We talk to startups and investors, you get the value.
Vasily Nikolaev is a venture investor, NetworkVC partner and the CEO of Braintree that is developing the next generation of artificial intelligence. Their latest successful deal was the sale of Coda Devices to Thorlabs. Vasily was a partner of the Quantum Wave Fund where he reviewed several hundred transactions and discovered the processes going on in Silicon Valley from both sides.
Vasily spoke on air at Angel Talks about the discipline of an investor in making investment decisions, finding good deals and evaluating founders, investment strategies, and the mechanics of venture capital funds.
We talk to startups and investors, you get the value.
I’ve lived in Silicon Valley long enough, but before I moved here, I’d worked in investment banking and private equity for more than 10 years where I provided management consulting services. I started my career at McKinsey & Company;. I got my first education at the Faculty of Physics in Moscow State University followed by an MBA at the IESE Business School in Barcelona.
As I said, I worked at McKinsey & Company in the late 90’s. It’s basically elite special forces in the world of business and consulting. There was no such thing as “impossible”, and they kept telling us “don’t let the night stop you”. I worked 70 hours on average and up to 100 at times. Having experienced this I think I’m no longer afraid of anything. And when my group mates at business school worked their butts off and complained about being exhausted, I was basically chilling. I had gone through a kind of army.
I learned structural thinking at the physics department. And then I applied scientific and mathematical methods to business, separating emotions from specific facts that I always paid attention to when making decisions. It seems to me that if we compare a humanities student and a person with technical education, we’ll see that they have slightly different skills. As a certified physicist, I will say that it is very important in business to be able to think logically, structure and separate emotional factors when making a decision. Humanitarians, on the other hand, have more developed empathy: they feel the people they talk to better, understand how to sell and know how to influence a person.
Silicon Valley is a huge funnel that offers deals for any given portfolio. There is a very big dynamic and if you do not decide what you want exactly, you may find yourself drowning in this huge market in the first couple of days.
It is important to understand which segment you are going into and why.
At the Quantum Wave Fund, we have built a clear pipeline. I had a few clear criteria that 95% of deals did not comply with. I was aiming at purely hardware segments based on very understandable advanced technology that is difficult to copy and the market of over $ 1 billion. It also had to be a b2b startup with the first traction for at least $ 100 thousand. On average, it took me a week to make the first detailed review of 3–4 transactions per day from the remaining 5%. Then there was an hour-long conversation with the founder on a call, where, together with one of my colleagues, we sliced and diced the project to understand if it could work out. If both agreed, the deal was submitted for due diligence, which also had certain rules.
I don’t really believe that a good deal is difficult to find. There are plenty of them in Silicon Valley and I rarely saw someone refusing money.
Venture investment is a kind of smart gambling. Let’s say you have a large number of horses that are racing somewhere, and you bet on the correct one, with the hope that you have now invested X, and it gave you 10X, 20X, etc.
When you go through all the stages of due diligence there are a lot of factors and you have to balance. On the one hand, the founder puts pressure on you. They rush you and say the deal can be closed at any time. Many investors fall for this. On the other hand, there is an investment committee that needs specific data. In terms of discipline, you balance between mistakes of the 1st and 2nd kind.
I believe it is better to miss an opportunity and not invest when you are not confident enough than to invest money without doing enough research. Don’t fall for beautiful words, emotions and other external factors.
The investor works among motivated startups who know how to influence people professionally. You need a certain inner discipline to keep a fresh mind and base your decisions on facts. I promised to hold the first meetings in the fund in person, but quickly realized that it was difficult. Founders begin to manipulate on emotions and look for purely personal approaches. It is much easier to keep strict discipline and not rely on emotions with the video format.
The founder’s motivation is a double-edged sword. Yes, they have the energy to get the ball rolling, because this is hard work and you need to go through hardships to the stars. I’ve seen enough examples of people breaking down because they lacked this inner desire. But here is another example, when a founder realizes that you have almost fallen for their motivation and energy, they can easily use the same trick with another investor and keep selling their companies.
The reason for the collapse of many companies is the founder’s “star fever”. Therefore, it is important that they are not only motivated, but also decent.
