20VC Has Price Discipline Disappeared Is it Possible to Build Ownership Over Time Why Venture Is Less Collaborative Now Than Ever How fast Do Breakout Companies Become Obvious How To Construct an Optimised and Repeatable Investment DecisionMaking Pr

In this episode of 20vc, host Harry Stebbings interviews Frank Rotman, co-founder of QED Investors, a leading fintech-focused venture fund. Rotman, an ex-Capital One analyst, discusses his journey from Capital One to QED, emphasizing the importance of clarity in decision-making and his approach to venture investing, which involves a deep understanding of a company's potential and the industry. He highlights the evolution of fintech from UX/UI improvements to fundamentally changing banking's atomic units. Rotman also shares his thoughts on the venture capital environment, noting a shift from collaborative to competitive dynamics and expressing a desire for a return to collaboration. Additionally, he touches on the challenges of long feedback loops in venture investing and how it contrasts with the immediacy of operating a business. Rotman's latest investment, Hello Alice, aims to support underserved small business owners, aligning with his mission-driven approach to investing.

• Frank Rotman is the co-founder of QED Investors, a leading fintech-focused venture fund.
• QED Investors has a portfolio that includes Klarna, Kavak, Quintuandar, Credit Karma, Armor, and more.
• Prior to QED, Frank was an early analyst at Capital One, contributing to the development of many business units and operational areas.
• After Capital One, Frank founded a student lending company before reuniting with Nigel Morris to co-found QED.
• The introduction also includes thanks to Nick Shalek at Ribbit, Nigel Morris, and Matt Harris at Bain for their question suggestions.

"I'm so thrilled to welcome Frank Rotman, cofounder at QED Investors, one of the leading fintech focused venture funds investing today with a portfolio including the likes of Klana, Kavak, Quintuandar, Credit Karma, Armor, and more."

This quote is an introduction to Frank Rotman and highlights his role and the significance of QED Investors in the fintech sector.

• Frank Rotman was hired directly out of the University of Virginia with a graduate degree in artificial intelligence, systems engineering, applied math, and statistics.
• Initially hired into what was Signet Bank, he was part of a small team tasked with expanding the bank's credit card division, which eventually spun off into Capital One.
• At Capital One, Frank played various roles in building and fixing business units and assumed positions like the first credit officer.
• After leaving Capital One, he attempted entrepreneurship by building a student lending company, which despite not ending well, provided valuable experience.
• He then partnered with Nigel Morris to envision and establish QED Investors.

"I was hired directly out of the University of Virginia, graduate degree in artificial intelligence, systems engineering, applied math and statistics, like a whole bunch of really nerdy math type things, was hired by Nigel into what was Signet bank at the time."

This quote provides insight into Frank Rotman's educational background and his entry into the financial industry, setting the stage for his future accomplishments.

• Frank Rotman is also known for his poker skills, having played high stakes games and even knocking out Annie Duke from a competition.
• Poker taught him to focus on the decision-making process rather than being results-oriented, a principle he applies to venture investing.
• The primary difference between poker and venture investing is the frequency of decision-making opportunities; poker allows for a fast feedback loop, whereas venture investing involves long-term decisions with a much smaller number of opportunities.

"More than anything else, poker taught me a lot about being process focused rather than results oriented."

This quote emphasizes the importance of focusing on the decision-making process, a lesson from poker that Frank Rotman applies to his venture investing strategy.

• Frank Rotman discusses the transition from being an operator with daily results to a venture capitalist with long-term feedback loops.
• He contrasts the immediate feedback and short-term goals of an operator with the long-term, consequential decisions of a venture capitalist.
• Despite finding the feedback loop challenging, he adapted to the venture capital approach and learned to operate with extended feedback loops.

"What's infuriating? When you're an operator, you get daily results. There's something that's just so pure about that."

This quote reflects on the immediate feedback of being an operator and the adjustment required when transitioning to the venture capital world with its longer feedback cycles.

• Capital One emphasized a test-and-learn approach, which has influenced Frank Rotman's investment style at QED.
• He prefers investments where risks can be systematically reduced through testing and market validation.
• The QED name itself is derived from the principle of proving hypotheses, which was central to Capital One's methodology.

"At Capital one, everything was about test and learn. It was about the scientific methodology."

This quote underlines the significance of the test-and-learn methodology that Frank Rotman learned at Capital One and how it informs his investment philosophy.

• Frank Rotman expresses concern over the impact of capital proliferation on entrepreneurs' motivation to de-risk their ventures.
• He stresses the importance of understanding a founder's thought process and their ability to be good stewards of capital.
• Despite the abundance of capital, Rotman maintains the perspective of being a "cheap bastard" who focuses on building businesses efficiently, regardless of available funds.

