20VC Initialized's Garry Tan on The Most Important Thing A Seed Investor Can Do For Founders, How Ownership Requirements Change With Evolution of Funds & Why There Is Not Too Much Capital Chasing Too Few Deals



In the latest episode of "20 minutes VC," host Harry Stebbings interviews Gary Tan, co-founder and managing partner at Initialized Capital, a prominent early-stage venture fund. Tan, a former partner at Y Combinator and co-founder of the YC-backed Posturus, shares insights from his extensive experience in venture capital and startup advising. The conversation delves into the nuances of building relationships with founders, the importance of supporting them through moments of doubt, and the strategies for transitioning from angel to VC investing. Tan highlights the significance of trust and human connections in venture capital, emphasizing that contrary to popular belief, there is no shortage of good ideas or capital; the challenge lies in connecting them effectively. Initialized Capital's approach to investing, ownership targets, and price sensitivity are also discussed, underscoring the importance of discipline and a supportive decision-making process within the firm.

Summary Notes

Introduction to the Podcast Episode

  • Harry Stebbings introduces the episode of "20 minutes VC," highlighting his new segment "a day in the life of VC."
  • He expresses his excitement for building relationships with inspiring individuals through the show.
  • Harry welcomes back Gary Tan, co-founder and managing partner at Initialized Capital.
  • Gary's background includes being a partner at Y Combinator, co-founding Posterus (acquired by Twitter), and being an early employee at Palantir.
  • Harry thanks various individuals for contributing questions and suggestions for the episode.

"And starting today, I will be doing a day in the life of VC. So that should be fun and very interesting. But to our episode today and the biggest joy for me of doing the show is always building relationships and friendships with just incredible and inspiring people."

This quote explains Harry's enthusiasm for his podcast, particularly the aspect of connecting with remarkable individuals, and introduces a new segment that will provide insights into the life of a venture capitalist.

  • Harry discusses Brex, a corporate card for startups, offering high limits and no founder liability.
  • He mentions Stripe as a valuable resource for startup founders, providing guides and insights on scaling technology companies.
  • Terminal is introduced as a solution for building skilled remote engineering teams, offering comprehensive support for managing logistics, benefits, and legal aspects.

"Brex founders Enrique and Pedro built a payments business in Brazil, but found themselves rejected for a corporate card when they were in Y Combinator. They decided to build Brex with instant online sign up, no founder liability required, and limits ten to 20 times higher than standard cards."

This quote describes the origin of Brex, emphasizing its benefits for startups, and serves as an example of how entrepreneurs can solve problems they encounter by creating new solutions.

Gary Tan's Journey into Venture Capital

  • Gary started as an engineer and had no initial intention of entering venture capital.
  • He realized the abundance of capital and the numerous problems needing solutions, which drew him into venture.
  • Gary sees his role as helping other builders and bridging the gap between capital and innovation.

"What I realized is it's kind of a common story. A lot of people have no intention of ever actually coming into venture capital. And then as you discover how much capital there is actually in the world and how many problems there are out there, then venture sort of sucks you in."

Gary shares his personal experience of how he was drawn into venture capital, highlighting a common narrative among VCs who start in different fields but find their way into the industry due to its potential to address global challenges.

Unbundling of Venture Capital

  • Gary discusses his early days at Y Combinator as a designer in residence.
  • He describes the unbundling of VC, where he started by helping startups with design before transitioning into taking advisor shares.
  • The conversation touches on the evolution of VC and how Gary was moved from an unbundled to a bundled situation in venture capital.

"And along the way, that was winter 2011. That was the batch that Yuri Milner and SV angel came along and said, we're going to give everyone $150,000 to every single company in that batch."

Gary recounts a pivotal moment in his career when significant capital was injected into Y Combinator startups, marking the beginning of his deeper involvement in venture capital.

Transition from Angel Investor to VC

  • Gary reflects on the transition to managing institutional capital and the challenges it brings.
  • He emphasizes the importance of a multidisciplinary approach to help startups reach their Series A funding.
  • The conversation covers the need for expertise in various areas such as marketing, branding, PR, design, engineering, and AI/ML.

"And the economics, the way people make decisions all of those things are all very tightly held because it's such a difficult journey to even be able to deploy that type of capital, be able to raise institutional capital is so rare that people hold it very, very tightly."

This quote highlights the guarded nature of venture capital, as the ability to raise and manage institutional funds is a challenging and rare achievement, influencing how decisions are made within the industry.

Investment Decision Process

  • Initialized Capital has a unique investment decision process that involves five operating partners.
  • Operating partners play a role in weighing in on investment decisions.
  • This approach is an ongoing experiment, believed to be effective due to software integration.

on the investment decision, and then five additional people who are operating partners who actually do also weigh in on the investment decision.

