20VC Semil Shah on Why The Most Important Thing An Investor Can Do Is Attract Follow On & The Fundamentals of VC Branding

In this episode of "20 minutes vc," host Harry Stebbings interviews Semil Shah, founder of Haystack, an early-stage investment firm with successful investments like Instacart and DoorDash. Shah shares his journey from industry consultant to establishing his own fund, Haystack, after realizing traditional hiring paths in VC firms wouldn't work for him. He discusses the challenges of fundraising, particularly for smaller funds, and emphasizes the importance of social proof and building relationships with potential investors. Shah also speaks on the significance of branding in venture capital for both attracting deals and follow-on capital, while touching on his selective investment strategy and the transition from seed to Series A funding. The conversation highlights Shah's straightforward, relationship-focused approach to investing and his vision for Haystack's future.

• Semil Shah is the founder of Haystack, an early-stage investment firm.
• Haystack is currently investing out of its third fund.
• Prior investments include notable companies like Instacart and DoorDash.
• Semil Shah has consulted for top Silicon Valley funds such as Kleiner Perkins, DFJ, and General Catalyst.
• He has contributed to TechCrunch and Harvard Business Review.
• Mark Andreessen recognizes Shah as one of the unknown rock stars in tech.

"Semil is the founder at Haystack, an early stage investment firm now investing out of its third fund with previous investments, including Instacart DoorDash, managed by Q and many more fantastic companies."

This quote outlines Semil Shah's role as the founder of Haystack and mentions some of the successful companies Haystack has invested in.

• Semil Shah's connections with venture capitalists on Sandhill Road were due to his writings.
• He initially worked as a consultant to various firms.
• Shah started his own fund after realizing he wouldn't be hired by the firms he consulted.
• The motivation to start Haystack came from friends who emphasized the need to prove he could generate and select sustainable deal flow.

"I sort of had no choice but to start my own fund."

Semil Shah explains that starting Haystack was not a choice but a necessity due to his career circumstances and the industry's perception of his abilities.

• Shah did not perceive starting a fund as a momentous challenge due to lack of alternatives.
• Concerns for a new fund manager include acquiring social proof and asking for investments, often from personal connections.
• The difficulty of raising a smaller fund is compounded by the personal nature of the investments.

"I really had no other option. I just either could do that or do nothing."

This quote reflects Shah's mindset when starting Haystack, highlighting that for him, creating the fund was the only viable path forward.

• Shah aimed to raise $5 million for Haystack but only managed to raise $1 million.
• His strategy involved making numerous small investments without follow-on funding.
• Lack of understanding of the fund model and reserves initially led to challenges in fundraising.

"Haystack one, I tried to raise five and I could only raise one."

Semil Shah shares the initial fundraising goal for Haystack and the shortfall he experienced, indicating the challenges of raising capital for a new fund.

• Shah has consistently failed to meet his fundraising targets for all his funds.
• He now recognizes the strategy of aiming high to achieve a lower, yet substantial, result.
• Raising smaller funds is difficult due to investors' preference for larger investments and not wanting to exceed a certain percentage of the fund.

"I've been unsuccessful in raising my target for every fund."

This quote shows the consistent challenge Shah faced in meeting fundraising targets, which is a common issue for fund managers of smaller funds.

• Investors often have minimum check sizes that do not align with smaller funds.
• Sophisticated investors typically do not want to exceed 10% of a fund's total capital.
• These constraints shape the dynamics of how much investors are willing to contribute to a fund.

"Most of the people that have capital, it's not really in their interest to write checks that are smaller than $5 million, so to speak, give or take."

Semil Shah explains the preferences of investors, which influence the fundraising process and the challenges of securing capital for smaller funds.

• Fund managers face different challenges at various stages of their fund's life cycle.
• First-time fund managers often struggle due to a lack of experience and established relationships with limited partners (LPs).
• In the initial fund, the key is to secure investments from individuals who have known the manager for a while.
• High net worth individuals in Silicon Valley often invest in the early stages out of a "pay it forward" mentality.
• The second fund's challenge involves attempting to engage with institutions, but often the fund is still too small to be of interest.
• By the third fund, a common feedback is the oversaturation of small funds in the market, leading to confusion and difficulty in differentiation.
• Semil Shah's model of investing in a larger number of companies than others is purposeful but can be seen as unconventional.

"I would say in the first one, you have to get people that have known you for a while, and I didn't know real lps, so you have to go to other people." This quote highlights the importance of leveraging personal relationships for initial fundraising efforts when formal LPs are not within the manager's network.

"80% of it was just, there's too many small funds, and so people get confused." This quote reflects the feedback received by Semil Shah that the abundance of small funds makes it challenging for LPs to differentiate and choose where to invest.

"My model is a little bit different in that I invest a little bit more in terms of number of companies than other people." Semil Shah explains that his investment strategy involves a larger portfolio of companies, which is a deliberate choice but differs from traditional venture capital approaches.

