20VC Flybridge's Jeff Bussgang on Why It Is Not All About Unit Economics & Why VCs Are Big Data Decision Makers

In this episode of "20 Minutes VC," host Harry Stebbings interviews Jeff Bussgang, General Partner at Flybridge Capital, a seasoned entrepreneur turned VC and a senior lecturer at Harvard Business School. Bussgang shares his journey from a computer science undergrad with entrepreneurial roots to becoming a VC, emphasizing the importance of adopting a realistic approach to unit economics and growth. He discusses the venture capital industry's focus on money-in, money-out metrics and the challenges of maintaining culture and values amidst hypergrowth. Bussgang also highlights the significance of transparent risk communication and mitigation strategies in pitches. Additionally, he touches on the implications of signaling risk for VCs making seed investments and the value of picks-and-shovels investments, citing Sentenai, a machine learning data engineering startup, as his latest public investment.

• Jeff Bussgang is a general partner at Flybridge Capital.
• He is a former entrepreneur turned VC.
• Jeff is a senior lecturer at Harvard Business School with 15 case studies coauthored.
• He has invested in companies like Crashlytics (sold to Twitter) and Raden.
• Jeff is the author of the book "Mastering the VC Game" (2010), acclaimed by TechCrunch, WSJ, FT, and others.

"Joining me in the hot seat, we have Jeff Bussgang, general partner at Flybridge Capital."

This quote introduces Jeff Bussgang as the guest, highlighting his roles and achievements, setting the stage for the conversation about his career and insights into venture capital.

• Jeff's background includes a computer science degree and being the son of an entrepreneur.
• He worked as a management consultant at Boston Consulting Group before attending Harvard Business School.
• His intent was to learn management to become an entrepreneurial manager.
• Exposure to VCs at HBS led to recruitment by one, but he chose to join a portfolio company instead.
• After going public and starting another company, he co-founded Flybridge with a former Greylock partner.

"The trajectory for me was first I was a computer science undergrad and son of an entrepreneur... I bumped into a bunch of VCs while I was at HBS... It was sort of a circuitous route through the path of entrepreneurship."

Jeff Bussgang narrates his journey from a computer science student and management consultant to becoming a VC, emphasizing the influence of his education and entrepreneurial background.

• Jeff's experience includes growing a company from zero to $100 million in revenue in a few years.
• He learned the importance of continually redesigning systems, including human capital, decision-making, and communication systems.
• Hypergrowth requires constant adaptation rather than settling into a routine.

"One of the most important ones was that all the systems that you design when you're a certain size are completely wrong six months or twelve months later."

Jeff reflects on the necessity of dynamic systems in a hypergrowth environment, implying that successful management requires flexibility and the ability to evolve.

• Jeff disagrees with the notion of a glass ceiling for aspiring VCs without operational experience.
• He cites examples of successful VCs, like his co-founder Chip Hazard, who had no operating experience before entering VC.
• While operational experience can be advantageous for empathy and understanding startups, it's not the only path to success in VC.

"I never believe there's one path to the final journey... I do advise a lot of my students and young folks who are aspiring to get into VC that if you can, I think it is advantageous to get some operating experience."

Jeff challenges the idea of a single path to success in VC, advocating for diversity in experience while acknowledging the benefits of operational exposure.

• Jeff emphasizes the importance of consistent values, culture, mission, and purpose for startups.
• Even in a state of constant change, these elements provide stability and direction.
• A strong foundation in these areas helps maintain a solid company culture despite structural changes.

"It really settles in on values and culture... if you have a consistent set of values and culture and hopefully a consistent mission and a consistent purpose that you're trying to achieve with your startup."

This quote underscores the significance of a strong, value-driven culture as an anchor for companies experiencing rapid growth and change.

• Startups should maintain a constant focus on the problem they are solving and the customer persona they are addressing.
• It is important to keep the culture, focus, strategy, and mission constant while being willing to change organizational and communication structures.
• Anticipating and adapting to the breakdown of structures is essential for startup success.

"If you can maintain that focus, then all the other pieces are more disposable. And that's really the key, is not to dispose of the culture and the focus and the strategy and the mission."

This quote emphasizes the importance of maintaining the core elements of a startup (culture, focus, strategy, mission) while being flexible with less critical aspects (organizational and communication structures).

• Venture returns are the financial outcomes of investments made by venture capitalists (VCs) and are of primary interest to Limited Partners (LPs).
• LPs evaluate venture performance similarly to how they would assess mutual or bond funds, focusing on money in versus money out.
• The success of a VC fund is measured by the return on investment and the time it takes to achieve those returns.

"It's really just about the return that you generate. It's money in, money out."

This quote simplifies the concept of venture returns to the basic principle of the amount invested versus the amount returned, highlighting the primary concern for LPs.