This quote explains the collaborative nature of Initialized Capital's investment decision-making process, highlighting the involvement of operating partners.

VC Operational Involvement

  • Gary Tan discusses the varying degrees of operational involvement by VCs at different stages of a startup.
  • Precede and seed stages focus on foundational questions like what to build.
  • Post-Series A, it shifts towards scaling and organizational care.
  • Operational coaching is most valuable at the early stages.

Well, it's really, to me, kind of a stage thing. The precede and seed level really still is about what should I be building?

Gary Tan emphasizes that the role of VCs at the precede and seed stages is to help founders determine what to build by providing guidance and leveraging experience.

The Softer Side of Precede and Seed Investment

  • Founder support is crucial at the precede and seed stages.
  • Impostor syndrome is common among founders.
  • Early investors can significantly impact by showing belief in founders.

And believing in people before they even truly believe in themselves, that's one of the most powerful things that an early investor can do for their founders.

Gary Tan describes the psychological support that early-stage investors can provide by instilling confidence in founders who may doubt themselves.

Conviction Building in Founders

  • High exposure to founders helped Gary Tan and his partner build a strong network.
  • Initialized Capital's strongest deal flow comes from founders they have previously worked with closely.
  • Maintaining a balance between nurturing existing relationships and cultivating new ones is key to a firm's longevity.

And that point you build this crazy network of thousands of people who you have a relationship with, who you've already helped, who they trust you and you trust them, you've seen them through adversity.

Gary Tan explains how building a network through consistent support of founders leads to trust and strong deal flow.

Fundraising Strategy

  • Initialized Capital advises startups to focus on product development post-funding.
  • Building a relationship with a Series A partner takes time and should not be rushed.
  • Fundraising should be less transactional and more about forming a long-term partnership.

And so what that means is don't do a shotgun wedding. You really can't expect to build a partnership with your series a board member more or less in an abbreviated process of a week or two.

Gary Tan advises against rushing into fundraising and emphasizes the importance of taking the time to build a meaningful relationship with potential investors.

Pre-Product Market Fit vs. Post-Product Market Fit Requirements

  • Pre-product market fit is about starting a business and handling initial challenges.
  • Founders at this stage may only have a demo or no code written.
  • Investors must evaluate founders' abilities and invest based on potential.
  • Post-product market fit involves scaling and refining the business model.
  • Companies may need to shift target markets, such as moving from SMB to enterprise.
  • Venture partners play a crucial role in aiding founders through transitions.

"Pre product market fit is often about just trying to start a fire, period... Post product market fit is, hey, we've actually built this fire." "One of the most common things we see in SaaS these days is that sometimes a company that gets started selling to SMB realizes they need to go upmarket to mid market and enterprise."

The quotes explain the difference between the stages of a startup's development, with the pre-product market fit stage focused on beginning and surviving initial setbacks, and the post-product market fit stage on growth and strategic adjustments.

Evolution of Ownership Requirements

  • Fund size increases necessitate larger ownership stakes.
  • Larger funds mean larger investments, which can lead to founder dilution concerns.
  • The shift from small checks to significant ownership targets can strain relationships with other seed funds.

"We got to 125,000,000... And that meant that we needed to get our ownership targets to five to 10%... We're actually up to a $225,000,000 fund with basically 15% ownership targets."

The quote details the progression of fund sizes and the corresponding need for larger ownership percentages, illustrating the challenges of scaling venture capital investments.

Price Sensitivity in Investments

  • Price sensitivity is about aligning valuation with the company's stage.
  • High valuations raise expectations for future funding rounds.
  • Venture funds must balance the desire for growth with the risks of overvaluation.
  • Disciplined investment strategies are crucial for long-term success.

"Price is actually about trying to match that correct valuation to the stage of that company... More money at a higher valuation sometimes can actually get in the way of that adventure to be able to get to the next stage."

The quote emphasizes the importance of appropriate valuation for sustainable growth and the potential pitfalls of overvaluation.

Discipline in Venture Capital Decision-Making

  • Venture funds operate with a disciplined approach to investment.
  • Internal decision-making processes involve collective input and voting.
  • Controversial investments can yield high returns but require careful consideration.
  • Initialized Capital uses a system of "silver bullets" and requires two strong yes votes for investment decisions.

"It's not one partner setting the price. It's us as a group through a voting process... We want to give people as much agency as possible in getting into a deal, but we don't want to do things that, frankly, are imprudent."

This quote conveys the collaborative nature of Initialized Capital's investment decisions and the balance between individual agency and collective prudence.

