20VC Why Now Is The Hardest Time To Raise an Institutional PreSeed in the Last Decade, What To Do When The Founder and VC Interests Do Not Align & The Rise of PreEmptive Rounds with Gaurav Jain, Founder & Managing Partner @ Afore Capital

Summary Notes


In the first 20VC episode of 2020, host Harry Stebbings reflects on the previous year's coverage of precede investing and introduces guest Gurav Jarin, co-founder and managing partner at Afford Capital. Jarin shares his journey from a childhood in India, inspired by the American dream, to co-founding Afford Capital, which focuses on precede funding. He discusses the challenges founders face in raising initial funds, the shifting seed market, and the importance of specialization in venture capital. The conversation also touches on the rise of angel funds, the role of multistage funds in early-stage investing, and the delicate balance of portfolio construction at the precede level. Jarin emphasizes the need for authentic founders with unique insights and the potential for market pull, rather than relying solely on founder resumes or market size projections.

Summary Notes

20 VC Podcast Introduction

  • Harry Stebbings introduces the first 20 VC podcast of 2020 with upcoming guests including Vinod Kosler, Patrick Collison, and Howard Marx.
  • Reflects on 2019's coverage and aims to focus more on precede stage investments in 2020.
  • Introduces guest Gaurav Jain, co-founder and managing partner at Afore Capital, a precede investment fund.
  • Mentions Gaurav Jain's previous experience at Founder Collective and his involvement with successful companies.
  • Discusses the financial and wellness support tools like Pilot for bookkeeping and Hims for men's wellness.

"We are back for the very 1st 20 VC of 2020, and I'm so excited to say in the coming months we have the likes of Vinod Kosler, Patrick Collison and Howard Marx coming on the show."

This quote sets the stage for the podcast, highlighting the high-profile guests expected and the focus on precede investment for the year ahead.

Gaurav Jain's Background and Journey to Venture Capital

  • Gaurav Jain grew up in India and was inspired by the American Dream, leading him to pursue opportunities in the United States.
  • He studied software engineering at the University of Waterloo and participated in a co-op program with internships at BlackBerry, Amazon, and Morgan Stanley.
  • Gaurav decided to become a founder rather than take a traditional job after graduation, starting a company that built native apps for media companies.
  • His first exposure to venture capital was when his company raised a Series A round.
  • Gaurav joined the Android team at Google in 2009 to help grow the platform's market share.
  • He explored venture capital seriously during business school and joined Founder Collective, learning from experienced investors.
  • Gaurav and his partner Anamitra Banerjee founded Afore Capital to address the difficulty founders face in raising money at the inception stage.

"As someone that grew up in India, I thought the concept of venture was kind of weird. The fact that somebody will trade a lot of cash, real cash, for a piece of paper that holds no collateral, purely for some promise of the future."

This quote reflects Gaurav's initial skepticism about venture capital and his realization of its importance in achieving the American Dream.

Takeaways from Founder Collective

  • Gaurav Jain highlights the importance of being founder-friendly, even when it conflicts with short-term fund interests.
  • Emphasizes the principle that "less is more" in venture capital, staying focused and excelling within a specific scope.
  • Stresses the value of being a good human being, observing the Founder Collective team's commitment to family, community, and ethical success.
  • These takeaways have influenced Gaurav's approach to venture capital and his mission with Afore Capital.

"Everybody says they're founder friendly because it's easy, it's what founders want to hear. But in cases where what's best for the founder is not the same as what's best for the VC, that is what really tests your value system."

This quote encapsulates the ethos of prioritizing founders' interests, a core value Gaurav observed and adopted from Founder Collective.

Precede Investment Challenges

  • Gaurav Jain contests the notion that precede funding is easier to obtain, citing data that shows a decrease in sub $1 million rounds and an increase in median seed deal size.
  • Explains that while there are many angels and scout funds, they do not typically lead investment rounds, making it challenging for startups to raise significant precede funding.
  • Emphasizes the need for lead investors to catalyze funding rounds for startups to reach the next inflection point.

"The reality on the ground is very different than that perception. It may seem at the surface level, based on how much money is going into venture, that it should be super easy to raise a precede round."

