20VC Why FollowOn Investments Are Always A Better Investment, Why Spray and Pray Investing Is Like The Stock Market & Why Startups Need A Board From Day One with Jerry Neumann

Summary Notes


In this episode of "20 Minutes VC," host Harry Stebbings interviews prominent New York angel investor Jerry Newman, known for his deep insights into investment mechanics and portfolio management. Newman, who has backed companies like The Trade Desk and Datadog, shares his journey from managing director at Omnicom's venture division to accidental venture capitalist, emphasizing the importance of hands-on involvement with startups and the power of a well-constructed portfolio. Newman and Stebbings discuss the nuances of early-stage investing, including the value of prorata rights, the significance of second-round funding, and the pitfalls of bridge rounds. Additionally, Newman advocates for VC's role in actively supporting founders beyond mere financial backing, underscoring the critical nature of board guidance and the founder-VC relationship in steering startups towards success.

Summary Notes

Introduction to Jerry Neumann

  • Jerry Neumann is recognized as one of New York's leading angel investors.
  • His portfolio includes successful companies like the trade desk (IPOed in 2016), Datadog, and Flurry (acquired by Yahoo).
  • Jerry's prior roles include Managing Director at Seneca Investments and building the first open market for real-time consumer data at Root Markets.
  • He also served as Managing Director at Omnicom's venture capital division, achieving five IPOs from the portfolio.
  • Jerry's insights on investing and portfolio management are shared on his blog, reactionwheel.com.

"Now Jerry is one of New York's leading angel investors with a portfolio including the likes of the trade desk, which ipoed in 2016, Datadog and Flurry, which was acquired by Yahoo, just to name a few."

This quote highlights Jerry Neumann's successful track record as an angel investor, emphasizing his involvement with high-profile companies that have either gone public or been acquired.

Jerry Neumann's Entry into Venture Capital

  • Jerry Neumann became a venture capitalist "primarily by accident" while working for Omnicom Group.
  • Omnicom Group aimed to build a portfolio of internet companies, leading to venture investments as outright purchases were not feasible.
  • The early venture deals lacked usual protections, such as preference shares, but were still financially successful.

"So I became a venture capitalist primarily by accident, learned on the fly. Nobody there had done venture investments before, so it was an interesting experience."

This quote explains how Jerry Neumann's venture capital career started unintentionally and without prior experience in venture investments, making his journey a learning process from the beginning.

Early Challenges in Venture Capital

  • Initial deals lacked standard venture capital protections, which is now seen as a naive approach.
  • Despite the lack of sophistication in these early investments, some, like Razorfish, were highly profitable.
  • Learning was a key part of the process, including engaging with other venture capitalists to gain insights.

"It's embarrassing to think about the first few deals we did because they had none of the usual protections a venture deal did."

Jerry Neumann reflects on the inexperience evident in his early venture deals, acknowledging that they were unconventional and lacked typical investor protections.

Portfolio Construction

  • Jerry Neumann challenges the prevailing wisdom that a vast portfolio is necessary for venture capital success.
  • He argues that while making many investments can increase average returns due to power law distribution, the quality of investments is crucial.
  • A hands-on approach, providing strategic and operational support, is essential for startup success.
  • The effectiveness of a vast portfolio depends on the presence of lead investors who actively contribute to the startups.

"So I'm a believer in more hands on in being there to help the entrepreneurs when they need it."

This quote underscores Jerry Neumann's belief in a proactive investment approach, where venture capitalists actively support and guide the entrepreneurs in their portfolio.

Impact of Venture Capitalists on Startup Success

  • Jerry Neumann asserts that venture capitalists can positively impact the success of startups.
  • He emphasizes the importance of venture capitalists in areas like strategy, hiring, and fundraising.
  • Neumann's experience indicates that startups with active board involvement perform better than those without.
  • The number of companies a venture capitalist can effectively support is limited by their ability to provide active help.

"I absolutely believe that vcs can increase the company's success."

This quote affirms Jerry Neumann's conviction that venture capitalists play a significant role in driving the success of the companies they invest in through active involvement and support.## Early Stage Board Dynamics

  • Having a board from the very beginning can help founders stay focused and drive the company forward.
  • Monthly board meetings can be simple, focusing on product plans and achievements.
  • The board's role is not to micromanage but to ensure founders are sticking to their plan and making progress.
  • Regular meetings add accountability and help in maintaining momentum towards market goals.

