20VC Michael Dearing on 5 Key Principles He Uses To Assess Startup Founders, Why Benevolent Dictatorship Is A Beautiful Thing & Why Markets Are Better Capital Allocators Than CEOs



In this episode of the 20 minutes VC, host Harry Stebbings interviews venture capital icon Michael Dearing, founder of Harrison Metal. Dearing shares his journey from eBay to VC, emphasizing the importance of personal exceptionalism in founders, which he distinguishes from arrogance. He discusses the balance founders must strike between vision and adaptability, and how his management philosophy, inspired by Daniel McCallum, focuses on alignment, responsibility, measurement, correction, and humanity. Dearing also touches on market pricing discipline, reserve allocation strategies, and the pitfalls of convertible debt. He highlights the significance of general management in startups, suggesting that timing issues often boil down to management challenges. Lastly, Dearing introduces Astro, a productivity tool that leverages AI and voice for work efficiency, underscoring his investment approach which prioritizes picking exceptional teams and products.

Summary Notes

Introduction to Michael Dearing and Harrison Metal

  • Michael Dearing founded Harrison Metal in 2006 and has invested in successful companies such as Twitter, Mopub, Birchbox, 99 designs, and PagerDuty.
  • He has a diverse background with experience at eBay, Shoe Warehouse, The Walt Disney Company, and Bain & Company.
  • Michael is highly respected and recommended by previous guests on the 20 minutes VC podcast.

"Michael's established himself as an icon of early stage venture over the last decade. With his founding of Harrison Metal in 2006. He's backed the likes of Twitter, Mopub, Birchbox 99 designs and page of duty, just to name a few of his incredible companies."

The quote highlights Michael Dearing's significant impact on the venture capital industry, particularly in early-stage ventures, through his company Harrison Metal.

Michael Dearing's Transition to Venture Capital

  • Michael Dearing joined venture capital after leaving eBay, where he worked for about seven years.
  • Initially, he planned to work inside a small company but ended up engaging with several early-stage companies.
  • His investment in these companies evolved into a portfolio, which led to full-time venture capital involvement.
  • Jim Getz from Sequoia Capital influenced his realization that he could pursue venture capital professionally.

"I realized I was having the most fun of my career. I was also doing some really fun work with terrific people. And so I realized that this was actually a portfolio."

This quote reflects Michael Dearing's unexpected but fulfilling journey into venture capital, where he discovered his passion and talent for the industry.

The Institutionalization of Harrison Metal

  • The shift from personal investment to institutional funding was driven by a desire to support companies over the long term and take on a leadership role.
  • Raising outside capital allowed Michael to have reserves for follow-on investments and to lead with term sheets.

"The main reason why I raised money from outside parties was because I wanted to be part of the longer journey with these companies."

The quote explains Michael Dearing's rationale for institutionalizing Harrison Metal, emphasizing the importance of being involved in the companies' growth and governance.

Founders and Personal Exceptionalism

  • Michael Dearing looks for founders who have transcended the bounds of their circumstances through risk-taking and unique experiences.
  • Personal exceptionalism is independent of educational or professional pedigree.
  • The distinction between personal exceptionalism and arrogance is crucial; exceptional founders are often self-critical, while arrogance can be identified through negative social behaviors.

"Personal exceptionalism just means that they see themselves as special and that their outcomes are going to be outside the bounds of normal."

The quote defines personal exceptionalism as a founder's belief in their unique potential and ability to achieve extraordinary results, separate from arrogance or entitlement.

Personal Exceptionalism vs. Arrogance

  • Michael Dearing discusses the importance of backing founders with a sense of personal exceptionalism, as opposed to those who are arrogant.
  • Personal exceptionalism is preferred because it implies a belief in one's own ability to succeed, whereas arrogance is seen as a negative trait that is not desirable in founders.

"ho have that personal exceptionalism sense, not necessarily the people who are arrogant. I don't want to back the latter, absolutely."

The quote emphasizes Michael's preference for investing in founders who possess a strong belief in their own capabilities without crossing into arrogance. This distinction is crucial for him in choosing who to support.

Balancing Vision and Stubbornness

  • The balance between a founder's vision and the potential stubbornness to persist with a failing strategy is a key consideration.
  • Michael values founders who can balance their gut instincts with market discipline and are willing to reevaluate their initial instincts.

"The think, you know, everybody walks around with these sort of... I'm a big fan of Daniel Kahneman and Amos Tversky... they're willing to reevaluate their gut, and they're willing to subject their gut to market forces and market discipline."

Michael references the dual-process theory of Kahneman and Tversky to illustrate how he looks for founders who not only trust their instincts but are also prepared to critically reassess them in light of market feedback.

Indicators of Founder Agility

  • Michael looks for tangible indicators of a founder's ability to iterate and adapt quickly.
  • He measures this by the speed of prototyping, frequency of software releases, and the rapid transition from discussion to action.

"The practical measure of that is, how fast do they release prototypes? How many days a week do they push new software to production?"

This quote highlights specific, observable behaviors that Michael uses to determine a founder's agility and responsiveness to change, which are critical in the fast-paced tech industry.