• There is skepticism about the efficacy of investing small amounts in a large number of companies.
• Concerns include insufficient ownership for significant returns, inability to follow on investments, and lack of time to build relationships with companies.
• A diversified portfolio approach may dilute the brand signal for downstream funding.
• Traditional LPs may prefer selective investment strategies, but Semil Shah believes the current market conditions justify his broader approach.
• The success of models like AngelList, Y Combinator, and First Round Capital demonstrates the viability of less traditional, more expansive portfolios.

"You won't own enough, or you won't be able to follow on enough to own enough." This quote addresses the financial concern that having small stakes in many companies may not lead to significant returns.

"The brand signal for downstream funding is a little bit more diluted because you have too many companies." Here, Semil Shah acknowledges that a large portfolio can weaken the perceived value of the investment brand in future funding rounds.

"I think you have an explosion of teams forming now, an explosion of markets opening, and it's very unclear early what's going to work." Semil Shah justifies his investment strategy by pointing out the rapid formation of new teams and markets, which makes it difficult to predict success early on.

• Semil Shah would still opt for a hybrid approach, combining a personal capital pool with ad hoc deals.
• AngelList syndicates are used selectively, respecting entrepreneurs' preferences for privacy or publicity.
• Some entrepreneurs may be hesitant about AngelList due to positioning issues or concerns about information sharing.
• There is a distinction between public ad hoc investments and more private pre-funded deals.

"I think I would probably do it like I'm doing now, which is have a hybrid, like I want my own pool of capital to drill down." Semil Shah expresses a preference for maintaining a personal capital pool while also engaging in ad hoc investments, providing flexibility in his approach.

"Sometimes entrepreneurs, for whatever reason right now, don't want, even in a private syndicate to be on there." This quote acknowledges that some entrepreneurs may have reservations about participating in AngelList syndicates, possibly due to privacy concerns.

"It's more just a positioning issue for AngelList right now, which I know that they're working through." Semil Shah suggests that AngelList has some challenges with its market positioning that are being addressed, affecting entrepreneurs' willingness to use the platform.

• Identifying teams capable of reaching Series A is a priority.
• Some teams progress independently, while others require guidance.
• The transition from seed to Series A funding can shift from a market-based game to one based on relationships.
• Semil Shah focuses on coaching founders to build organic, long-term relationships with potential investors.
• Not all founders are willing or able to invest in relationship building.

"I'm trying to identify teams and people that I think can make it to series A." Semil Shah's process involves assessing teams for their potential to advance to the next funding stage.

"It's the folks in the middle that I spend the most time on." He spends the most effort on teams that are neither failing nor rapidly succeeding but are in a position where strategic guidance can make a difference.

"A lot of it is trying to coach that behavior into founders." This quote reflects Semil Shah's role in mentoring founders on the importance of relationship building for fundraising success.

• Relationship building is not considered a strategy but rather a natural, social aspect of the investment process.
• Semil Shah maintains a tight network and focuses on organic interactions with fellow investors for co-investment opportunities.

"I think of it as just, it's all very social." This quote emphasizes that relationship building in the investment community is a social activity rather than a calculated strategy.

• Venture capital is not a zero-sum game, especially in seed investing.
• Seed investors often share opportunities with a network of other investors.
• Series A and B investing is more competitive, with funds seeking maximum ownership.

of about 80 seed investors, angels that I know, larger vcs and kind of executives at companies that I've all invested with in some way or worked with in some way. And if there's ever room in any of the companies that I'm investing in, I just share it with them. No fancy stuff. I just make the introduction. If they want it, I just view it as like, it's not a zero sum game like venture capital. Series A and B. Investing is those funds cannot afford to share deals. It cannot afford to not get as much ownership as possible.

This quote explains the collaborative nature of seed investing, contrasting it with the more competitive stages of Series A and B investing, where funds are less likely to share deals due to the desire for significant ownership stakes.

• Successful transition from seed to Series A involves either significant traction or strong investor relationships.
• Companies that fail to transition either lack the necessary qualities or mishandle investor relationships and feedback.
• Market choice is crucial; a poor market choice can lead to failure.

Yeah. So the companies that do either fit one of two characteristics. One is that they're off to the races and people are dying to invest in them because of the quality of the team or the opportunity or the market. The second category, the one that I explain I spend the most time on, is that they have built a relationship with a set of investors that have been able to track them over a few months and understand what they're doing and understand what the team is and be willing to still buy the dream at series A because they've had the time, energy and space to gain conviction in what folks are doing.

Semil Shah discusses the two main characteristics of companies that successfully make the leap to Series A: either they have strong traction and desirability or they have cultivated meaningful relationships with investors who believe in their vision.

• Brand building is crucial for differentiation in a crowded venture capital market.
• A strong brand acts as a mental shortcut for entrepreneurs when choosing investors.
• Authenticity in branding is important; it must reflect genuine interactions and value.

I mean, I think branding is like one of the three or four most critical things an investor has to have. It doesn't need to be known wide and far, but it needs to be there. And the reason is that with so many options for people selling the same product, meaning venture money, entrepreneurs who have a choice need to pick on based on a choice. And when there's a lot of noise in an environment, the best line I've ever heard about what defines a brand is that it's a shortcut for the brain.