Investment Decision Structure at Initialized Capital

  • Initialized Capital employs a unique voting structure for investment decisions.
  • The most controversial investments often perform best due to high conviction.
  • The firm allows general partners to have "silver bullets" for strong personal convictions.
  • A requirement of two strong yes votes ensures high conviction in investments.

"At initialized, all the gps get silver bullets, not unlimited ones, but that's sort of the release valve. And then up the middle, we basically require too strong yes in that process."

The quote describes the internal mechanisms at Initialized Capital that enable both individual conviction and collective agreement in investment decisions.

Attribution in Venture Capital

  • Gary Tan emphasizes the importance of minimizing the negative effects of attribution within venture capital firms.
  • He advocates for a balance between reducing harmful behaviors like deal protection and vote trading, and maintaining some level of attribution to assess performance and encourage improvement.
  • Gary Tan stresses the importance of managing partners having one-on-one conversations to navigate this delicate balance.

"At this point, we really want to reduce the effect of attribution. So I don't want people to basically act as if they have to protect their deal at all cost. And the vote trading and things like that that happen at other partnerships I would be desperate to avoid at initialize."

The quote highlights Gary Tan's desire to steer clear of the negative practices associated with attribution in venture capital, such as protecting deals at all costs or engaging in vote trading, which can be detrimental to the firm's culture and decision-making process.

Influential Books for Venture Capitalists

  • Gary Tan finds "Zero to One" by Peter Thiel to be a profound book that encapsulates contrarian thinking in capital deployment and societal values.
  • He also recommends "Hackers and Painters" by Paul Graham for insights into how the world operates.
  • These books provide a powerful combination of knowledge for understanding successful startup dynamics and the broader technological landscape.

"Zero to One is probably the most interesting book that frankly just crystallizes a lot of the super contrarian thinking that nobody talks about around how to deploy capital and even at a deeper level, what's important in society."

This quote explains why Gary Tan values "Zero to One" so highly—it offers unique perspectives on capital deployment and societal importance that are not commonly discussed, providing valuable insights for venture capitalists and entrepreneurs.

Learnings from Palantir's Culture

  • Gary Tan describes Palantir as a "cult" in a positive sense, where a shared belief in the mission binds the team together.
  • He notes that successful startups often have a contrarian nature, requiring belief in something that most do not.
  • Palantir's mission to provide high-quality software engineering to sectors that lack it, such as government and businesses, was a powerful motivator.

"Palantir at the end of the day was one of the most powerful cults I ever came into contact with. And cult in a good way, in that every startup that I've ever worked with that worked very well, had that sort of atmosphere of, this is something we believe that nobody else believes."

The quote reflects on the strong, mission-driven culture at Palantir, which Gary Tan sees as a hallmark of successful startups—a deep, shared belief in a unique mission that sets them apart from others.

Traits of an Effective Board Member

  • Gary Tan praises Satish Dharmaraj at Redpoint for his technical expertise and hands-on approach as a board member.
  • He highlights the importance of board members understanding the product and how it's built to provide fundamental support to founders.
  • This approach has been a consistent factor in Gary Tan's successful career, and he expresses gratitude for such mentorship.

"Satish Jamaraj at Redpoint was actually our first board member for Posturis. And so my favorite things about him was that he's so technical."

Gary Tan's quote underscores the value he places on having technically knowledgeable board members like Satish Dharmaraj, who can deeply understand and support the startups they are involved with.

Misconceptions About Venture Capital

  • Gary Tan contests the notion that there is an excess of money chasing too few good deals and ideas in venture capital.
  • He argues that there are many talented founders who may not fit the stereotypical mold and that there is a wealth of good ideas and capital available.
  • Gary Tan maintains an optimistic view of technology's role in society, believing that it can solve many problems and improve the world.

"I think there's just infinite ideas, infinite people and infinite capital. And if we can connect all of those things, then we really will live in a better world."

This quote encapsulates Gary Tan's rebuttal to the common misconception in VC that there is a scarcity of good deals and ideas. He believes in the abundance of ideas, talent, and capital, and the potential for positive change when these elements are brought together.

Investment in Cashierless Checkout

  • Initialized recently invested in Standard Cognition, a company offering cashierless checkout technology.
  • Gary Tan is excited about the potential impact on retail, comparing it to Amazon Go.
  • He sees the technology as a way for other retailers to compete with Amazon, equipping them with tools to modernize and streamline the shopping experience.

"We just announced a really big round for standard cognition. And so they are cashierless checkout."

The quote reveals Gary Tan's enthusiasm for Initialized's investment in Standard Cognition, a company that is innovating in the retail space with cashierless checkout technology, which he believes has the potential to transform the industry.

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