Assessing the Management Team

  • Michael Dearing uses a five-part checklist, inspired by 19th-century executive Daniel McCallum, to assess the quality of a management team.
  • The checklist includes ensuring alignment behind the right projects, appropriate allocation of responsibility and authority, measuring progress, making corrections, and treating people with humanity and respect.

"So that very simple five part checklist is exactly what I use today when I diagnose and try to coach and help these companies that I work with."

Michael explains how the timeless principles from McCallum's treatise on general management still apply today and form the basis of his approach to evaluating and advising management teams.

Separating the Great from the Good

  • Michael believes that the truly great management teams not only possess personal exceptionalism but also demonstrate high velocity in iterating their business aspects.
  • The five-part checklist from Daniel McCallum is also a marker of exceptional general management, which is rare and thus highly valued.

"They are in the 99th percentile of general managers on earth... it's that easy to be exceptional."

The quote underscores Michael's view that exceptional general management is uncommon, yet the criteria for excellence are straightforward and achievable, as exemplified by McCallum's checklist.

The Role of Timing in Startup Success

  • Michael acknowledges that timing can be a significant factor in a startup's success but ultimately sees it as a general management challenge.
  • He believes that general management involves adapting to timing issues, either by influencing external conditions or pacing product development to market readiness.

"I would say, though, that if you start with the premise that timing is always slightly wrong... it becomes a general management problem to figure out how to either accelerate the external conditions... or pace your product investment so that you don't run out of money."

Michael's perspective is that while timing is important, the key to overcoming timing challenges lies in strategic general management decisions.

Price Sensitivity in Investment Decisions

  • Michael Dearing discusses the concept of price sensitivity when considering investments.
  • He believes that while price is an important factor, it must be weighed against conviction in the business and the team.

"And so the way I think about it is I try to stay away, put it mildly, stay away from situations where pricing expectations are totally out of whack with the opportunity and the team's level of progress so far."

This quote indicates Michael's approach to investment decisions, where he avoids overpriced opportunities and instead seeks a balance between the risk and the progress of the team and opportunity.

Valuation and Market Dynamics

  • Valuation of companies is influenced by the progress they've made, the potential outcomes, ownership percentages, and the appropriate check size for investment.
  • Honest conversations with the team about the evolution of thinking around valuation points are important.
  • Strong conviction and evidence of progress justify paying a higher price for certain companies.

"If what Peter means is that pricing is one consideration, and for those companies that you have strong conviction and you have evidence of terrific progress, you should be willing to pay up for those."

This quote emphasizes that pricing should be one of several factors considered in valuation, and that it can be appropriate to pay a premium for companies with strong evidence of progress and high potential.

Seed Investing and Market Evolution

  • The market for seed capital has grown significantly from a decade ago.
  • There are now hundreds of firms and thousands of individual angels participating in seed investing.
  • Equity investments are generally priced reasonably with consideration of company progress and potential.
  • Convertible debt markets are seen as undisciplined, influenced by an abundance of capital and a 'tulip auction vibe' from demo days.

"Today, it's completely exploded, and there are hundreds of firms that are organized just like mine. And forget about the thousands of individual angels who are chasing convertible debt deals or these so-called safe notes."

Michael Dearing describes the dramatic expansion of the seed investing market, highlighting the proliferation of firms and individual investors chasing investment opportunities, particularly in convertible debt.

Reserve Allocation Strategy

  • Reserve allocation is challenging due to the need to make assumptions about company mortality rates, premature exits, and future market conditions.
  • Initially, a 1:1 ratio of reserve to primary investment was used, but this has varied over time.
  • Reserves are now allocated unequally and decided upon separately from initial investment decisions.
  • The reserve strategy involves treating each backing decision as a fresh investment decision based on current opportunity.

"Reserves was the big unknown to me, because you have to make a range of assumptions. [...] Now, that reserve account is allocated very unequally. So we don't park the money in the name of that company. We park the money in the name of general reserves."

Michael Dearing explains the complexity of reserve allocation and his approach to managing reserves, highlighting the importance of flexibility and treating each investment as a new decision.

Signaling Function of Investment

  • It's not necessary to always allocate reserves to the same companies initially invested in.
  • Transparent communication with founders about limited resources and decision-making is key.
  • Decisions are made based on the highest and best use of funds at the time.
  • Reserve strategy is treated like a fresh backing decision, with rare complete pullouts usually due to values violations.

"No, and I really straightforward with the founders about that. I mean, I have reserves. They also understand that I don't have unlimited resources."

Michael Dearing discusses the importance of being transparent with founders about reserve allocation and the decision-making process, emphasizing the strategic considerations involved.

Recycling Capital and Fund Strategy

  • Recycling capital is not a core part of the strategy for Harrison Metal.
  • The primary focus is on initial investment picking, which drives the majority of outcomes.
  • Liquidity is returned to investors as quickly as possible to support their missions, such as universities, museums, and foundations.

"I just sort of have an operating principle that I want that liquidity back in their hands as quickly as possible."