Semil Shah emphasizes the importance of branding for venture capitalists. A strong brand helps entrepreneurs make quick decisions in a crowded market, acting as a mental shortcut amidst the noise.

• Attracting follow-on capital is a significant aspect of a venture capitalist's role.
• Branding and reputation can aid in securing additional investment for portfolio companies.

probably the most important thing any investor can do is attract follow on capital for their investments.

Semil Shah asserts that attracting follow-on capital is one of the most important tasks for an investor, implying that it is a key part of adding value to portfolio companies.

• Founder friendliness is often misunderstood as avoiding conflict to maintain deal flow.
• True founder friendliness involves honesty and setting realistic expectations, even if it's tough.
• Consistency in communication and separating personal feelings from business assessments are key.

That people think founder friendly is like, they walk on eggshells around other people so that they don't piss somebody off, even the founder. They're so nervous about losing deal flow or getting a negative review that they're just going to be nice all the time. I'm perfectly nice, but I'm just not going to lie to people.

Semil Shah challenges the conventional notion of being "founder friendly," suggesting that it's more about being honest and straightforward rather than constantly agreeable or fearful of losing potential deals.

• Bot mania is considered by some to be an inflated hype, but also has legitimate excitement due to the scale of mobile messaging apps.
• Messaging platforms like Slack and Messenger are crucial as they are how billions access the internet and communicate.
• The vast user engagement in these platforms justifies the attention bots are receiving.

I mean, there's definitely an inflation to it because everyone is chattering in real time online. I think it's legitimate, too, because if you think about pure size and engagement around mobile messaging apps, even including Slack, that are cross platform and messenger this is how billions of people will access the Internet and communicate.

The quote explains the dual nature of bot mania, recognizing both the hype and the legitimate potential due to the extensive use of messaging apps as a primary means of internet access and communication.

• "Burmese Days" by George Orwell is Semil Shah's favorite book.
• He appreciates historical fiction and considers Orwell a brilliant writer.
• Orwell's personal history with India and Burma enriches the narrative of the book.

Oh, burmese days. Burmese days by George Orwell. I like historical fiction. I think George Orwell is a brilliant writer. And then he grew up in India, where I think his father's uncle was part of the british army there. And he kind of wrote about his days going back and forth between Burma and India.

This quote shares Semil Shah's preference for historical fiction and his admiration for George Orwell's writing, influenced by Orwell's familial connections to India and Burma.

• Bill Gurley's blog posts are considered highly valuable for their signal versus output pace.
• Gurley's ability to weave together known and unknown elements is thought-provoking.

Yeah, I'd have to say Bill Gurley's post, the most interesting to me in terms of signal versus the pace of the output. He's able to thread together things that are known and unknown in a way that makes you really think.

Semil Shah expresses his preference for Bill Gurley's posts, highlighting the quality of the insights and the thoughtful analysis that Gurley provides.

• Semil Shah's vision for Haystack in five years is to continue investing in companies.
• The primary goal is the survival and persistence of the investment firm.

I would like to still be investing in companies. My vision is survival.

The quote succinctly states Semil Shah's long-term vision for Haystack, emphasizing the importance of sustaining the company's investment activities.

• Meetings with various venture capitalists (VCs) on Sandhill provide valuable learning experiences.
• Semil Shah respects the privacy of the individuals he meets, indicating the specific identities are not as important as the wisdom shared.

I tend to meet with lots of vcs all the time... And I learn from those conversations, which is just amazing.

This quote reflects the value Semil Shah places on the knowledge gained from interactions with other VCs, suggesting that the learning experience is more important than the names of the individuals involved.

• Semil Shah admires several VCs, including Chris Sacca, Josh Kopelman, Paul Graham, Naval Ravikant, and the founders of Benchmark.
• He respects them for their unique contributions to the venture capital industry and their impressive investment track records.

What Chris, I mean, I want to probably give a longer list. So Chris Socka did from investing early, basically going in with conviction and creating more vehicles to invest, and now managing billions of dollars, even though he keeps a small early fund, is basically unbelievable.

The quote highlights Chris Sacca as an example of a VC who has made significant contributions to the field, admiring his early investments, conviction, and the scale of his success.

• Aquacloud is a company focused on water management through a distributed sensor network.
• Semil Shah invested in Aquacloud because of its business model and potential impact on water quality crises, like the one in Flint, Michigan.

I invested in a company called Aquacloud... they wouldn't have had this crisis, they would have been able to detect it.

This quote explains the rationale behind Semil Shah's investment in Aquacloud, indicating his belief in the company's ability to prevent water quality issues.

• Harry Stebbings thanks Semil Shah for his participation in the podcast.
• Michelle Tandler at Trinity is acknowledged for making the introduction to Semil Shah.
• Listeners are encouraged to follow Harry on Snapchat and sign up for the newsletter for updates.

What a fantastic and different episode that was with Semil. And again, a huge thank you to him for giving up the time today to appear on the show.

Harry Stebbings expresses gratitude to Semil Shah for joining the podcast and contributing to a unique episode.