Four Questions Before You Write the Cheque

Thanks for being here, everybody. Just quick intro about myself, anyone here hasn't met me. I'm the product of this ecosystem, a UCSD grad. Mechanical engineer undergrad, went and worked in aerospace for years, started what I thought was LinkedIn for engineers, became LinkedIn for students. Moved the company to San Diego when I got into Evo Nexus in 2013. Raised first capital from Tech Coast Angels, which is now Newfund, in 2014. And also kind of helped take San Diego Startup Week off the ground at that point as well. And had an exit in 2018 and returned capital to all my investors at 6-fold. And so immediately joined as a Newfund member in pretty much every ACE fund that's existed for Newfund, and then joined SDAC 7 last year, and also run my own fund called Rise and Tide Partners. I've been managing a fund for about 6 years now in terms of capital invested as a group into 50 companies, and I also have angel invested directly into probably 30 or 40 companies. And then an LP in maybe 10 funds. So very much got into as a side hobby, became a full-time job for sure. And so I'm just a startup junkie. I love founders and I love backing great people. And so that's why I'm here and honored to be a part of this with you guys. We're going to talk through, but we're not going to— we are going to collectively— this is going to be an interactive night. All right. I'm going to look for hands and have people getting up and be walking around with the microphone. So we're gonna have some fun, hopefully. Okay, let me do a quick poll of the room though. Who has angel invested into a company before? Okay, awesome. Who is interested in angel investing in a company?

Still.

Still interested. Yeah, still interested, still in. All right, awesome. Specifically, who's been a part of SDAC in the past? Okay, cool, awesome. Well, great. Well, we're going to use— we're not— this, this is not going to talk explicitly about SDAC, but SDAC, San Diego Angel Conference, and really angel groups in general have a very specific way of how they evaluate companies. And so we're going to use the framework of how angels and angel groups evaluate companies. And there's so many different ways. And if you've actually been to one of the other investor networking nights, I had a little like very technical sheet that I showed you, which is one way. There are so many ways to evaluate companies. I'm going to show you, we're going to ask 4 questions, and just, it's really about kind of you. And we're going to go through them and talk about them out loud together about evaluating other companies, all right? So just go with me on a ride, all right? So. The biggest problem, really, that most investors have is that there's too many companies, to be honest, to look at. Especially as soon as you raise your hand that you are an investor, everyone finds you, every startup finds you, okay? People smiling, people know. And there's a tight time frame and a variety of reasons why time matters and attention and momentum matters. Okay, companies that are still raising 2 years on the same thing that when you met them 2 years ago, nothing's really changed, is a little telling to a certain guard. Companies that everything changes every day you talk to them, also it's very telling. So there's some piece around momentum, but I'm going to break this down into 4 really easy human questions for you tonight. And if we get this right, if we, you know, learn a little bit about how we are as evaluators, with a very easy framework. It's going to make March to May for the SDAC community hopefully easier, more streamlined, and more efficient. That's what I'm going for. And we all learn a lot more together as well too. Okay, the 4 questions. Why is this company more special than any other company? So just for them really just I'll let you read them, but then I'm going to say them out loud as well too. Do I understand what this company does? Is there a plausible path to venture-scale outcome? Don't worry, we're going to explain what all these mean if you don't know, it's okay. Is there something here that excites me? And would I spend more time evaluating this company? Okay. Now if we align on how to answer these, the rest of the process just works, okay? But Let's take each one of these one at a time. Question 1, do I understand what this company does? This is not a test of intelligence. This is a test of clarity. And this is on the company, not on you. If the company did its job right, it's very clear to all of us. One sentence, no acronyms, no caveats. So we're going to play a little game here. We're going to have a few different people. Get up and give a one-liner on a few companies. They're well known. We're going to start easy with Uber. Anyone want to give the one-line pitch of Uber? All right.

It takes you where you want to go.

Okay. How was that, people? Clear? Anyone else want to try?

I'll try.