This quote highlights the disconnect between the perception of ease in raising precede funding and the actual challenges founders face in securing their first institutional investment rounds.## Precede Funding Challenges

  • Seed funds historically invested at inception stages but now demand traction.
  • Seed funds are comfortable with higher valuations given there is company traction.
  • Raising a micro VC fund has become more challenging due to LP saturation.
  • New LPs overwhelmed by the number of funds, leading to a flight to quality.
  • Established managers are preferred over first-time managers.
  • More companies are starting than ever, creating a vacuum at the precede stage.
  • A4 accounts for 40% of capital going into funds focused exclusively on precede.

"historically seed funds used to invest at this inception stage, but they have moved later and they're demanding traction."

This quote explains the shift in seed fund investment behavior, emphasizing the requirement of traction before investment.

"it's actually getting harder and harder to raise a micro vc fund."

This quote highlights the increasing difficulty in raising micro VC funds due to market saturation and LP investment behaviors.

"A4 accounts for about 40% of capital that has gone into funds exclusively focused on precede."

This quote provides a statistic on the market share of A4 in the precede funding space, indicating its significant role.

Stability of Precede Rounds

  • The structure of precede rounds has remained stable over time.
  • Notable companies like Amazon, Google, and Uber raised similar amounts in their early stages.
  • Cost savings from technology are offset by rising labor costs.
  • The demand for institutional-grade lead investors at the precede stage is high.
  • Expectation of more specialists entering the precede investment space.

"The round will always be there. Exactly what it's called may change."

This quote suggests that the precede round is a constant in the startup ecosystem, though its naming may evolve.

"the biggest cost driver for the company at this stage is people."

This quote explains why the amount raised during precede rounds has remained stable despite technological cost savings, emphasizing labor as the primary cost.

Capital Inflation for Star Founders

  • High-profile founders can raise significantly more capital due to their pedigree.
  • This phenomenon is less common than media portrayal.
  • Most first-time founders raise modest amounts initially.
  • Series A funds preempt rounds for companies with traction in interesting spaces.
  • Specialization is viewed as a future trend over generalist investment strategies.

"Their 500k precede suddenly turns into two and a half just because of the sheer capital supply."

This quote illustrates how the presence of capital can inflate the funding rounds of founders with strong backgrounds.

"the moment there's some modicum of traction, and if they are in an interesting space, that, especially if it falls in a prepared mind for a series A fund, we certainly see those rounds getting preempted."

This quote explains how Series A funds preempt rounds based on traction and market interest, leading to earlier and potentially overvalued investments.

Multistage Funds' Impact on Early-Stage Investing

  • Multistage funds are entering precede and seed markets due to abundant capital and lack of proprietary deal flow.
  • Venture capital is a service business that doesn't scale like software.
  • Specialization is key to success in a competitive landscape.
  • Series A funds may eventually refocus on their core competencies.

"Their entry into precede seed is just a function of the economic cycle we're living in."

The quote connects the behavior of multistage funds to the current economic climate, explaining their strategic shift to earlier-stage investing.

"venture will always remain to be a small industry."

This quote emphasizes the inherent limitations of the venture capital industry regarding scalability and capital deployment.

Signaling Risks with Multistage Fund Investments

  • Multistage fund investments can add risk to a company due to signaling concerns.
  • The impact of signaling is significant when a business is in the middle of its growth trajectory.
  • Series A funds' decisions can influence other investors' perceptions.

"it puts a real risk on the company."

This quote acknowledges the potential negative consequences of multistage funds investing early, particularly related to signaling.

"if that very large mega fund... chooses to not invest in your company, it adds the question mark for everybody else."

This quote explains how a multistage fund's decision not to continue investing can create doubt among other potential investors.

Specialization vs. Generalization

  • Problems faced by companies are more similar across stages than sectors.
  • Specialization in venture capital is more about stage focus than sector focus.
  • Cross-pollination of ideas is beneficial, but specialization in stages is crucial.

"we think there's more variance on the problems that companies face across stages and phases of the business than there are across sectors."

This quote argues that the challenges companies face are more dependent on their stage of development than their industry sector.

"If you look at some of the best vcs in the business over the last few decades, they've been generalists from a sector perspective, but they've always been focused on a stage."

This quote suggests that the most successful venture capitalists have historically been stage specialists rather than sector generalists.## Generalist Investment Approach

  • Being a generalist from a sector perspective is beneficial for investing in companies with similar problems despite being in different sectors.
  • This approach allows for a broader range of investment opportunities and the ability to address common issues across various industries.

"So being generalist from a sector perspective allows you to then invest in companies that are different but then still have the similar set of problems?"

This quote highlights the advantage of being a generalist investor, which is the capability to invest in a diverse set of companies that face analogous challenges, enabling a more flexible and wide-ranging investment strategy.