"It worries me a lot. It puts a premium on understanding how a founder thinks, how good of a steward of capital they actually are."

This quote conveys Frank Rotman's apprehension about the current trend of capital abundance and its potential to diminish the entrepreneurial drive to de-risk business ventures efficiently.

• Venture capital is about deconstructing large problems into smaller, manageable segments and funding them with the minimum necessary capital to validate the business concept.
• The current VC market trend is risky, with companies attracting massive capital before fully proving their business models or even going public.
• There is a strong historical correlation between earnings per share and share price, implying that companies must be profitable to justify their valuations.
• The current market is characterized by a focus on growth over immediate profitability, influenced by the low-interest-rate environment.
• The venture asset class will persist despite changes in interest rate environments, but it may undergo adjustments such as increased price sensitivity and a renewed focus on time to profitability.

"Ultimately, businesses are only real businesses when they're self-sufficient."

This quote emphasizes the traditional view that a company's long-term sustainability is defined by its ability to generate profits and be self-sufficient without continuous external funding.

"There's a 95 plus percent correlation between earnings per share and share price of companies throughout the history of the stock exchange."

This quote underscores the historical importance of profitability as a determinant of a company's stock price, suggesting that current market trends may not be sustainable.

• Interest rates can influence the supply of capital into venture capital, as investors may seek different asset classes in higher interest rate environments.
• Venture capital is designed to mitigate various risks, including technical, product-market fit, and regulatory risks, by systematically investing in businesses with potential but also inherent uncertainties.
• The venture asset class is relatively small compared to larger asset classes but is growing and attracting more capital due to longer private company lifecycles and the increased potential for returns.
• Different interest rate environments may lead to shifts in venture capital strategies, possibly reintroducing a focus on quicker paths to profitability.

"Venture as an asset class is going to exist, but it might look a little bit different in different interest rate environments."

This quote acknowledges that while the venture capital industry will continue, the strategies and approaches may vary depending on the macroeconomic context, particularly interest rates.

• Current market valuations, especially in fintech, are perceived as inflated, leading to a dilemma between maintaining investment discipline and adapting to the market's demands.
• The influx of capital into venture capital has distorted traditional valuation methods, creating a founder's market where founders have significant leverage in dictating terms.
• Investors must balance the intrinsic value of a business with its potential future value, often leading to disagreements on valuations with founders.
• The current market requires investors to understand and operate within the prevailing dynamics, which may include bending traditional rules on price discipline.

"The price discipline has disappeared from the market, and I think it's collapsed to math."

This quote reflects the current state of venture capital investing where traditional valuation methods have given way to a simpler, more arithmetic approach due to the high demand for promising startups and the founder-driven market dynamics.

• Investment decisions in the current market often involve discomfort and require strong conviction and a willingness to occasionally bend one's own rules.
• Some investors have had to adjust their price expectations significantly due to rapid changes in the market and the exceptional growth trajectories of certain companies.
• The phenomenon of funds being deployed faster than traditional three-year cycles raises questions about the importance of temporal diversification in venture capital.

"It's about comfortable being uncomfortable. It's about conviction. It's about knowing when to bend your own rules."

This quote captures the essence of navigating the current venture capital landscape, where investors must sometimes go beyond their comfort zones and adapt their investment principles to the market's rapid pace.

• The growth rates of successful startups today are unprecedented, challenging investors to determine the right valuations for high-growth companies.
• Financial plans provided by founders are rarely accurate but contain valuable insights into the founder's vision and expectations, which investors should analyze carefully.
• Understanding the assumptions behind financial projections, such as marketing spend and margin improvements, is crucial for investors to assess the viability of a startup's plan.

"Extraordinarily high growth companies are hard to figure out what the right price is because you're staring at a plan and you're looking at trajectory of the company and momentum that they have."

This quote highlights the difficulty of valuing startups that are growing at an accelerated pace, as their future potential can be both immense and hard to predict.

• Insider rounds often occur when a startup has not met its goals and needs additional funding to continue operations.
• These rounds can be indicative of "anti proof," where the market has provided feedback that contradicts the startup's assumptions or business model.
• Investors must discern whether an insider round is a result of positive momentum or a response to setbacks, which can impact the perception and future funding prospects of the startup.

"Everything that you do is either proof or anti proof."

This quote reflects the binary nature of startup validation, where every action or result either supports or refutes the underlying business assumptions, influencing the need for and the outcome of insider rounds.

• Insider bridge rounds are often a response to a lack of external investor interest and are meant to provide more proof to counteract any negative perceptions.
• It's challenging to explain to founders why an investor may choose not to reinvest, especially when the investor has a people-pleasing personality.
• Frank Rotman emphasizes the difficulty in having conversations with founders about the viability of their businesses when the market signals are negative, despite the founders' best efforts and intentions.
• The investor-founder relationship is complex, involving not just financial investment but emotional and relational aspects as well.