• The two main metrics used by LPs to measure VC performance are multiple on cash return and internal rate of return (IRR).
• A successful fund is expected to return about three times the investment and achieve a 15% to 20% IRR net of fees.
• These metrics are consistent regardless of the fund size or number of funds managed by a VC firm.

"So the metrics that LPs use to measure our performance are typically two. One is multiple on multiple cash on, cash return... And the second is a factor of time, which is the IRR..."

This quote outlines the two key metrics for assessing venture fund performance, emphasizing the importance of the amount returned relative to the amount invested and the time value of money.

• The macroeconomic environment, particularly low-interest rates, has made traditional low-risk investments less attractive.
• This environment has increased the appeal of venture funds due to the potential for higher returns, despite the increased risk.
• The risk premium of venture funds becomes more attractive when traditional safe investments, like US Treasuries, offer low or zero returns.

"The premium becomes more attractive if a venture fund can return 15 20% year over year."

The quote highlights the attractiveness of venture funds in a low-interest-rate environment where traditional investments yield low returns, making the higher risk of venture funds worthwhile.

• The loss ratio is a concern for VCs and involves not only the number of portfolio companies that lose money but also the amount of capital exposed.
• VCs are becoming more cautious and are staging investments to mitigate risk, taking advantage of the disaggregation of seed investing.
• Incremental investments allow VCs to make better decisions over time as they gain more information about the company.

"Venture capitalists can dole out the money and mitigate the risk over time."

This quote explains the strategy of distributing investments over time to reduce risk, which is a shift from larger, upfront investments to smaller, staged ones based on company performance and information.

• There is a current shift in the startup ecosystem towards a focus on unit economics and profitability rather than just growth.
• Founders are encouraged to be optimistic yet realistic, balancing ambitious goals with tangible business results.
• The speaker appreciates a realistic approach from founders, indicating a balance between visionary aspirations and practical business operations.

"I am pleased when founders are realistic... But you also have to focus on real results and building a real business and creating real value."

The quote reflects the speaker's approval of founders who maintain a balance between optimism and practicality, ensuring they are building a sustainable business while pursuing ambitious goals.

• The venture capital industry often swings towards irrational exuberance rather than realism.
• Founders and VCs are now being more realistic about profitability and sustainable business models.
• The focus is shifting from businesses being merely exciting to being fundamentally good.

"And in our industry, typically, the pendulum does not swing too far in the realism category."

This quote emphasizes that the venture capital industry usually leans more towards enthusiasm and high expectations than towards a realistic assessment of businesses.

"It typically does swing too far into irrational exuberance, to quote Alan Greenspan, and founders getting very markets getting frothy, and founders and vcs feeding that froth."

The quote references Alan Greenspan's term "irrational exuberance" to describe the overly optimistic and sometimes unrealistic expectations in the market that can lead to inflated valuations.

• Jeff Bussgang discusses the importance of balancing growth with profitability in venture-backed companies.
• The alignment between entrepreneurs and VCs on equity value creation is highlighted.
• Market conditions dictate whether capital markets favor high growth or solid business models.

"I can't think of a single one where we're not being aggressive enough and not thinking enough about growth balanced with profitability."

Jeff Bussgang indicates that in his experience, there is a consistent effort to balance growth with profitability, suggesting that neither aspect is being neglected in the companies he is involved with.

"We're all focused on equity value creation, both the entrepreneur and the VC."

This quote underlines the shared goal of entrepreneurs and VCs, which is to increase the value of the company's equity, suggesting that both parties have a vested interest in the success of the business.

• Jeff Bussgang disagrees with the notion that positive unit economics from day one is crucial for consumer portfolios.
• He provides examples from his portfolio, MongoDB and Codecademy, where adoption was prioritized over immediate monetization.
• The strategy of focusing on adoption first can lead to significant equity value creation once the company becomes a standard in its field.

"So I disagree with that VC."

Jeff Bussgang explicitly disagrees with the unnamed VC's strategy, setting the stage for an alternative approach to building a company's value.

"There are times when you want to drive adoption first, monetization later, and delay the focus on unit economics."

The quote suggests that there are strategic periods during a company's growth when focusing on adoption can be more beneficial than immediate profitability, with monetization and unit economics becoming a focus later on.

• Transitioning from free to premium or paid products can be challenging for companies.
• The struggles include setting the right value proposition for paid products and managing conversion rates without losing adoption.
• Evernote's recent changes to its product are used as an example of this challenge.

"A difficult bridge to cross. And we've had some companies that have struggled to cross that bridge."

Jeff Bussgang acknowledges the difficulty companies face when trying to convert free users to paying customers, indicating it's a common challenge.

"If you lower the bar on the free product, then sometimes you lose conversion rates and suddenly you have a lot of attrition and your adoption strategy goes away."

