talk about some specific up and coming technology and make that your niche, probably a lot of other people are going to do that too. 

David: Are you going to try and invest in the PayPal Mafia but you're not Roelof?

Ben: Right. One really fantastic way to be non consensus—we never know if we're going to be right—is find an opportunity to go and invest in people that everyone else isn't rushing to invest in because of how it's been historically. As you can probably tell, David and I are uncomfortable talking about this topic and are trying to discuss it not in one fell swoop here. We've been more into our conversations because making yourself uncomfortable is the way that we fix the systemic issues that we have. It would pain me if we didn't discuss it on this episode of how do you bring in top of funnel for people to fund, to not bring that to light here in this episode.

David: Amen. I'm so glad you said all that and brought it up. It's also great because not all, but most of those old school tactics that we were just talking about, not old school in that they don't work anymore, they certainly do work. There's also something else about them. Most of them require you to be at an established VC firm. It's pretty hard to do something, like make late-stage investments in brand name companies if you haven't had a big established [...] venture capital firm that can do that or to have a big PR resource that can help you build a public presence and get cameos in CNBC and the like. Even just that contributed to keeping a lot of people who (otherwise) would've been great investors out of the industry.

Ben: David, you made a great point. In a lot of ways, these strategies are ways for people or brands who already have influence, success, or track record leverage to generate more in the future. It's really an interesting thing to think about that cold start problem, how do you do either new firm building or new reputation building on your own. 

David: Yeah. This is what's cool. There's certainly a lot in this dynamic, obviously, that still exists in the industry. Success aggregates to firms and platforms that already have success, investors who already have success and all that. But it is so different now than it was in 2013 or 2014 when I was asking Andy for his tactics in how to succeed in a venture. We'll run through some of the tactics here. 

In broad scope, I think it has become not only so much easier but pretty critical these days that you as a person have a voice, use it, and have that be part of who you are as a person, as a VC, and have that be part of your sourcing strategy. I think even Benchmark has done this, accepted this new reality incredibly well. You've got Benchmark.

Ben: Yeah. Go to their website if you've never gone to their website to try and understand the level of quietness that we're trying to refer to their past as.

David: Yeah. I was even going with the biggest brand, the most successful, biggest platform out there. Although part of their brand is being quiet, I think they are very effective brand marketers of themselves. Part of that strategy is being quiet about the firm. 

If you go back five-plus years ago, other than Bill who was always blogging going back to his heritage and days as an equity research analyst, the partners were pretty quiet behind the scenes, too. Now, all of them are out there, all on podcasts. Chetan's killing it on Twitter right now.

Ben: Oh, boy. VC Twitter. Is this a sourcing strategy?

David: Yes, it is. This is actually the point I wanted to make. Today, between Twitter, blogging, Medium, and podcasting, there are so many ways to put your thoughts out there and have a point of view on things. Sure, yeah, it helps if you are an investor at NEA, Benchmark, Sequoia, Index or whomever, that helps amplify, but that's not going to get you thousands of followers on Twitter. That's not going to get you a top podcast. That's not going to get you a widely-read blog or newsletter. What's going to get you there is actually doing the work and making great content that is going to get you followers, which is going to bring you to opportunities.

Ben: It's such a good point. Like the friend of the show, Turner Novak, an awesome example of this. He's a Gelt VC. It's definitely not a brand in a way that Benchmark or Sequoia is. Turner is one of the smartest, most well-written, and tweeted people about consumer social. People pay attention. That, no doubt, will get him conversations with people starting the next great consumer social app in a way that he wouldn't know before.

David: Yeah. All of these are tactics whether it's Twitter, blogging, or podcasting. They work incredibly well. To be a little biased about ourselves here in Acquired, I think where this is heading is building a community. I think that's what we really try to do here at Acquired with the main show, with the Slack, with the LP show, with the LP calls, with everything we do. It's about creating a community around a shared interest and passion for—in the case of Acquired—understanding, studying, building, and learning about great companies. That's naturally going to develop its own center of gravity and have great things come out of it.

I kind of think of this as the most evolved version of this. It even lives completely on its own. I just won the award of the biggest self-tooting of a horn.

Ben: Oh my God. Give me a galaxy brain, maybe right now.

David: Okay, maybe we should cut this.

Ben: No, no. It's staying in. I love it.

David: Dammit.

Ben: David, you make a great point. Greg, my partner, and incredible community builder in the tech ecosystem in Seattle over the last 20 years. All of us who were starting companies at Startup Weekend thought maybe we'll get a meeting with Greg so he's always the judge at the Startup Weekends. He's always here. He's always at stuff. He's accessible. There's a tremendous amount that comes from being an accessible person, who is willing to have conversations with anyone, anytime. I know that's not the brand of lots of VCs. There are multiple strategies here. 