"We don't want data leakage. Again, there are a lot of good reasons for insider rounds coming together, but if it's an insider bridge round, it really is about figuring out more proof on the board to overcome the anti proof that you probably just generated."

This quote highlights the purpose of insider bridge rounds: to gather additional evidence of a company's potential to offset any negative impressions that may have arisen, particularly in the absence of external investment interest.

• Frank Rotman discusses the emotional difficulty of informing founders about the decision not to reinvest, especially when they have executed well but the market response is unfavorable.
• There is a fine line between being supportive and enabling a failing business, as founders often continue to push for their company's success until they run out of cash, not ideas.
• Investors have a responsibility to communicate to founders that it is acceptable to fail in the venture capital industry, as not all investments will succeed.

"The hardest part of the business is when someone is trying, they're executing well, and the thesis is just wrong, and the market is basically telling them that the business is just harder to build than they thought it was going to be."

This quote acknowledges the challenge investors face when they have to deliver tough news to founders, especially when the founders have put in significant effort but external market forces have not been favorable.

• The current venture capital environment makes it difficult for investors to increase their ownership stakes over time.
• Initial investment size is crucial as it often determines future ownership stakes.
• Founders must balance the benefits of accepting additional capital from existing investors versus seeking new investors who may bring different skills and perspectives.

"The challenge in venture today is that that initial check that you write almost sets the stage for how much ownership you're going to have in the future."

This quote emphasizes the importance of the initial investment size, as it often sets the precedent for future ownership stakes within a company.

• Frank Rotman explains that there is no uniform signaling risk associated with choosing to lead or not lead subsequent investment rounds, as the decision is based on a multitude of factors.
• The venture capital market is competitive, and decisions are made on a case-by-case basis, considering the unique circumstances of each company.

"It's not like the signaling risk is a single signal. It's a bunch of mixed signals, and the market is the market, and it's competitive."

This quote clarifies that signaling risk is not a straightforward concept but rather a collection of various signals influenced by the competitive nature of the market.

• The venture capital industry has shifted from a more collaborative approach to a competitive one.
• Historically, venture capitalists would work together, sharing ownership and providing diverse experiences to the benefit of the startup.
• Current market dynamics, including ownership constraints and less equity being sold in rounds, have made collaboration among highly active investors more challenging.

"I actually used to be more collaborative, where the venture community would come together and discuss companies."

This quote reflects on the past collaborative nature of the venture capital industry, which has since evolved into a more competitive environment.

• Venture capital is viewed as a product offered to founders, combining capital, time, effort, brand, and network.
• Ownership matters to venture funds because there are constraints on how many investments an individual partner can actively manage.
• The shift in founders selling less equity has impacted the possibility of having multiple co-leads in investment rounds.

"Venture capital is a product like anything else, that the venture fund is actually selling to the founders."

This quote frames venture capital as a multifaceted product that venture funds market to founders, encompassing various elements beyond just financial investment.

• The venture industry is exploring innovative financial instruments that may offer nondilutive capital solutions.
• Founders currently have more control over the terms of funding rounds due to the abundance of capital and options available.
• The challenge remains in balancing the desire for initial ownership with the evolving dynamics of fundraising rounds and potential new financial solutions.

"I think time will tell. There's a lot of innovation that's taking place in that space."

This quote suggests that the venture capital industry is in a state of flux with respect to financial instruments and that the future will reveal which innovations become successful and widely adopted.

• QED's approach to winning deals historically relied on demonstrating their value through the diligence process, where founders would recognize the quality of their advice and partnership.
• The compressed time frame for diligence in the current market presents challenges for investors who rely on this period to showcase their value to founders.

"The founders would very quickly realize with the questions that we are asking, the way that we are helping them think about their own business during diligence, what it's going to be like working with us, and we would win the deal during diligence."

This quote explains how QED historically won investment deals by impressing founders with their hands-on approach and insightful questions during the diligence process.

• Being a successful venture capitalist requires clarity of thought and consistent decision-making logic.
• The venture capital industry has a significant gap between those who perform the job well and those who do not.
• Frank Rotman believes that his ability to provide clear, logical reasoning behind decisions is one of his superpowers as an investor.

"I think clarity of thinking is one of my superpowers, where if you take any of the businesses that I actually underwrote over the past twelve or 13 years, and there are hundreds of them that I've dug into deeply, and there are probably a"

This incomplete quote suggests that clarity of thought is crucial for making sound investment decisions and providing consistent advice to founders.