Okay.

On-demand cabs with none of the inconveniences of cabs.

Okay, we used cabs twice. That's okay. Anyone else? Did one feel different than the other? Oh, sorry.

You match drivers with people who need rides.

Okay, good. Felt very marketplace-y. Oh, say it again. It matches— we match drivers with people who need rides. Okay, so understanding comes before evaluation, right? About clarity. First of all, there's no right answer. It's how each of us take that information and do something with it. You're going to find that's the answer of all these questions. It's subjective. It's very much relative to your own entire bank of knowledge and reception. And by the way, the way it is also explained to you could be that you just learn it much better visually, audibly, written, all the above. All that goes into this as well, too. So we're already biasing it just by hearing just the audio version only. But let's do another one and we'll stay within the marketplace theme. Let's do Airbnb. Anyone explain one line? What Airbnb is?

Short-term rent your home as a hotel.

Okay, short-term. Yeah, thank you. We got a second one here. Anyone want to do another one for Airbnb? This one's a little harder maybe. Let's go to Randall. A hotel for anyone by anyone. A hotel for anyone by anyone. One more over here.

Home away from home and you don't have to do the cleaning.

A home away from home and you don't have to do the cleaning. Okay, all right, we talked, two of these by the way are marketplaces and a lot of you used both sides of the marketplace in the answer. It's interesting, you didn't have to say, no one said marketplace by the way. It's just what happens is the process of connecting supply demand. Anyone, any last ones on Airbnb? Okay, let's go for a little harder one. Palantir, who wants to do a one line of what Palantir is? And that's kind of the point. That is kind of the point. It's really hard. And in fact, they do hard things. And by the way, it's taken them 16 years to get to market. Oh, you want to do it? Let's hear it. Sorry, I beat you to it.

I don't have to say what they do because they're surveillance.

So I'm not going to. Palantir knows what you do is what you're saying. Got it. That's a good one-liner. We unlock your company's knowledge. We unlock your company's knowledge. I like it. Okay. If honestly, if Palantir, like, I don't know what their pitch was when it was a 2-person startup or a 4-person startup, by the way, in 2004. But I'm sure it's a lot different and was just as hard sounding as it is now. Okay, so clarity matters a lot. Of those companies, by the way, I think probably Palantir is probably the most valuable of those three that I mentioned, Uber, Airbnb, and Palantir, interestingly. What was that? Depends on the day. You're right, if Karp was on TV or not, 100%. But it's about clarity, all right? And that's really the importance here is that if a founder can't make us understand the business, the problem isn't the reviewer. It's not on us. It's on the company, okay? And that's it. So that's what I want to make sure you sit home with is that it's not on you to have to go do heavy hard work to figure out what the one sentence is. It's on the founder. Kathy?

Some investors have a fear of missing out. And what if this is the most amazing opportunity, but the founder is ill-equipped to communicate what they do?

