20VC 500 Startups' Dave McClure on Whether Unicorns Are Necessary For Venture Returns & Why Ownership Is Not The Math To Think About When Investing



In this episode of 20 Minutes VC, host Harry Stebbings interviews Dave McClure, founding partner of 500 Startups, a venture capital firm with over 1500 investments including Twilio and Sendgrid. McClure shares his journey from Johns Hopkins graduate to a leading figure in the VC world, detailing his early career as a software developer, his time at PayPal pre-IPO, and his angel investments which led to the establishment of 500 Startups. He discusses the importance of diversifying investments, the role of accelerators in nurturing startups, and how 500 Startups ensures participation in follow-on funding rounds. McClure also addresses the value of diverse portfolios for venture success and the potential for growth in emerging markets. The conversation touches on the challenges of maintaining investment opportunities in competitive funding rounds and the misconceptions surrounding accelerator programs. Additionally, McClure reflects on the legendary "PayPal Mafia" and the lessons learned from working with renowned entrepreneurs.

Summary Notes

Introduction to Dave McClure and 500 Startups

  • Dave McClure is the founding partner of 500 Startups, a significant venture capital firm.
  • 500 Startups has made over 1500 investments, including Twilio, Sendgrid, Intercom, and Makerbot.
  • Dave's background includes roles at Founders Fund, the Facebook fund incubator, and marketing at PayPal pre-IPO.
  • The host, Harry Stebbings, promotes Eve mattresses before introducing Dave McClure.

You are listening to the 20 minutes VC with your host Harry Stebbings at H Debbings on Snapchat. Now, today's guest I really have wanted to have on the show for a very long time, so I'm very excited to welcome Dave McClure to the show today.

The quote introduces the podcast and expresses the host's excitement about having Dave McClure as a guest, highlighting his significance in the venture capital industry.

Dave McClure's Background and Career Journey

  • Dave graduated from Johns Hopkins in 1988 and moved to California in 1989.
  • Initially a software developer, he transitioned into entrepreneurship with his first startup.
  • He consulted for major companies like Microsoft and Intel from 1994 to 1998, growing his business to about 20 people.
  • Despite challenges in running a small business, he achieved a small exit.
  • Dave worked at PayPal from 2001, through the IPO and sale to eBay, until 2004.
  • He began angel investing in 2004 and achieved notable exits with Mint.com, Mashery, and Slideshare.
  • Dave worked for Founders Fund and ran the Facebook fund incubator before starting 500 Startups with Christine in 2010.

I graduated from Johns Hopkins in Baltimore in 88, I think. Came out to California in 89, was a software developer programmer for a few years. That kind of turned into my first startup.

This quote provides a brief overview of Dave McClure's early career and the transition from a software developer to an entrepreneur.

Dave McClure's Investment Philosophy and Hits

  • Dave's amateur angel investments included Mashery, Slideshare, and Mint.com.
  • He considered Mint.com to have the potential for a significant impact, led by a compelling founder, Aaron Patzer.
  • Dave emphasizes the unpredictability of early-stage investments and their outcomes.
  • The investments in Lyft (formerly Zimride), Credit Karma, and Twilio were not competitive rounds, despite the founders' capabilities.
  • The period around 2008-2010 was difficult for raising capital.

I still feel like most of the time when I invest in companies or when we 500 invest in companies, it's very early and it's hard to predict what's going to happen in the future.

This quote reflects Dave's perspective on the uncertainty associated with early-stage investments and the difficulty in predicting their success.

Investment Strategy and Returns

  • Dave's angel investment portfolio consisted of approximately 13-15 companies, with three achieving 100 million plus exits ("centaurs").
  • His angel investments yielded about a threefold return, without any unicorns (billion-dollar companies).
  • Dave suggests that a 20% hit rate on winners is higher than usual and not necessarily required for good returns.

So I basically made about a million dollars, maybe a little bit more than that on 300,000 in. So a three x return, or slightly more than a three x return.

The quote summarizes the financial outcome of Dave's angel investments, indicating that substantial returns are possible even without unicorn-level exits.

Portfolio Size and Unicorn Investments

  • Dave McClure discusses the importance of portfolio size in relation to finding unicorn companies.
  • He states that with a larger portfolio, the expectation to find unicorns or companies with a 50 to 100x return profile increases, but only occurs about 2% of the time.
  • A portfolio needs to be at least 50 to 100 companies to have a shot at finding a unicorn.
  • The goal is to aim for 3 to 5 unicorns, which necessitates a portfolio size of 200 to 500 startups for predictability.

"Our expectations are that we'll find those unicorns, or at least, let's say 50 to 100 x return profile companies, probably not more than 2% of the time." "We're probably aiming for like three to five [unicorns]. And then our portfolio size starts to become necessarily more like 200, 300, or even 500 startups in order to have predictability around that outcome."

The quotes illustrate the strategy of increasing portfolio size to improve the odds of finding high-return investments and the necessity of a large number of startups to achieve predictability in finding unicorns.