• Harry Stebbings discusses the importance of having clarity in decision-making and the ability to recall the rationale for past decisions.
• Clarity allows for the creation of frameworks to guide future decisions.
• Understanding one's own decision-making process is crucial for self-improvement and learning from outcomes.
• Analyzing past decisions helps identify areas of right judgment and mistakes, leading to better risk assessment in future decisions.

"If you gave me a few minutes just to review the last investor deck, I could tell you precisely why I made a yes or a no decision and probably have a 30 to 60 minutes discussion with you on that company."

The quote signifies the speaker's meticulous approach to decision-making, where each decision is well-considered and documented, enabling detailed recall and analysis.

"But without that clarity of thought, it's actually hard to fine tune your own decision making process. So I think it actually starts with knowing why you make every decision that you make."

This quote emphasizes the significance of understanding the 'why' behind each decision to refine and improve one's decision-making skills.

• Frank Rotman identifies patterns in his investment decisions where he was incorrect.
• Survivorship bias is a common issue, where unexpected factors lead to a company's success.
• Venture capital involves dealing with many unknowns, which can result in missed opportunities if the potential is not clear at the outset.
• Frank prefers to invest based on concrete information rather than betting on a team and market size alone.

"So there are some commonalities. One is there is a survivor's bias issue in venture capital..."

The quote points out the tendency to overlook the unpredictable elements that contribute to a company's success, which can lead to incorrect assumptions during the investment process.

"So those are businesses that, for someone like myself, are very difficult to underwrite, because I try to underwrite based on the information that I have available to me."

Frank Rotman explains his investment strategy, which relies on available information rather than speculation, making it challenging to invest in companies with uncertain futures.

• Harry Stebbings questions whether the approach to investment differs between early-stage and growth stages.
• Frank Rotman clarifies that the distinction is not about the stage but about the method of gaining conviction in an investment.
• Frank requires a deep understanding of the industry and the problem the business is addressing, which influences his investment decisions.

"It's not early in growth. I think it is a way of approaching diligence and conviction."

The quote illustrates that the approach to investment is not necessarily tied to the company's stage but to the investor's personal method of establishing confidence in the potential of the business.

• Frank Rotman reflects on how his investing style has evolved over time.
• Initially, he focused on niches within banking and financial services, leveraging his industry experience.
• The growth of fintech has expanded the scope of opportunities and changed the landscape of potential investments.
• Frank's style has adapted to the evolving industry, allowing for new strategies and considerations in investments.

"There is an appreciation for the art of the possible that just was not there when we first started."

The quote acknowledges a shift in perspective towards the potential of fintech, which was not initially apparent but has become clear over time.

"So I think my investing style has changed just by seeing what's possible and understanding it and then having a new playbook to work with the V 20 and v 30 companies..."

Frank Rotman explains that his investment approach has adapted based on the advancements and achievements in the fintech sector, which have provided new insights and strategies for investing.

• Harry Stebbings discusses the perception of a fintech bubble and the potential for a new wave of acquisitions by incumbents.
• Frank Rotman expresses optimism for the future of fintech, citing the development of foundational elements that enable tackling more complex banking issues.
• The evolution of fintech from V10 (user experience and APIs) to V20/V30 (fundamental banking products) suggests significant growth potential.

"So I'm actually more bullish on the next ten years than I have been on the last ten years."

The quote conveys Frank Rotman's positive outlook on the fintech industry's future, anticipating greater advancements and opportunities than in the previous decade.

"I actually think we're going to see bigger companies built in this next wave than you saw in the first wave."

Frank Rotman predicts that the next wave of fintech will result in the creation of larger companies due to the industry's maturity and the availability of new building blocks for innovation.

• Harry Stebbings transitions to a quickfire round, prompting Frank Rotman to provide immediate responses to various questions.
• Topics include favorite books/authors, the dynamic between Frank and his business partner Nigel, respected firms in fintech, and recent investments.
• Frank's responses offer insights into his personal preferences, working relationships, and views on the venture capital industry.

"So, Tom Robbins, I just think he's a lot of fun. And if you ever want to take your mind into a completely different realm, just read some."

Frank Rotman shares his admiration for author Tom Robbins, suggesting that his works are an enjoyable escape.

"I feel like I'm going to betray some of my favorite people by picking a favorite. So I will say there are many, many firms that I respect the people at."

The quote reveals Frank Rotman's reluctance to single out one firm for respect in the fintech space, indicating his admiration for multiple firms and their contributions.

"The mission of the company is really about helping overlooked small business owners get access to the resources and kink the curve on the outcomes of their small businesses."

Frank Rotman explains his recent investment in Hello Alice, highlighting the company's mission to support small business owners as a key factor in his decision to invest.