Well, luckily we have 3 more questions to consider. In this framework, though, theoretically, though, in this framework, if you can't do the pitch, if the founder can't do the pitch, and you're a no, I don't understand, then you might just completely write the whole thing off. And so you might miss 100% if you are super heavy indexed on this. But again, we all index and are very subjective in general. We don't take one data point, we generally take a bunch. But valuation, momentum, speed, that kind of brings us to number 2. The second question here, let's go with venture scale outcomes. Okay, we're going to explain what this is. Venture scale does not mean a good exit. It means an outcome that can return the fund or has return potential. Now venture has a word in it that means larger than your average return. Okay, so this is probably a good example here. It's really also venture potential or venture scale or the things that we're doing investing in. Off-nominal but potential to change the world kind of businesses, they have to potentially beat something else that you're comparing to where you could put your money. It's the easiest way to say it. You have a lot of places to put money that could bring some side of return. Venture scale means that it has potential to be larger than that, but has higher risk. Accordingly. So take your savings account. It's very much, I mean, also can go up and down depending on the news lately, but not too much. Within single digits percent-wise of where you're going to end up. Venture capitalists are typically judged by how the stock market is doing, the S&P. They look over a 100-year time frame and they say about 8 to 10% annual rate of return is what the stock market's done for about 80 to 100 years. So we just have to beat that, is what professional investors have their low bar for. So venture scale has been pegged at that, but even within that there is a wide range of what the return potential is for you as an investor. So I just want to stop there and just see if there's any questions, because there's a lot of different ways to explain this. No? Okay. So higher rate of return, but also higher risk. Creative failure as well too. All right, so let's do an example here where we're going to take 3 different companies that all potentially look the same on day 1, or even the idea on paper when they applied for Estac even 20 years ago, if Estac didn't exist. Let's take down the street here, there's Salt Couture. It is a clothing store, sell boutique high-end clothes. I think they have their own brand as well. You've got Reef, which is a line of surfwear. And you have Vuori. All three of these have very different end outcomes, but all looked the exact same probably when the founder said, I'm going to start something. It's about clothing, and I'm going to bring it to a lot of people. A lot of people is very relative, by the way, in this regard, okay? Who, so my ask is, Who wants to explain the path of the 3 differences? Like, how would you maybe seen all 3 and looked at an application and said, oh, here's, here, here's something I can see that's an attribute of one versus another that looks venture scale versus the other 2 potentially not from the very beginning.

I think one you said was one the women's clothes.

I didn't say.

Okay, well, one sounded like sort of more of a boutiquey, a boutique, femaley type thing. So I would think the size of that total market is not that tremendous.

Visa V, Visa V, Visa V, Visa V.

Björri, which was leisure wear for men, women, or markets.

Their pitch is men only.

Which was men in the beginning.

Really? Yep.

All right, well, that blows my—

somewhat.

But let's pretend it wasn't. Let's pretend it was men and women. And then Reed. So Reed was kind of niche too, right? I mean, it was kind of, you know, the sports and active lifestyle market. So my hypothesis was one was very niche, one was slightly larger market size, one was huge. And that's it, Neal. Sorry.

Okay. No, it's good. So your framework was market size? Yes. You looked at market size? Yes. And you think at the beginning it was apparent that each were in 3 different markets? Yes. Okay, cool.

Tracy, raise your hand. Um, it was about 10—

this is a little closer. Yeah, you can be really close though.

It was about 10 years or so ago. I was down at Yoga Tropics when I was just down the street here, and afterwards we were sitting outside and I met a gentleman who had come down from LA. He was an accountant. He was an early investor in this company, Yori, and he was telling me about it. I think they just opened the store here. And I was like, man, that's a tough market. If I had been given the opportunity to invest in Beaurry at that time, I would not have done it because I thought it's too crowded, it's too competitive. So just being honest, like, they've done amazing. But like, that was a really hard one at the time to think like, how are you going to differentiate yourself?

So the question is, because you represented with Beaurry, weren't you? Yeah. And you didn't. What did we miss?

Man, I mean, I think, well, everyone missed a variety of things. The pitch that I think I was— that I remember hearing was the one-liner was Lululemon for men.

Right.

Okay. Which was athleisure that already women were really into that were really high end. But men are going to be just as into it, right? It's a really hard pitch. I don't know. It just like was really hard to— from, from— and this is the personal side, probably my side— was from an accountant who, you know, had no background in clothing. Right. So probably that's what a lot of people said no to. Shoulda, coulda, woulda.

And the 40% discount that comes with it. But the key is, again, there's your personal view. 100% analyze it objectively, but you still have this lens that comes from your personal viewpoint.