Ownership Stakes in Seed Investments

  • Dave McClure explains that the typical ownership stake in seed round investments ranges from 1 to 5%.
  • Ownership stakes might be slightly higher in international markets where valuations are lower.
  • The investment strategy focuses more on the number of investments and the probability of finding large outcomes rather than ownership percentage.
  • The expectation is that 2% of the portfolio will yield a 50x return or better, and about 5% will yield a 20x return or better.

"The typical ownership that we hold in most of our seed round investments is probably between one to 5%, maybe a little bit higher in some of the international geographies, where valuations are lower." "We really think more in terms of number of investments, and the likely probability distribution of finding large outcomes."

These quotes emphasize the approach of prioritizing a diversified portfolio and the likelihood of significant returns over the size of individual ownership stakes.

Follow-On Investment Strategies

  • Dave McClure discusses the challenges and strategies around follow-on investments.
  • Follow-on rights are sometimes secured contractually, especially with accelerator companies.
  • The fund has a structure to invest in follow-on rounds without exceeding 20% of the round.
  • Large portfolio sizes are a strategic measure to ensure enough opportunities to deploy capital into winning companies.
  • Not getting into follow-on rounds can be due to oversubscription, larger investors' preferences, or a lack of available capital.

"We usually do that so that we can invest in at least one follow on round with our accelerator companies." "We want to get that to happen in at least enough scenarios where we can deploy follow on capital into our winners."

These quotes explain the mechanisms used to participate in follow-on rounds and the importance of having a large enough portfolio to invest further in successful companies.

Challenges with Follow-On Rounds

  • Dave McClure acknowledges that sometimes larger investors or a lack of contractual rights can prevent participation in follow-on rounds.
  • He notes that rounds that are oversubscribed and in high demand can be difficult to get into, but this does not always correlate with future value.
  • Maintaining a good relationship with founders is crucial, and while they may not always look out for the interests of all investors, earning the right to follow on is a part of the investment partnership.

"Sometimes it's larger investors who want to take as much of the next round as they possibly can." "Hopefully, if we are doing a good job in being an investment partner with the founders, they do hopefully look out for our interests in follow on rounds."

These quotes highlight the competitive nature of follow-on rounds and the importance of investor-founder relationships in securing opportunities to invest further.

Signaling in Investment Decisions

  • Dave McClure addresses the issue of negative signaling in the market when investors do not follow on in subsequent rounds.
  • He argues that signaling is more of an issue for institutional lead investors and not typically for their role.
  • The focus should be on the performance of the company rather than the investment decisions of any particular investor.
  • If there are concerns about an investor's decision, it may indicate underlying issues with the company's performance.

"My perspective on this is typically that if the founder or other investors are more worried about my investment decision than the baseline performance of the company, there's already likely some kind of problem there."

This quote suggests that the concern over signaling might be overemphasized and that the primary focus should be on the company's performance rather than investors' actions.

Company Performance and Investment Decisions

  • The primary factor in deciding to invest in a company is its performance.
  • Founders' concerns about follow-on investments may indicate weak metrics or underlying issues.
  • Strong performance can alleviate worries about securing further investment rounds.

"to say that the most important thing in making a decision to invest in the company is the company's performance."

This quote emphasizes the primacy of company performance when making investment decisions, suggesting that other factors are secondary.

Accelerator Programs and Adverse Selection

  • The idea that top entrepreneurs avoid accelerators is challenged, especially for established programs.
  • Accusations of adverse selection are dismissed as largely unfounded.
  • Accelerators provide valuable networks and resources, especially for first-time entrepreneurs.
  • Successful companies and experienced founders sometimes return to accelerator programs.
  • The benefits of top accelerator programs are likened to those of elite educational institutions.

"I think that's kind of bullshit. I mean, that really depends a lot on the program."

Dave McClure dismisses the notion of adverse selection in accelerators, indicating that the value of the program is highly dependent on its reputation and structure.

The Value of Established Accelerator Programs

  • Established accelerators like Y Combinator, Techstars, and 500 Startups offer significant networking opportunities and alumni support.
  • The value derived from these programs often outweighs the cost of dilution for entrepreneurs.
  • These programs can lead to valuation increases and other benefits beyond just capital.

"But I think you've also seen very successful companies come back and do an accelerator program, or founders who've had exits come back and do an accelerator program a second time."

Dave McClure argues that the return of successful companies and founders to accelerator programs is evidence of their ongoing value.

Sam Altman's Views on Accelerator Programs

  • Sam Altman's post about Y Combinator's expectations for previously accelerated companies is discussed.
  • Disagreement with Altman's conclusion that entrepreneurs should wait for YC rather than join other accelerators.
  • The importance of not delaying progress in hopes of joining a specific accelerator is emphasized.

"I think that's kind of laughable and actually probably really poor advice for entrepreneurs."

Dave McClure criticizes the idea that entrepreneurs should hold out for Y Combinator, suggesting that such advice is not in the best interest of entrepreneurs.

Investment in Accelerator Alumni

  • 500 Startups invests in companies from various accelerators, including Y Combinator and Techstars.
  • A significant portion of the 500 Startups portfolio includes companies that have participated in other programs.
  • Investing in companies from global accelerator programs is common, and such companies often join U.S. programs later.

