20VC The Power Of A Concentrated Seed Portfolio, Why Operational Value Add Models At Seed Do Not Make Sense & Why We Will See A Shakeout Of Growth Stage Investors with Roger Ehrenberg, Founder & Managing Partner @ IA Ventures

In this episode of "20 Minutes VC," host Harry Stebbings interviews Roger Ehrenberg, founder and managing partner of IA Ventures, a leading early-stage fund in New York. Ehrenberg discusses his nontraditional path from Wall Street to venture capital and his focus on a concentrated investment strategy, favoring depth over breadth with a portfolio approach that targets 15-18% ownership in seed rounds. He emphasizes the importance of alignment and clarity with founders on the criteria for Series A success, advocating for a disciplined, process-oriented approach to venture investing. Ehrenberg also shares his skepticism about the effectiveness of broad VC platforms, predicting a future industry barbell with specialized early-stage and growth-stage firms. Additionally, he touches on his recent investment in Octane Lending, highlighting the company's innovative approach to alternative finance and proprietary data in power sports credit scoring.

• Roger Ehrenberg is the founder and managing partner of IA Ventures, a leading early-stage fund based in New York.
• IA Ventures has made investments in companies such as Transferwise and the Trade Desk.
• Before founding IA Ventures, Ehrenberg was an angel investor with over 40 company investments, including Buddy Media and Stocktwits.
• Ehrenberg's background includes serving as president and CEO at DB Advisors, Deutsche Bank's internal hedge fund trading platform.
• The introduction to Roger was facilitated by Rory O'Driscoll at Scale.

"So, joining me in the hot seat, I'm thrilled to welcome Roger Ehrenberg, founder and managing partner at IA Ventures."

This quote introduces Roger Ehrenberg as the guest on the podcast and provides a brief overview of his professional background and current role.

• Roger Ehrenberg's path to venture capital (VC) was nontraditional, with 18 years spent in derivatives and quantitative trading on Wall Street.
• He was unfamiliar with VC until leaving Wall Street in late 2004 and beginning to make seed-stage angel investments.
• Over five years, Ehrenberg invested several million dollars of his own money, leading six rounds, and seeding 40 companies.
• This experience led to the clear vision for the kind of firm he wanted to start, ultimately leading to the creation of IA Ventures.

"It was really only after I decided to leave the street in late four and had started to make some seed stage angel investments in technology companies in New York that I even became aware of and immersed in the venture capital industry."

Ehrenberg discusses his transition from Wall Street to venture capital, highlighting his initial lack of familiarity with the VC industry and his subsequent angel investment activities that led to the founding of IA Ventures.

• Ehrenberg has a deep appreciation for the benefits of diversification, as well as the power of concentration due to his trading background.
• His experience as an angel investor showed that outsized benefits accrued to positions with significant early investments followed by substantial follow-on investments.
• When starting IA Ventures, Ehrenberg believed in a more concentrated strategy rather than the traditional approach of having 40 to 60 portfolio companies.
• The goal was to achieve three to five times net returns for the institutional construct.

"And so what that really led me to believe, when I looked at modeling portfolio construction around the time that I started IA, was that a much more concentrated strategy than a more traditional 40, 50, 60 portfolio constituent approach was what I felt had the best opportunity to generate the three to five x net returns that in the institutional construct I was seeking."

Ehrenberg explains his preference for a concentrated investment strategy over a diversified one, aiming for higher net returns based on his experience and analysis.

• Ehrenberg acknowledges that firms like Excel, Greylock, Kosla, and Kleiner historically have many investments but concentrate capital in a few that drive most returns.
• IA Ventures, being a small firm, takes an artisanal approach to venture investing, with each partner deeply involved in a few companies each year.
• The firm aims to have around 25 portfolio constituents in a given fund, with the expectation that two will drive the majority of the returns.
• This approach has proven successful over IA Ventures' seven-year history and aligns with their capital-efficient approach to VC.

"Our adaptation of that... we're a very small firm taking an artisanal approach to venture investing... by going deep in two to three companies a year... and having that kind of 25 portfolio constituents in a given fund, and that two of those will drive the lion's share of the returns in a given fund."

Ehrenberg discusses IA Ventures' tailored approach to venture investing, emphasizing a more focused and hands-on strategy with a smaller number of portfolio companies.

• IA Ventures aims for 15% to 18% ownership in a company at the seed round.
• The firm may increase its stake in companies that prove their hypotheses and execute their plans well, often buying up in Series A and maintaining pro-rata in Series B.
• The typical goal is to own between 12% and 15% of a company at exit, with some variations depending on circumstances.
• This ownership strategy is designed to generate the alpha required for the fund to return three to five times the investment to limited partners (LPs).

"So our goal at the seed round is to own somewhere in the 15% to 18% range of a company... IA will end up owning somewhere between twelve and 15% at exit."