"So there was a company where I was the first investor and the board was me and the founder. Now, this was very early stage, and every month we'd sit down and we'd say, all right, well, I would ask him, what have you done this month?"

This quote highlights the simplicity and focus of early-stage board meetings, emphasizing progress checks and planning.

"But having somebody who could come in and say, great, I'm glad you're focusing on details, but we need to continue having major improvements made every month."

This quote underlines the importance of a board member in helping the founder maintain a balance between detail orientation and strategic progress.

Establishing a Board

  • Founders should establish a board from day one, despite it being an unpopular opinion among them.
  • Early board meetings should not be labor-intensive but should mirror the founder's focus areas like product plans and development tracking.
  • The board should be a source of accountability, not a high-pressure control mechanism.
  • External board members provide valuable outside perspective and enforce a discipline of regular updates.

"I think they should have a board from day one."

This quote suggests that having a board from the onset is beneficial for founders, providing structure and accountability.

"It's also not a control thing. The board can be me and you and your dog, and hopefully your dog likes you better than me."

This quote emphasizes that a board's purpose is not to exert control but to serve as a sounding board and accountability partner, regardless of its composition.

Board Member Roles and Relationships

  • Board members wear multiple hats, balancing fiduciary responsibilities to investors and support for the founder.
  • Honesty and clarity about the role a board member is playing at any given time are crucial.
  • Founders value knowing when advice is given with their interests in mind versus when it's focused on shareholder interests.

"So a board member has a lot of hats. One of them is, as a board member, I am responsible for the investors interest in the company."

This quote acknowledges the dual responsibilities of a board member: to the investors and to the company's success.

"I think being explicit about which role you're playing, depending on what you're saying, is important."

The quote stresses the importance of transparency about the capacity in which a board member is speaking, ensuring clear communication and trust.

Founder vs. Company Focus

  • The company's interests should take precedence, but the founder is often integral to the company's success.
  • Removing the founder in early stages typically leads to worse outcomes for the company.
  • Founders are usually more motivated and aligned with the company's vision than a replacement would be.

"Well, you have to be company first. But my experience is when you remove the founder from a company, the company almost always does worse."

This quote conveys the delicate balance between prioritizing the company while recognizing the founder's critical role in its success.

"Who are you going to hire in a company which is clearly not doing well? Because that's why you're removing the founder that is going to be more motivated to make that company work than the founder was."

The quote questions the logic of replacing a founder, highlighting the difficulty of finding someone with equal motivation and vision.

Board Member Excellence

  • Great board members often have entrepreneurial experience, allowing them to challenge founders effectively without causing defensiveness.
  • The ability to guide founders to the right answers and deep industry knowledge are marks of an excellent board member.
  • Sincerity and a genuine desire for the founder's success contribute to a board member's effectiveness.

"Josh Coppleman was awesome. I was on a board with him for a while."

This quote introduces an example of an effective board member, setting the stage for discussing the qualities that make a board member stand out.

"He could challenge founders on their premises from a base of experience, and also because when he did so, he didn't do it in a way that the founder would have a hard time accepting."

The quote illustrates the importance of experience and the ability to communicate challenges constructively in board member-founder interactions.

Competition in Deal-Making

  • Being a top choice for founders and having an efficient decision-making process are key to winning deals.
  • Founders prioritize VCs who understand their business and avoid those perceived as difficult to work with.
  • Warm introductions and reputation play significant roles in the deal-making process.

"I think there's two steps to winning a deal. One is being one of the first people they talked to, right, being top of their list."

This quote outlines a two-step strategy for winning investment deals, emphasizing the importance of being a preferred choice for founders.

"And two is having an open and transparent and rapid process to coming to a decision."

The quote highlights the necessity of an efficient decision-making process in securing deals amidst competition.## Venture Capital Engagement

  • To be among the first VCs a founder engages, it's crucial to show interest in their work and make this known.
  • A VC's reputation among other entrepreneurs is vital as founders seek recommendations on who to engage.
  • Accessibility to VCs is important, but there should be a filtered mechanism to prevent unqualified deal flooding.
  • Building a network to facilitate introductions to founders is a mix of hustle, hard work, and time.