"So whether that's YC or Techstars or Angel Pad or Seedcamp or whatever, we've invested in plenty of other companies that have gone through both major globally recognized programs here in the US, as well as other programs around the world."

Dave McClure notes that 500 Startups invests in companies from a range of accelerator programs, highlighting the non-exclusivity of their investment strategy.

The PayPal Mafia and Team Dynamics

  • The PayPal team, known as the PayPal Mafia, is recognized for its extraordinary success.
  • Working with the PayPal team provided valuable lessons and growth opportunities.
  • The challenges faced by PayPal, such as competition and fraud, contributed to the team's learning and success.
  • Comparisons are made between PayPal's journey and those of other major tech companies.

"But the lessons that we probably learned at PayPal were probably learned in the trenches with a lot of other people on the team."

Dave McClure reflects on the collective learning experience at PayPal and the importance of teamwork in overcoming challenges.

PayPal Alumni Impact

  • PayPal's environment was stressful, requiring constant adaptation in product and marketing to survive.
  • This environment produced many strong founders with thoughtful, experienced backgrounds.
  • PayPal alumni have founded numerous well-known companies.

So for whatever reason, PayPal became an interesting place where a lot of people dealt with stress from multiple sources and obviously a lot of really smart people. But it was a terrific place to meet very thoughtful and experienced and strong founders. And the alumni have obviously gone on to create a bunch of very recognizable company names.

The quote explains that PayPal's challenging environment fostered a community of smart, resilient individuals who went on to become successful founders.

Venture Capital Availability

  • Dave McClure believes there is not enough venture capital, especially outside of Beijing and Silicon Valley.
  • He identifies Southeast Asia and India as current priorities for investment due to a lack of VC capital.
  • Latin America, the Arab-speaking Middle East, and Africa are also seen as regions with potential but insufficient capital.

Definitely not enough vc capital. And we should be clear about know, in Beijing and in Silicon Valley, there is a lot of money. In most other places around the world, there isn't.

This quote underscores the disparity in venture capital distribution, highlighting the concentration in certain regions and scarcity elsewhere.

Focus on Diversity in VC

  • Dave McClure acknowledges Social Capital and Kapoor Capital as entities that focus on diversity in venture capital.
  • He notes that individuals from underrepresented groups are also making significant contributions.

Well, I think probably social capital. Chamath polyapatia has made that a pretty big focus. I think Mitch and Frida Kapoor at Kapoor Capital, they're not always considered a VC, but they certainly do both for profit and non profit investments and social impact investing.

The quote identifies specific venture capitalists who prioritize diversity and social impact in their investment strategies.

  • Dave McClure recommends "Guns, Germs, and Steel" by Jared Diamond, "The Mystery of Capital" by Hernando DeSoto, and "Spent" by Geoffrey Miller.
  • He emphasizes the value of these books in understanding capital formation and behavioral psychology.

The mystery of Capital is probably an under promoted book. That's not really common on a lot of people's lists. I think that's just amazing for thinking about capital formation. Spent is an amazing book. Know talks really about behavioral psychology and impact.

The quote highlights the importance of these books for their insights into economics and human behavior, suggesting they offer valuable perspectives not widely recognized.

Missed Investment Opportunities

  • Dave McClure candidly admits missing out on investing in Uber multiple times.
  • He reflects on this as a significant mistake.

Clearly Uber was the deal that I totally fucked up. Travis gave me the opportunity to invest in June of 2010. Does it keep you awake every day, every week I think about that deal.

This quote reveals a personal anecdote about a missed investment opportunity, indicating the lasting impact such misses can have on an investor.

Essential Reading for VCs

  • Dave McClure reads content from Mark Suster, Brad Feld, and Fred Wilson, who have been influential in his career.
  • He encourages others to write their own thoughts and not solely rely on established blogs.

There's a bunch that I like out, definitely, you know, good friends with Mark Suster, read his stuff all the time. He's probably one of the more thoughtful people out there. Brad Feld and Fred Wilson have been sort of mentors.

The quote points to specific thought leaders in the venture capital space and the value of their insights while also advocating for the creation of original content.

Recent Investment Highlight

  • Dave McClure talks about investing in Markhor (public name Hometown), a company producing high-end custom shoes.
  • The company, with roots in Pakistan, impresses with its profitability and product quality.

There's a company that went through the Y carbonator program called Hometown. I guess the public facing name is called Markor. They do custom high end shoes.

This quote showcases a particular investment Dave McClure is proud of, highlighting the company's success and unique market position.

Show Appreciation and Updates

  • Harry Stebbings expresses gratitude to Dave McClure for participating in an early morning interview.
  • Listeners are encouraged to follow Harry on Snapchat and sign up for the newsletter for updates.

Thank you so much for joining me and I look very forward to welcoming you back on in the future.

This quote is a closing statement thanking Dave McClure for his time and contribution to the show, while also providing information on how listeners can stay connected with the show's content.

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