Ehrenberg outlines IA Ventures' ownership goals and strategies throughout the investment cycle, which are critical to achieving the desired fund returns.## Founder Alignment and Investment Follow-Ons

• Roger Ehrenberg discusses his perspective on the concept of founder alignment with venture capitalists.
• He mentions Eric Paleott from Founder Collective and their differing approaches to follow-on investments.
• Roger emphasizes the importance of clarity with founders regarding the criteria for success before investing.
• He believes that there is no misalignment as long as expectations and hypotheses for the company’s success are clearly established.
• Roger suggests that the market for capital is efficient and that smart investors will have similar assessments of a company's progress.

"So I think there is not misalignment. So Eric's a good friend and we've co-invested a ton. We just had a company go public that Eric and I were the original investors in. So we think Eric, David and Mike are three of the best investors out there." "We do not think there's misalignment as long as there is absolute clarity with the founder prior to investing as to what constitutes success for the series A."

Roger rejects the idea of misalignment between founders and VCs when it comes to follow-on investments, citing his successful co-investments with Eric Paleott and the importance of clear communication about success criteria for Series A funding.

• Roger discusses the importance of the length of a startup's runway during the institutional seed stage.
• He advises 18 to 24 months of runway, considering the maturity of the business and the degree of product-market fit.
• Roger notes that companies with a product already in the market may get preemptive funding within 12 months if they execute well.
• For companies in a more developmental stage, he emphasizes the necessity of a 24-month runway to account for unforeseen challenges.

"In terms of Runway, I generally say 18 to 24 months." "If there's one thing I do know, Harry, and as you, I'm sure know and certainly will in your new position as a VC, nothing ever goes the way you expect, never does."

Roger advises founders to plan for an 18 to 24-month runway to accommodate the unpredictable nature of startup development and to ensure they have enough time to achieve product-market fit.

• Roger Ehrenberg shares his insights on recognizing product-market fit in startups.
• He notes that product-market fit is indicated by the ability to sell a product without heavy consultation.
• The transition from over-serviced accounts by founder CEOs to a scalable sales model is a key sign of product-market fit.
• He suggests that a reduced sales cycle and less need for services to make a sale are indicators that a product is ready for the market.

"So I don't know that I actually have a hard metric or I don't think Brad and Jesse do either. For what constitutes product market fit, I think it's when you've been able to sell in a way that isn't heavily consultative."

Roger explains that the ability to sell a product with less hands-on involvement and over-servicing is a sign of achieving product-market fit, rather than relying on a specific metric.

• Roger discusses the use of round extensions when startups need more time to achieve product-market fit.
• He acknowledges that technical challenges and product complexity can necessitate additional time before raising a Series A.
• Roger cites examples of successful companies that required extension rounds, indicating that these rounds can lead to future success rather than an "unfaltering end."
• He provides a counterpoint to the view that bridge rounds are often futile, demonstrating that they can be part of a successful path for some companies.

"We have used round extensions quite frequently when it's taken longer to have product market fit unfold, either because of technical challenges where getting the build done simply took longer, or where the product complexity was such that there hadn't been enough time to kind of productize in the way to sell it in a scalable manner."

Roger advocates for the strategic use of extension rounds when startups face delays in achieving product-market fit, highlighting that such rounds can be a necessary step toward eventual success.## Series A Fundraising Discipline

• Raising a Series A funding round requires a clear vision of the company's future state.
• It's essential to understand the gap between the company's current status and the envisioned future.
• The amount of Runway needed to achieve the future state is crucial.
• A crisp plan and a line of sight from the present to the future state are key to successfully raising an extension within the seed stage.

"It really comes down to discipline, Harry. It comes down to, are you clear on what the future state of the company needs to look like in order to raise a great series a and understanding what the gap is between where the company is now, what that future state looks like, and how much Runway you need in order to be able to achieve that?"

The quote emphasizes the importance of discipline and clarity in planning for Series A fundraising, highlighting the need to bridge the current state of the company with the future goals and the required resources to get there.

• VC platforms offering a broad range of services are not always necessary or beneficial.
• Providing focused support tailored to the company's stage is more effective.
• Early-stage companies benefit from assistance with fundraising, clarity on goals for the next funding round, and operational setup.
• Offering a coach for founders and helping with basic operations like KPI tracking can be more valuable than a wide array of services.

"We help companies with an outsourced CFO for their first year of life. We found those basic things to be what really matter, much less all of the broad scope of services that a lot of firms are trying to help with."

This quote highlights the practical support that early-stage companies value, such as financial management, over a broad scope of services that may not address immediate needs.

• The venture industry may evolve into a barbell shape, with specialized firms at either end of the spectrum.
• Seed-stage firms focus on helping companies prove their business models.
• Larger firms may offer extensive platform resources to assist with scaling.
• Firms in the middle may struggle to compete due to a lack of specialization.

"I think it really that the industry is going to look like a barbell... You need to be absolutely the best at whatever it is you're doing."

Roger Ehrenberg predicts a bifurcation in the venture capital industry, with success lying in specialization and excellence in a specific focus area, whether in early-stage support or scaling resources.

• Capital allocation among partners in a VC firm should be focused on engagement with portfolio companies rather than fixed amounts per partner.
• Streamlining processes and maintaining hyper-transparent communication with founders is prioritized over individual capital allocations.