"So if you want to be one of the first five VCs that a founder talks to, I think you need a couple of things."

This quote emphasizes the prerequisites for a VC to be among the initial contacts for a founder seeking investment.

"You need to have a good reputation among other entrepreneurs because they're going to ask and say, which of these people should we talk to and who shouldn't we waste our time on?"

The quote highlights the importance of a VC's reputation in the entrepreneurial community for securing opportunities to engage with founders.

"So you need to have a way that entrepreneurs can reach you quickly, but not so quickly that the people who really aren't qualified flood you with deals."

This quote suggests the necessity for VCs to be accessible but also to have a system in place that filters out unqualified deals.

Price Sensitivity in Investments

  • Jerry Neumann expresses his price sensitivity, contradicting the common Silicon Valley notion of binary outcomes.
  • He believes in a binomial distribution of outcomes, making entry price important.
  • Pricing decisions often follow market trends, but personal analysis is crucial for long-term success.
  • Tracking market exits and understanding the sweet spot for potential exits aids in determining reasonable investment prices.

"I am price sensitive. I don't believe in the binary outcome that Silicon Valley has been sort of talking about for the past ten years."

Jerry Neumann challenges the prevalent Silicon Valley mindset that entry price is irrelevant due to binary outcomes in investments.

"I have a spreadsheet of hundreds of exits in enterprise software. And I kind of have a feel, having done all that research for what the sweet spot for an exit is..."

Jerry Neumann uses a data-driven approach to understand exit valuations, which informs his pricing decisions.

Solo Investment Decision Making

  • Being a solo investor requires self-check mechanisms to avoid hasty decisions.
  • Jerry Neumann follows a rule to sleep on decisions to gain perspective.
  • Writing investment memos and consulting with potential next-round investors helps in assessing and mitigating financing risks.

"The hardest thing about being solo is that there's nobody to tell you that you're making a stupid decision."

This quote reflects on the challenges of solo investing, particularly the lack of a sounding board for decision making.

"I never make this snap decision, because if I made snap decisions, I would always say yes."

Jerry Neumann emphasizes the importance of taking time to reflect before making investment decisions to avoid impulsivity.

"I write myself an investment memo... I talk to investors who might fund the next round."

Jerry Neumann describes his thorough approach to decision making, including self-reflection and seeking external opinions.

Guiding Companies for Future Funding

  • Understanding what a company needs to look like for future fundraising is critical.
  • Guiding founders toward meeting those requirements is part of an investor's role.
  • This guidance is not merely "packaging" but fostering real progress towards what the company should become.

"A lot of conversations I have in the first year with founders are along the lines of, your company needs to look like this, you need to get there, or else we can't raise more money."

Jerry Neumann discusses his hands-on approach in directing founders towards achieving a state that makes their company attractive for further investment.

Reserve Allocation and Follow-On Investments

  • Jerry Neumann believes follow-on investments are often better risk-return propositions than initial investments.
  • He insists on prorata rights to ensure he can invest in subsequent rounds.
  • The first investment helps in understanding the founders, and the second investment is made with greater knowledge.

"I always insist on getting prorata in a company because I think that the second investment is a much better investment than the first investment."

Jerry Neumann explains his strategy of securing the right to invest in future rounds, emphasizing the value of follow-on investments.

Perspectives on Bridge Rounds

  • Jerry Neumann's view on bridge rounds is not explicitly stated in the transcript provided.
  • The mention of bridge rounds alludes to a conversation about their effectiveness, which is a topic of debate among investors.

"I spoke to Mike Maples and he said that, Harry, bridge rounds are often a bridge to nowhere. How do you view bridge rounds especially, given your appetite for those earlier?"

This quote introduces the topic of bridge rounds and their perceived value, setting the stage for a discussion on the subject.## Investment Strategies and Outcomes

  • Jerry Neumann discusses the concept of tranched investments and the necessity of multiple funding rounds.
  • He notes that the gap between funding rounds has increased, often requiring more than the initial investment to reach Series A.
  • Jerry highlights the importance of reserving capital for companies that demonstrate progress.
  • He credits his investment success to not losing significant money on failed companies due to smaller initial investments.