Impact of Multistage Funds and Angel Investors

  • Multistage funds and angel investors have entered the precedent seed market, significantly impacting the investment ecosystem.
  • The influx of capital from Series A funds and individual GPs is driven by the desire for more deal flow rather than additional venture exposure.
  • Angel funds and scout programs are seen as mutually beneficial, providing both institutional support and strategic insights.
  • The trend of Series A funds raising capital is expected to continue and possibly accelerate.

"Yeah, the reason we're seeing this huge influx is really a byproduct of the intense and growing competition at Series A."

This quote explains that the surge of angel funds and scout programs is a direct result of the competitive environment at the Series A funding stage, where funds are seeking more opportunities to invest and gain deal flow.

Portfolio Construction

  • The prevailing wisdom suggests that earlier-stage investments require a more diversified portfolio due to the higher risks involved.
  • Contrary to the belief that pre-seed investing is akin to gambling due to lack of data, the focus is on unique product insights, novel distribution approaches, and validation of hypotheses through founder experiments.
  • The approach to portfolio construction is not significantly different from typical Series A funds, with a balance between primary investments and reserves for follow-on support.
  • The number of investments in a portfolio should allow for significant risk-taking while enabling close support and involvement with the companies.

"It's prevailing wisdom that the earlier you go, the more diversified your portfolio needs to be, just because of the lack of data, lack of certainty."

This quote addresses the common belief that diversification is crucial in early-stage investing due to uncertainties and the absence of substantial data to inform investment decisions.

Pre-Seed Investment Diligence

  • Pre-seed investment diligence involves assessing whether a company can progress to the next stage rather than predicting its potential to become a multibillion-dollar business.
  • The focus is on the company's ability to reach the next funding round and the founders' capacity to validate their business hypothesis.
  • An 86% graduation rate to the next funding stage is attributed to thorough diligence and understanding of the company's progress against initial milestones.

"We keep probing until we hear I don't know. And just because these pre-seeds don't have traction and data, they have plenty of traction and thought."

This quote emphasizes the importance of thorough questioning during the investment diligence process to understand the depth of the founders' insights and the level of thought put into their business plans, despite the lack of traditional traction and data.

Reserve Allocation Strategy

  • Reserve allocation is crucial for supporting portfolio companies in reaching the subsequent funding round, balancing the need to maintain ownership with avoiding overinvestment in underperforming startups.
  • Each follow-on investment is treated as a new investment decision, with a rigorous evaluation process that considers the company's progress and potential for success.

"We consider each check we write, even in existing portfolio companies, as a new investment."

This quote underscores the disciplined approach to reserve allocation, where each follow-on investment is critically assessed as if it were a new opportunity, ensuring that additional capital is allocated effectively.

Startups and Momentum Analogy

  • Startups are compared to airplanes needing momentum to take off, with the implication that sufficient capital is necessary to build momentum in the business and reach an inflection point.
  • Recommended fundraising amounts for startups are between half a million to a million dollars to balance the ability to execute with not overcapitalizing or overvaluing the company early on.

"You need momentum before you can lift off. And I think it's similar with startups and you should start and stop."

This quote draws an analogy between the momentum needed for an airplane to take off and the capital required for a startup to build enough momentum to reach an inflection point in its growth trajectory.

Decision Making and Speed in Fundraising

  • The speed of investment decision making is important, but it should not be rushed without proper diligence.
  • Transparency with founders about the diligence process and potential areas of value addition post-investment is critical.
  • The decision-making process is conviction-driven, with a focus on understanding how a company can reach the next inflection point.

"It's important to move fast and mostly to be efficient with the founders time, but I don't think it's an arbitrary race to the finish line."

This quote conveys the importance of being efficient and quick in the investment decision-making process, while also ensuring that the process is thorough and not rushed simply to close a deal.

Market Size Evaluation

  • Market size is a dominant factor in investment excitement, but the approach to evaluating market size is nuanced.
  • The best companies are expected to either expand existing markets or create new ones, making the assessment of market size a complex but essential part of the investment process.