Don’t give money to scientists. It is very good when there is a decent and motivated businessman working together with a scientist who knows all the startup technology and at the same time does not go into business. This is important to minimize the risk of losing touch with reality.
Everything you do as an investor from analyzing a startup to trying to predict the future is like a weather forecast. You do this using modern methods, but a hurricane can still strike. So failures happen and this is ok. But any venture fund runs on statistics. For example, they invested in 10 companies, some of them went bankrupt, some showed a normal ARR (the indicator characterizes the impact of investments on accounting rate of return as the ratio of average annual profit to average annual investment — Startup Jedi.) If you listen to the pitch of the founder of 500 Startups, they claim that 1 out of 100 startups takes off. So they say that you need to invest a hundred and show that according to statistics, they get 30–35% ARR.
Spray and pray (a strategy of investing a lot to increase the chances that at least some projects will work out, — Startup Jedi.) is an approach in which investors need to adhere to a different balance. There is a huge market in Silicon Valley, and there are only 24 hours in a day, so you can spend time either analyzing in breadth or in depth. The choice greatly depends on the size of the fund and the check. That is, if you invest tens of millions, you can allocate more resources to dig deeper. If you invest small amounts, the spray and pray principle works.
Before the virus, it was necessary to be in the Valley to invest in a startup. First, there was a huge number of events happening in real time. You listened to pitches, communicated with people, built a network of some random contacts that ultimately bring deals.
Secondly, you are already immersed in the local mentality. While in Russia, it is almost impossible to delve into these things. If you are outside this cultural context, you simply will not understand how things work. Now with a virus it is possible to do it remotely and even better than before. But being in America has its advantages.
The question is at what stage do you want to invest. There is a curve that looks like this: there are a huge number of startups and very few investors in the early stages. As you progress through Stage B, there are many investors and few companies. And it so happens that out of ten deals that you choose, nine are interrupted by your “neighbors.” Most likely they offer the best conditions and somehow agree with the company.
The work of the fund at stage B is reduced to business development. That is, the fund chooses a target company it would be interested to invest in, and starts offering to “be friends” in order to raise money together in the future. If you invest hundreds of thousands, then there is a completely different extreme: there are not as many investors as there are startups, you can safely build a conveyor belt. At stage A, where millions are invested, it is plus or minus balanced. This is where peer business partners talk.
Investing in the early stages is an opportunity to enter at a later stage.
Venture funds look only at money, while corporate funds look at how much it will bring to the whole company, and often invest early on to get the benefit of the First Buyout Rule. That is, if the investor of a corporate fund understands that the technology of this project can take off and bring huge benefits for the corporation, you can invest a small amount in a startup. In case everything works out, you need to foresee all possible options: either an auction for a buyout at a pre-agreed price and gaining control, or buying this startup at a reasonable price before competitors get it.
How do investors earn money
The standard model for any fund is 2/20. Roughly speaking, there may be a deal for $100 million, and $2 million a year goes to the investor to cover management fees like salaries, office and other minor expenses. And after you left the fund, you earned say 10X, out of which you get 2 and give 8 to the investor.
Fund partners are the main unit that looks at all projects and chooses, and then, depending on the structure of the fund, either advise the investment committee what to invest in, or make a decision themselves.
The structures are different. As a rule, one of the partners is GP (General Partners) who puts their penny into the fund. Most of the money comes from LP (Limited Partners) that are either high-net-worth individuals (including family offices), or institutional investors.
At Network VC we welcome angels who can join our deal and invest tens and hundreds of thousands of dollars with us.
Our criteria is that the founder or head office of the company is located in Silicon Valley or the USA. There should also be the first traction and validation of the idea by one of the famous investors or accelerators. Since we don’t have enough resources to dive deep we rely heavily on the opinion of other investors and accelerators. We trust that they have checked everything and are confident that this is a good deal.
I advise novice investors not to forget about the basic assessment of the company or due diligence. Even if there is a queue of investors behind you who are threatening to take the project, do not neglect the check and do not get fooled by emotions. The decision must be made with logic.