"So if you raise a precede round of 500k, you're almost certainly going to need at least another million to get to the series a."

This quote emphasizes the reality that initial funding rounds are often insufficient to carry a company to Series A, necessitating additional investment rounds.

"I think part of the reason that my returns have been good is that for the companies that have failed, I haven't lost a lot of money."

Jerry Neumann explains that by investing smaller amounts initially, he minimizes losses when companies fail, which has positively impacted his overall investment returns.

Venture Capital Discipline and Decision-Making

  • Jerry discusses the importance of discipline in venture capital and the need to make informed decisions about follow-on investments.
  • He explains that he does not have an obligation to always write a second check and does not lead second rounds, relying on other leads to validate the company's potential.
  • The difficulty of decision-making is highlighted, especially when companies are close to achieving milestones but require additional funding.
  • Entrepreneurs are encouraged to be clear about their progress and realistic about their position when seeking further investment.

"I don't tell them I always will, but I have always."

This quote reveals that while Jerry does not promise to always provide follow-on funding, his track record shows that he often does when another lead investor is involved.

"You have to have done these things. You have to have gotten this far."

Jerry Neumann insists on clear milestones and progress from companies before considering leading a second investment round.

Work-Life Balance and Personal Beliefs

  • Jerry Neumann shares his perspective on work-life balance, quoting Jack Welch on the inevitability of trade-offs.
  • He includes his children in work discussions and allocates time for shared activities, acknowledging that there is no perfect balance.
  • Jerry expresses his belief that the world is improving, despite prevalent skepticism.

"There's no such thing as work-life balance. There are only trade-offs, I think."

Jerry Neumann quotes Jack Welch to convey that balancing work and personal life is about making choices rather than achieving perfect equilibrium.

"I believe that the world is getting better."

In this quote, Jerry shares his optimistic viewpoint that the world is on a path to improvement, despite challenges and setbacks.

The Future of Venture Capital and Startups

  • Jerry advocates for venture capitalists to take more risks and support founders who are inventing transformative solutions, rather than focusing on short-term gains.
  • He distinguishes between risk, which is measurable, and uncertainty, which is not, and suggests that venture capitalists should invest in uncertainty.

"I'd like to see VCs go back to really taking more risks in trying to help founders who are inventing really new things that really change industries."

Jerry Neumann expresses his desire for venture capitalists to prioritize innovation and industry-changing ideas over safer, short-term profitable ventures.

"Risk is measurable... Uncertainty is unmeasurable."

This quote differentiates between the concepts of risk and uncertainty, with Jerry advocating for venture capital investment in the latter, which involves unquantifiable outcomes.

New York's Tech Ecosystem

  • Jerry Neumann, with 20 years of investing experience in New York, speaks to the growth and potential of the New York tech ecosystem.
  • He acknowledges the cyclical nature of the ecosystem but remains long-term optimistic about its prospects.
  • Jerry is encouraged by indicators suggesting New York will continue to improve as a market for startups.

"New York is well ahead of any other place except for the San Francisco Bay Area, which is amazing to me how much it's changed over 20 years."

Jerry Neumann reflects on the remarkable growth of New York's tech ecosystem over the past two decades, recognizing its significant position in the industry.

"I think it's going to be enormous here."

This quote conveys Jerry's bullish outlook on the future of the New York tech ecosystem, anticipating substantial growth in the coming years.

Jerry's Investment in Edmit

  • Jerry discusses his recent investment in Edmit, a startup based in Boston.
  • He cites the impressive team, profound industry knowledge, and the potential to create a new market as key reasons for his investment.
  • The problem Edmit addresses—paying for college education—is significant and resonates with Jerry personally.

"They had found a problem which people were solving in a small, inefficient way, and decided that it could be solved in an efficient way and create an entirely new and very large market."

Jerry Neumann explains why he invested in Edmit, highlighting the team's approach to solving a widespread problem in a new and efficient manner.

"Great team, big idea, new market that could grow quickly and big problem."

This quote summarizes the factors that led Jerry to invest in Edmit, encompassing the team's quality, the scale of the idea, market potential, and the gravity of the problem being addressed.

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