"What we are much more focused on is our approach to a portfolio company less what each partner has in a given fund."

Roger Ehrenberg dismisses the idea of fixed capital allocations for partners, emphasizing the importance of the firm's collective approach to engagement with portfolio companies.

• There's an oversupply of growth funds, which may lead to a market shakeout.
• Only a few growth funds will likely achieve the return objectives to justify LP investment.
• Success in growth-stage investing requires skillful stock picking, smart capital allocation, and the ability to generate premium deal flow.

"I think there's going to be a real shakeout because I think that there are relatively few growth funds that are going to be able to hit the return objectives to kind of justify LP investment."

Roger Ehrenberg anticipates a consolidation in the growth fund market due to intense competition and the scarcity of opportunities that can deliver the expected returns.## Importance of Process in Venture Capital (VC)

• Dr. W. Edwards Deming's teachings on process-oriented and data-driven approaches led to success in Japan and Korea.
• Alexis Ohanian from Initialized and Reddit emphasized the fundamental importance of process in VC operations.
• Roger Ehrenberg agrees with the pivotal importance of process, especially in early-stage investing where data is sparse.
• Emphasizing a rigorous approach to data collection, analysis, and iteration is crucial for VC success.

"And in the 1950s, he went over to Japan and Korea, and they became amazingly successful because they built this process oriented approach, this data driven approach that was far superior to that that we were using in the US at the time."

This quote highlights the historical success of process-oriented and data-driven approaches in manufacturing, which are also applicable to VC.

"100%. I think, especially, Harry, where we're investing at IA, which is so early, where there is such sparse data, that if we don't have a process, if we don't have founders that embrace experimentation, if we don't have a rigorous approach to data collection, analysis, iteration, then I think it would be very difficult for us to be successful."

Roger Ehrenberg emphasizes the necessity of having a strong process in place for VC success, especially at the early stages of investment where data is limited.

• Fred Wilson identified as Roger Ehrenberg's greatest mentor.
• The relationship began through their children's school and evolved from a peripheral acquaintance to a significant mentorship.
• Fred Wilson's humility, self-awareness, and understanding of VC as a lifelong pursuit made a profound impact on Ehrenberg.

"Say probably Fred Wilson has been my greatest mentor. Funnily enough. I met Fred and Joanne because our kids went to school together."

This quote explains how personal connections, such as their children attending the same school, can lead to meaningful professional relationships and mentorships.

"Know here was somebody who was so successful at venture you could not find a more humble, self aware person who truly understood and embraced the fact that venture, being a great venture capitalist, was a lifelong pursuit and in fact that it would never end and that it is such a humbling, challenging endeavor, but one that brought great joy."

Roger Ehrenberg describes Fred Wilson's qualities and perspective on VC, highlighting the importance of humility and the recognition of VC as a continuous and evolving career.

• Maria Popova's Brain Pickings is Roger Ehrenberg's favorite blog.
• It provides insights beyond VC, encouraging thoughts about life and art.
• Engaging with diverse content helps maintain an open mindset towards opportunities and life in general.

"That's interesting because it makes me think about stuff that's not related to VC. It makes me think about life, it makes me think about art."

Roger Ehrenberg values content that expands his thinking beyond the VC world, suggesting the importance of a well-rounded perspective.

• Desire for increased transparency in VC.
• Advocacy for industry-enforced best practices across various documents and terms.
• Eliminating unnecessary complexity and focusing on the essential task of aligning with great people on challenging missions.

"I would like to see continued transparency. I would like to see kind of industry enforced best practices around everything from term sheets to venture debt documents to just all the nuts and bolts of what we do."

Roger Ehrenberg expresses a wish for the VC industry to adopt more transparent and standardized practices, enhancing clarity and focus on core activities.

• Roger Ehrenberg's recent public investment was in Octane Lending.
• Attracted to the company for its founders' expertise, proprietary data, and service to an underserved market segment.
• Octane Lending created a unique asset with FICO scores for power sports, demonstrating innovation in credit assessment.

"One amazing founders out of Capital one and GE Capital, so knew the space, knew the domain extremely well. One of the other things is that they actually had created a differentiated asset in the form of FICO scores for power sports."

This quote reveals the reasons behind Ehrenberg's investment in Octane Lending, highlighting the founders' domain expertise and their innovative approach to credit scoring in a niche market.

• Expressions of gratitude for the interview and the opportunity to discuss VC and investing.
• Acknowledgment of Rory O'Drisco at Scale Venture Partners for facilitating the interview.
• Promotion of personal social media channels and the new blog, MojitoVC.com.
• Introduction to X.AI's AI-powered personal assistants and Workable's recruiting software as tools for startups.

"Thank you, Harry. Great questions. I really enjoyed it."

Roger Ehrenberg thanks Harry Stebbings for the interview, indicating a positive exchange of ideas on VC topics.

"And if you'd like to see more from us, then you can follow me on Snapchat at htebings with two B's, or you can follow Roger on Twitter at info arbitrage."

Harry Stebbings promotes social media engagement for continued discussions and insights into VC.