100%. Everyone views ventures. Let's, let's just talk about the potential to go from small to big. All right. That's really what we're talking about, to see an outsized return. Is the potential for this to hit wherever it is now, much bigger. Generally in venture scale, what we see is that the market doesn't exist. You have to create your own market. And that's why it's really hard for us to wrap our brains around it because we are looking at doing MBA studies of, well, the market is this size. And it's like, the venture scale ones, the market doesn't exist. Or it's this size and it's now this size. I guarantee you the market for black cars, which is what Uber's first pitch was, we were black car service on demand, was nothing compared to the size of Uber right now, right? So the markets, that's what most humans, we have a hard time wrapping our brains around that, that markets actually can expand and grow. But so here's the counterpoint that I kind of just said at the end. A lot of us discount, oh no, we'll come back to you real quick. A lot of people on the market side, if they can't see that the market can do this, it's a no for them. But that isn't generally the case in venture scale. Okay, so those are the parts we're gonna have to learn to like retrain our brain. It's kind of the same as buy high and sell low. I mean, our brains obviously also do the opposite in the stock market as well too.

Anyway, uh, Hans, I guess back to the original question, but, but I think the big question often has— is this something that's just going to become a great small business, or is this something that's going to explode 100x, 1000x, where someone will buy them for a lot of money so we get paid back? Because you say like it's a boutique, even if it's a very profitable boutique. Okay, maybe they're making 30% on their money every year, but we're never going to get— maybe we'll get a little dividend, but that never happens. We're not going to get something. But the other two pitches, Reef, it's still like, oh my gosh, you're going to go against all these surfwear brands and then shoes or whatever. It may be tough, but at least they're going for it. And the other is like Lululemon for men. For one, that's like a sitcom pitch or whatever. I understand. Okay, this could be— enormous. But then this often, when you look at the company, it's like, this is going to be great business for them, maybe, but we'll never get paid back. Versus like, there's a small chance of this going gargantuan and getting, you know, acquired by a major, major retailer. But sometimes they start small. Like, the nicest house I ever went to was, you know, the people who founded Charlotte Russe, which is gone now. But like, oh my gosh, you know, as an inexpensive women's clothing retailer, did great until that whole industry got destroyed.

So that's a great point. I also think just if I were to assess those 3 businesses now, and with your framework around exit potential, those 3 businesses would actually get evaluated 3 very different ways, right? The boutique is going to get evaluated on EBITDA. They're expected to be profitable and expect to be growing EBITDA. We're not even going to talk about VRE's EBITDA. Well, they actually are, but they're not typical for venture capital funds. Reef is going to be valued on cost of acquisition. They're generally an e-commerce brand with some retail. They're going to be looking at what's their CAC, what's their cost of acquisition. Totally different than Boutique. Boutique is not being evaluated on how can they acquire their customers. Viore, well, yes, e-commerce, but they're really being evaluated on month over month and year over year just growth. Where are they growing and where's the momentum? And that's why hundreds of millions of dollars being thrown at them to keep funneling growth. So those are 3 totally different metrics. You really couldn't evaluate those 3 companies side by side to say, how could we get our money back? If you were just investing in cash-flowing businesses, well then yes, you'd look at just EBITDA. But then you would probably never look at any venture capital tech-based firms because there is no EBITDA. They take any EBITDA and put it into growth so they grow faster and quicker. So anyway, just another framework around exit potential of how one business would be evaluated versus another and how our brains tend to think about some things, whether we want to or not. Any other questions on this before I move on? Okay, let's go to exercise or question number 3. We having fun? Yeah? All right, cool. Okay, is there something here that excites me? This is real. We're going to see 100+ companies. Something's got to jump out and say yes, and many are going to glaze over, and that just happens. And the thing you glaze over could be all the above: the people, the market, the technology, the not technology, all the above. There has to be some hook for you. And so we're going to experience what those hooks could be. And how different they are for each other, okay? And by the way, this question may make people uncomfortable, and this is a good thing. Excitement is not hype, okay? Excitement is signal. If something's pulling at you, you should be leaning into that. That's your gut talking, okay? Imagine a startup using AI to reduce hospital staffing shortages. Who feels excited about that? Okay. Why? Let's ask them why.