"In my opinion, best companies will either e"

The quote is incomplete, but suggests that the speaker believes the most successful companies have the potential to expand or create markets, indicating the importance of market size and potential in the investment evaluation process.## Market Dynamics in Precede Stage Investing

  • Precede stage markets can expand or shrink unpredictably, often beyond founders' initial projections.
  • Uber's initial TAM (Total Addressable Market) was estimated at $4.2 billion, but they achieved $60 billion in bookings, illustrating market expansion.
  • Google revolutionized advertising by introducing performance marketing, which made the market more efficient and smaller than it would have been otherwise.
  • At the precede stage, the focus is on early market pull and whether it can propel the company to the next stage, rather than the eventual market size.
  • Precede stage companies often lack traction and paying customers, but potential customer feedback can gauge market opportunity.
  • Specialization in investment stages is crucial; using the wrong investment framework can lead to missed opportunities.

Uber, of course, you've seen the first deck, right? Talks about the tamp being $4.2 billion, and they now do almost $60 billion in bookings.

This quote exemplifies how initial market size estimates can be drastically outperformed as a company grows, highlighting the importance of recognizing potential beyond early projections.

So over time, the market is going to become more efficient, which means that it'll be smaller than what it would have been if it wasn't for performance marketing.

The quote suggests that innovations like performance marketing can streamline a market, potentially reducing its size but increasing efficiency, which impacts investment considerations at the precede stage.

The Role of Unit Economics in Precede Stage

  • The significance of unit economics at the precede stage is debated, with some investors prioritizing it while others find it premature.
  • High Customer Acquisition Cost (CAC) at this stage may indicate a lack of genuine market pull.
  • Observing the process of how CAC changes can provide insights into founders' understanding of the market and distribution channels.
  • It's important to look at leading indicators and use judgment to extrapolate future outcomes rather than focusing solely on current unit economics data.

The number one thing they look for at precede when investing is validation around unity economics and unit economics at the center of their thinking.

This quote reflects the perspective of some investors who prioritize unit economics early on, despite the challenges of accurately assessing these metrics at the precede stage.

I think you cannot take it literally on what the unit economics are, but I think you start to see some leading indicators on the idea of market pull that I talked about.

Here, the speaker emphasizes the importance of interpreting early signs of market pull and distribution strategy over concrete unit economics at the precede stage.

Founder-Centric Investment Approach

  • Precede stage investment is often misconstrued as solely betting on the founder's resume and idea.
  • Investors seek authentic founders with a clear connection between their career arc and their startup.
  • Founders should have nonobvious product insights and unique distribution strategies, indicating an unfair advantage.
  • High clock speed, information gathering, and learning capabilities in founders are key traits.
  • Understanding the experiments and customer interactions founders have undertaken is part of due diligence beyond the founder's background.

One of the big myths in the industry is that precede is betting on founders resume and idea and not much more.

This quote challenges the common misconception that precede stage investment is only about the founder's past achievements and the initial idea, suggesting a more nuanced approach.

What we look for are a few things. First of all, authentic founders, folks that are building this, not because it's a hot space, but because if you look at their arc of their career, you can see how they ended up starting this company.

The speaker outlines specific qualities sought in founders, emphasizing authenticity and a career trajectory that naturally leads to their current startup venture.

Venture Capital Insights and Personal Reflections

  • The book "Trillion Dollar Coach" emphasizes the importance of coaching founders using first principles and empowering them to make decisions independently.
  • The venture industry could benefit from a more efficient system to match investors with the right companies at the precede stage.
  • Venture capital is an artisanal business focused on honing one's craft, not about world domination.
  • Balancing short-term tasks with long-term goals is a challenge in venture capital, similar to the challenges faced by founders.
  • Fundraising timelines are pressured, likened to the importance of dating before marriage, but also a process founders want to expedite.
  • Modern Health's mission to provide mental and emotional wellbeing support resonated with the investor, leading to their investment.

It's called the trillion Dollar coach, and it was actually written by Jonathan Rosenberg, who I used to work for. He had a product at Google and Eric Schmidt. And it was about Bill Campbell, who was a coach for Larry and Sergey, Steve Jobs, many of the iconic founders in Silicon Valley.

The speaker references a book that influenced their perspective on venture capital, highlighting the value of coaching and supporting founders rather than directing them.

That it's an artisanal business, that it's about honing your craft. This is not a world domination kind of business.

This quote reflects the speaker's realization over time that venture capital is about refining one's skills and approach, rather than pursuing a strategy of aggressive expansion or control.

It's a company that builds a platform for employers to offer mental and emotional wellbeing support to their employees. I just love the mission.

The investor explains their recent investment decision based on the company's mission and the societal need it addresses, demonstrating the importance of alignment between investor values and startup objectives.

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