Michael Dearing expresses his philosophy on managing fund liquidity, prioritizing the quick return of capital to investors for their respective missions.

Personal Insights and Experiences

  • Michael Dearing's favorite book is "A Confederacy of Dunces" by John Kennedy Toole, which he finds incredibly funny.
  • A personal transformational experience involved leaving a corporate job to start a business, which ultimately failed, leading to financial hardship and a pivot to selling on eBay.

"Oh, confederacy of dunces. John Kennedy Toole wrote this book about these wacky, wacky figures in New Orleans."

This quote reveals Michael Dearing's appreciation for literature and provides insight into his personal interests outside of investing.

"The transformation for me came when I was out of money personally, and I needed to raise cash as much as possible and for the business to pay back our creditors."

Michael Dearing shares a personal story of transformation and resilience, highlighting the challenges and learnings from entrepreneurial failure.

Early Experience with eBay

  • Michael Dearing sold items on eBay in 1999 and received constructive feedback from customers.
  • He learned from strangers online how to improve his eBay listings.
  • This learning experience led to a job at eBay and was a pivotal moment in his career.

"I didn't know what I was doing, but I sold some stuff and strangers paid me. And a couple of those people who bought from me said, your listings would be better if you had pictures."

This quote highlights the initial lack of expertise Michael had when starting on eBay and how customer feedback was instrumental in his improvement.

Belief in People's Goodness

  • Michael Dearing holds the belief that people are fundamentally good.
  • He suggests that with the right incentives, people can self-govern effectively.

"I think that most people are basically good. And I believe that if you leave people alone and you give them the right incentives, they can self govern."

This quote encapsulates Michael's philosophy regarding human nature and governance, emphasizing the importance of incentives and autonomy.

Markets as Capital Allocators

  • Michael Dearing favors markets over CEOs for capital allocation due to market pricing systems.
  • He points out the inefficiency of internal capital allocation in companies, where true opportunity costs are not always considered.
  • Markets provide clear pricing signals that guide smarter purchasing decisions.

"Oh, mostly because of the pricing system that's inherent in the market."

This quote serves to explain why Michael believes markets are superior to CEOs in capital allocation, emphasizing the role of pricing systems.

Adam Smith's Invisible Hand

  • Michael Dearing is an admirer of Adam Smith's concept of the invisible hand.
  • He had a revelatory moment in college when he discovered that his personal beliefs aligned with Adam Smith's ideas.

"It was a big moment for me in college when I read that, and I realized that some of these wacky ideas that I believed personally were actually beforehand, yeah."

This quote reveals the personal impact of Adam Smith's economic theory on Michael, highlighting a moment of intellectual validation and connection.

Economic History and Twitter Interactions

  • Michael Dearing enjoys reading economic history and follows economic historians on Twitter.
  • He engages with Anton Howes, an economic historian, who conducts a daily invention quiz related to the industrial revolution.

"I read a lot of economic history, and so I follow this gaggle of economic historians on Twitter."

This quote shows Michael's interest in economic history and his method of engaging with the subject through social media interactions.

The Role of Founders and CEOs

  • Michael Dearing describes the ideal role of founders and CEOs as "benevolent dictators" in product roadmap decisions.
  • He emphasizes the importance of listening and then making judgment calls, rather than relying solely on data analytics or A/B testing.

"The benevolent dictator in product roadmap decisions to me is a very listening, focused executive."

This quote provides insight into Michael's view on leadership and decision-making in product development, advocating for a balance between listening and decisive action.

Investment in Astro

  • Michael Dearing recently invested in Astro, a company that aims to simplify work through AI and voice technology.
  • Astro's new feature allows voice-powered email across different platforms, which Michael finds particularly promising.

"Astro is basically saying, look, there is a whole bunch of work that we do in our daily lives, and that work can be made much simpler."

This quote explains the rationale behind Michael's investment in Astro, highlighting the potential of AI and voice technology to improve productivity.

Personal Endorsement for Astro

  • Harry Stebbings personally recommends Astro as a useful tool for voice-enabled email management.
  • He expresses gratitude to Michael Dearing for his insights and participation in the podcast.

"But I do want to give a personal recommendation for Astro, not an ad, but it really is a must use tool for me and one on the desktop homepage for me on my phone."

Harry's quote serves as a personal endorsement of Astro, indicating its value and utility in his own workflow.

Promotion of Lattice and Recurli

  • Lattice is presented as a top performance management solution for growing companies, facilitating various HR functions.
  • Recurli is recommended for its subscription management platform, which aids in increasing revenue and reducing churn.

"With Lattice, it's easy to launch 360 performance review cycles as often as you want, and you also get an incredible continuous feedback system with OKR goal tracking, real time feedback, and one on one meetings to ensure employees get feedback between reviews."

The quote highlights the benefits of using Lattice for performance management within organizations, emphasizing its comprehensive features.

"And they have the ability to not only increase revenue by 7%, but also reducing the all important churn rate."

This quote focuses on the advantages of using Recurli, specifically its impact on revenue and customer retention.

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