Hospital staffing shortages is a big issue. You're paying nurses a really high rate in order to attract them to come to your organization. When you don't have nurses, you can't get things done. Inpatient, um, the level of service for patients decreased significantly. So if you can create an efficient system where hospitals can find nurses at an equitable rate, there's a financial benefit for the hospitals and also better care for the patients.

Who here is not excited by that? And that's not a problem. It's totally subjective. Who's not excited about AI for hospital staff shortages? Okay, a few. Do you want to say why?

Yeah, put him on the mic. I don't really know anything about—

Go a little closer.

I don't really know anything about how hospitals work, and I understand intuitively that's an important problem to solve, but it doesn't get me going.

Great. Appreciate that. One more? You had one. Give it to her.

It's something that can solve a problem, but is it exciting? No.

Okay, great. Those are real because those are how we feel, and that's how people assess other people in other companies. So that is how it— that is the realness of it. Excitement usually comes from founder insight, market timing, technical leverage, domain familiarity. Nothing excites you, you might not do great diligence. You might do some, and that's okay. You should know that within you. If something is not exciting, you should jot that down. And in fact, the diligence process, we will in the evaluation process. So just something to know about yourself, what excites you, what doesn't. Okay, question 4, time commitment. A yes to this question implies real engagement. This is for real. This is all of us. We have a million things pulling at our time right now. The fact that you're giving me the time, I do not take it for granted. Hopefully we're taking a lot away from it, and that's what's important. You decided to go here versus something else. You decided to meet some founders versus others. You decided to read certain startups and get to know them more than others, and that's super important here. And that's what we call the calendar test. Would I spend more time evaluating this company? All right, so let's use a time blocking example. It's March 18th, and we know we have to invest in companies by May 29th. You're asked to spend one more hour on a company. You've got two months to, oh, let's do this, no, sorry, swap this. We have one week to go. It's March 18th, and you have one week to decide What companies do we want to invest in? And you have 50 to look at. Now through the framework of who would actually schedule that hour, who would spend one more hour with one more company or one more hour with 50 companies? Really hard to assess, yet that's what's going to be asked of us at different times. Spend more time. Well, how do you choose one versus another on that? And we're going to look at all those pieces. And actually, it turns out that all 3 of those questions before, questions 1, 2, 3, kind of come back to this. It really is actually that you're going to look through that lens of, is this exciting? Is this, you know, have the potential return? It's all time. Is this one worth more than this one, time-wise? And it's important to know that you, have that pull in you for one versus another, okay? And so it's a framework altogether. This fourth question kind of collapses all three here. And so within SDAC, we're going to find that you kind of need a yes to all four to be— you need to be excited, maybe all four, to move forward with a company. And that's just kind of like because we just discovered that we all are looking at things different. And so the power of many through that lens is going to find us a great bundle. Of great companies to look at. So this is one framework I've got. I'm not saying it's above all and all. Everyone has different versions. And the goal here isn't consensus. That's actually the greatest thing about all this. It's not consensus. It's about alignment between conviction and effort. Okay? And so if you understand the framework, you can explain it to someone else, which is helpful because we are going to move fast over the next few months. But we're going to do it together, and we're going to stop and say, hey, we don't understand something that meets this framework, or we don't understand something at all about this company. Someone here does, and we're going to stop and learn. But at least you have a few lenses of how we move fast without lowering the bar. That's what's super important, that we don't change our bar here. Any questions around that? No. OK, so let's do a quick exercise. We are going to have you turn to someone next to you and explain the 4 questions to them in a super succinct way of how you understood them. Go for it. All right, how do we do? Did we remember all 4, or is one of them harder to remember than the others? You guys remembered all 4? Yeah? You guys remembered all 4? You remembered all 4? He says I did, but he's not so sure. All right. Well, we'll get to know these more because we're going to put them into practice. So thanks, everyone. We got 30 more minutes here, open networking. I'm all done. There's still food and drink. Thank you to the C3 guys. And thank you, SSEC.