You're famously bad at emails. You don't even answer my emails. You just pick where you want to be active. Not to get you in the chair here, but you just choose in what way you want to engage in a community. The Acquired Slack is a huge one. I'm just trying to say you're not accessible by email.

David: That is very true. I think, defensively, I would put that in a separate topic for this. I think I find the rabbit hole, my being bad at email. We're really pulling back the curtain here on this episode. For me, I found over time, when I first started my career, I was hyper, hyper-responsive on email. I think that served me really well when the primary function of my job was to work for and support other people and help them achieve what they want to achieve. But then, over time, as that evolved, as it does in any career, especially once you get into investing and making leading investments, I realized it's a whole different ball game now.

For me, at least, as I think about things, I'm super hyper bad at context switching. I need large blocks of time to focus on whatever it is. It could be mundane stuff. Stuff like sourcing or stuff like thinking about a company or a board problem or whatever. I started finding that by shutting myself out of email and related stuff, that gave me space to do that. Maybe I've gone too far. I think I've just got hooked on it. Now, I just find excuses to push all off doing email for days and days at that time.

Ben: It's interesting. To bring it back to sourcing, it's basically a resource management problem where you can't do everything, so what are the tactics you're going to do to best support your strategy? It's going to be different for everyone. It's going to be different for every strategy. There are only so many hours a day. 

Similar to the way you've pulled back from email, I kind of pulled back from events. I think it's important for me to have the evenings to catch up on work and personal relationships. In a lot of ways, I actually do the work since the days are filled with meetings. I used to go to tons of events. Accessible is the wrong word because I think no one would think it would be hard to access me, but I loved being out there in the community and mingling all the time. That became an unsustainable thing for me. It's like okay, how do you want to allocate the resource that is your time? What is the highest leverage activity you can perform that will support your strategy?

By the way, sourcing is only one of many jobs. A great venture capitalist and a great startup studio person.

David: You hit the nail on the head there with resource allocation. I think that's the full circle here on sourcing. That's what it is. All of these broader firm strategies, different buckets of sourcing, and individual tactics are all tools at your disposal. You've got to figure out which ones work for you, which ones you like using, and which combination. For anybody, it's going to be multiple of these. Hardly anyone has just one tactic that they use for sourcing. Then, you need to think about what's going to be the most productive.

Ben: One takeaway that I just don't think I quite realized is it's a funnel like any other. Sort of before getting into venture, there are sourcing you'll do accidentally and there's sourcing you will do intentionally. Some of those things are the only world of possible things that you can invest in. 

I do think one other thing that we should dive into here a little bit, we didn't prepare this in the notes, but, who does sourcing at a venture firm? I think we've done an episode very early on called, How a Venture Firm Works, and talks about roles. But I think it's worth talking about who does what form of sourcing at venture firms so folks can parse through that. 

David: Yeah. It's super different in different firms. At one extreme, you have a firm, say, Benchmark, where there's basically only GPs and they're just doing it all themselves. Actually, I think more and more over time, investors and firms are operating more like that even if they have different structures. At the other extreme, you've got places like Summit, NTA, and Growth Equity pioneered the model of it's opposite that associates all the way down at the bottom were the ones doing all the sourcing, and then the partners are just sifting through.

Ben: Take the final meetings.

David: Yeah, exactly.

Ben: Do the high-level diligence calls, call the CEO of incumbent companies, ask if they think this is a good investment, and the up-and-comer, not doing any of the customer diligence. We're talking about different jobs to be done at the venture firm right now. There are structures that come from the private equity world and from the more traditional finance public market investors world. Then, there are structures that look completely different like you described on the Benchmark or any firm that's just GPs and the GPs do everything.

David: There are all sorts of things in between that. There's also the team sourcing model. Certainly, I think MetriTech was like this when I was there. Madrona was pretty much like this too. As Madrona got bigger, I think, it became more individual but still at a very strong team ethos which was hey, we're all in this together. You, Ben, might have more expertise in a given area but I David, might meet somebody who—either a company or a person—is right for that. Well, great. Let's do a handoff or let's work on it together. That can be super fun too.

Ben: Yeah. A great example is whenever I get a pitch for a digital health company. Immediately I CC my partner TA and I'm like, awesome. TA is one of the best people in the world to talk to about this. I am not. In some cases, because we have a strong relationship, I want to do this together with TA or if it's a cold email, I'm like, I have no value here. Straight-up hand-off.

David: Yup. Cool. This episode has gone a lot deeper than I think we wanted. Hopefully, it's been helpful to LPs. Certainly, it's been helpful to me to codify and think about all these, think about where I'm allocating my time.

Ben: Like many episodes that we do, and I think all six or if we decide to add or subtract 5–7 of these VC fundamentals episodes, everything is going to be on a spectrum. Every firm is going to do something different. You just have to decide where you sit on each one of these spectrums.

David: Yup. Cool.

Ben: LPs, thanks so much for joining us. We will talk to you next time.

David: Until next time.


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