This quote highlights the delicate balance companies must strike when adjusting the features of their free products to encourage users to upgrade to paid versions without losing the user base.

• Founders often try to hide risks in their pitches to VCs, which is not the most effective strategy.
• The best pitches include a transparent discussion of risks and detailed risk mitigation plans.
• Confidence in a pitch is important, but it should be genuine and not mistaken for bravado.

"I think the most compelling pitches are when the founder articulates more risks than I can think of and then lays out really thoughtful risk mitigation plans."

Jeff Bussgang emphasizes that acknowledging and addressing potential risks upfront makes a startup pitch more compelling to investors.

"It's a common feature of the best pitches and the most confident founders."

The quote suggests that transparency about risks is a hallmark of the most successful pitches and is associated with founders who exude a certain level of confidence.

• The best pitches often exhibit a founder's vulnerability and their ability to admit mistakes.
• This trait is seen as a strong positive by venture capitalists.

"y to be vulnerable and an ability to admit mistakes that comes through very strongly with the best pitches."

This quote emphasizes the value that investors place on founders who can openly acknowledge their vulnerabilities and mistakes, indicating a level of honesty and self-awareness that is appealing to venture capitalists.

• Jeff Bussgang recalls Mike Baker from Datazoo as having delivered one of the best pitches.
• Datazoo became a market leader in programmatic advertising, fulfilling the vision laid out by Baker.
• Baker's deep domain knowledge and ability to articulate his vision were key to the pitch's success.

"I think one of the best pitches I've seen was Mike Baker from Datazoo... Mike had a vision for how the future would unfold... and that vision... has exactly played out."

This quote highlights the importance of having a clear and compelling vision for the future, as well as the ability to effectively communicate that vision to investors, as demonstrated by Mike Baker's successful pitch.

• Speaking to associates or principals at a VC firm is an early stage in the investment process.
• It is worthwhile because they can champion a founder's cause to the partners.

"You're at an early stage in the investment process. It is worth your time, because if they can be a champion for you and get you credibility with the partner, it's worth it."

Jeff Bussgang indicates that engaging with non-key decision-makers can be beneficial as they have the potential to advocate for the founder within the firm, thus advancing the investment process.

• Jeff Bussgang's favorite book is "Man's Search for Meaning" by Viktor Frankl.
• The book's philosophy resonates with Bussgang due to personal family history and its profound moral view.

"Your favorite book and why Viktor Frankl Man's search for meaning my dad survived the Holocaust in pre war poland as a refugee and soldier in the war."

The quote reveals the personal significance of the book to Jeff Bussgang and underscores the impact of Viktor Frankl's work on his worldview.

• Founders need to study the size of the fund, typical investment size, and the investment profile.
• Reference checking with CEOs and entrepreneurs who have worked with the fund is crucial.

"Size of fund, size of typical investment profile of the investments made, and do reference checking with ceos and entrepreneurs that have worked with that fund before to get their likes and dislikes."

This quote outlines the key areas of research a founder should conduct before meeting with a VC fund to better understand the fund's preferences and track record.

• Large later-stage VCs cannot make seed investments without inherent signaling risk.
• Signaling risk is a significant data point in the decision-making process for VCs.

"No, they can't."

Jeff Bussgang succinctly asserts that it is not possible for large VCs to avoid signaling risk when making seed investments.

• VCs are likened to pattern recognizers and machine learning algorithms.
• They make decisions based on data points, with signaling risk being a crucial factor.

"Vcs are big data decision makers. Think about us as pattern recognizers and machine learning, deep learning algorithms that feed on data."

The quote draws a parallel between VC decision-making and machine learning, emphasizing the data-driven nature of investment choices.

• Jeff Bussgang advocates for transparency regarding key issues, timing, and investment priority.
• An investment partner can only focus on a few investment opportunities at a time in a meaningful way.

"A lot of transparency with respect to the key issues and a lot of transparency with respect to the timing, and a lot of transparency with respect to how high a priority this is."

The quote stresses the importance of being open about the investment process and where a particular opportunity stands in terms of priority for the VC.

• "The Economist" and "Mattermark" are essential reads for Jeff Bussgang.
• Mattermark is a Flybridge portfolio company, and Bussgang discloses this association.

"The Economist is a must read for me. And then Mattermark is the other must read."

Jeff Bussgang shares his preferred sources of information, which include a publication covering global affairs and a company specializing in startup data.

• Sentine is a machine learning-based data engineering startup.
• The technical founder's vision and the team's ability to provide tools for machine learning were compelling reasons for investment.

"The most recent public investment was Sentine... I thought that the technical founder was incredibly compelling and had a great vision for how the world was going to play out in the machine learning world."

This quote explains Jeff Bussgang's rationale behind investing in Sentine, highlighting the founder's vision and the startup's role in the burgeoning field of machine learning.