overheard concepts in vc

i will try to keep this page as a living document of frameworks and concepts i’ve heard about from other investors. also will try to sprinkle in some observations of my own, and personal thoughts / takes. some of these might resonate or not resonate (or seem too transactional / reductive); i think everyone’s investing style is highly personal and what makes sense to them depends on their background and worldviews.

conviction is check size divided by fund size. pretty simple - how much of your total assets would you put into this company? your standard check size, or higher? would you put 1% of the fund into this company, or go all the way up to 30%, or even more?

the diligence process is “talking yourself out of investing.” this one makes a lot of sense to me as a pre-seed investor. you start by meeting a founder and getting really excited by them as a person on your first call. then you try and talk yourself out of investing, and if you can’t do that, maybe you should invest. even if you really like the person you should ask yourself the hardest and most important questions you can, and then loop in other team members to help try and come up with some more questions. most of the time you don’t have to invest same-day, so you have the luxury of being able to sleep on it, and see how you feel the next morning. are you still really excited, or has that excitement waned a little bit? were you able to satisfy the biggest doubts expressed by your team / yourself, and are the answers to these questions satisfactory enough to merit investing? there will always be risks, but as long as you’re comfortable and can’t talk yourself out of it, you might have conviction and should invest

what to optimize for in an investment: 1. conviction 2. ownership 3. valuation. in this order. first build conviction, and if you strongly believe in the opportunity, you should do anything you can to get into the round, regardless of what the dynamics are. next, after you have conviction, you probably want to own as much of the company as you can because you think it’s going to be big. again it’s fine if that’s not a lot, a little bit of uber’s first round is better than none (which you might end up with if you can’t hit your ownership threshold). if the first two are satisfied, the last thing you might want to optimize for is valuation (getting in at a low entry price, of course). but it’s probably good to think about optimizing things in this order. there are other pre-seed firms that seem to go about this in the opposite direction - first, find companies that have low valuations, then examine the business and see if you can talk yourself into investing. now it’s good to be generally disciplined about ownership and not investing at crazy high valuations, but it also seems like a good idea to know when to make exceptions. vc is all about knowing when to break your rules, some people even say it’s “the business of exceptions.”

before deal flow there is people flow, and before people flow there is information flow. there are “deals” (a word that i don’t like using for some reason) which are transactions that involve companies. these companies are searchable on pitchbook / crunchbase / google, but before those entities are formed, they exist as people (a few founders). and if you’re trying to go even further upstream and find people before they’re obvious, it could be useful to be in the information flow. your portfolio founder tells you about their cracked roommate who is thinking of leaving their job to start something. you hear from an investor friend that a big company is getting acquired and many of their employees would make for great founders. your college friend tells you about a few people who are ideating, they don’t even have co-founders yet but might be good to reach out to. some vc firms try to be deep in the information flow, others avoid it, both approaches work.

there are only a few companies a year that “matter.” this is a common phrase, it feels a bit demeaning to me but has an element of truth. sequoia’s analysis showed that “for the last 20 years, not the number of companies valued at a billion privately, but the number of actual billion-dollar exits—IPOs or acquisitions—has remained constant at roughly 20 a year.” if you’re not in one of those twenty as a large fund, it’s tougher. so most funds are competing to be invested in this very limited supply of companies. the fund math differs at every place, but say you’re a $500m fund, in order to 3x your fund ($1.5b), and assuming you shoot for 20% ownership and get diluted down to half (10%) at exit, your portfolio needs to be worth $15b total. the math changes a lot when you tweak those numbers, but the point is for most funds past the smaller “emerging manager” aum’s, you can’t be happy with singles, or doubles, or even triples, you need home runs. large seed funds have to shoot for the moon and be in the companies that “matter.”