20VC Why Small Funds Outperform Large Funds & AUM is a Vanity Metric Why 99% of Investments in AI Startups Will Go To Zero Being a Traction First VC & Investing Lessons from Investing in Canva and Missing Figma with Nikhil BasuTrivedi

In this episode of "20 VC," Harry Stebbings reconnects with Nikhil Basu Trivedi, co-founder and general partner at Footwork, to discuss the venture capital landscape. Nikhil expresses skepticism about the current AI investment hype, noting that while AI presents opportunities, the competitive noise and inflated valuations may not align with Footwork's investment strategy. Harry and Nikhil also delve into the dynamics of fund size, with Nikhil advocating for smaller funds due to their potential for higher returns, a stance that contrasts with the trend of large fund accumulations. They touch on the importance of being selective with follow-on investments, especially in a hype-driven market. Additionally, Nikhil shares insights on the significance of early signs of product-market fit over market size or team composition in investment decisions, and the conversation turns personal as Nikhil reflects on how fatherhood has reshaped his perspective on time management and investment commitment.

• Nikhil Basu Trivedi believes small funds outperform big funds.
• Achieving a high net return on a billion-dollar fund is incredibly difficult.
• Small funds have a better chance of delivering high multiples on investments.
• The industry has overrotated towards larger funds, but this may not align with maximizing returns.

"My firm belief in my bones is that small funds outperform bigger funds. It is incredibly difficult to have a five x net return on a billion-dollar plus fund."

Nikhil expresses his core belief that smaller funds have a better capacity to yield high returns, emphasizing the challenge of achieving such returns with larger funds.

• Nikhil is skeptical about AI investment opportunities due to the current hype.
• He feels that the market has quickly become overexcited about AI.
• AI-enabled companies may not fit Footwork's investment strategy as they are too expensive and surrounded by competitive noise.

"I honestly don't know if there's great AI first opportunities for us at Footwork to invest in just the insane hype cycle around it at the moment."

Nikhil questions the viability of AI investment opportunities for Footwork, suggesting that the hype has potentially inflated values and created a noisy competitive landscape.

• Advises young venture capitalists to think beyond their titles and focus on core VC activities.
• Emphasizes the importance of finding, deciding, winning, helping, and exiting investments.
• Believes that adopting a VC mindset, regardless of position, can lead to better performance.

"Don't look at the title on your business card... Just think about yourself as a venture capitalist and do as venture capitalists do."

Nikhil shares advice given to him early in his career, which he now passes on to others, encouraging them to embrace the broader role of a VC beyond their job title.

• Nikhil holds that exceptional companies should be considered even if they don't fit the usual investment model.
• Searching for outliers is a key part of a venture capitalist's job.
• He has applied this mantra throughout his venture career to identify and invest in standout companies.

"Exceptional companies deserve exceptions."

He explains the significance of being flexible in investment strategies to accommodate companies that show outlier potential, even if they deviate from the norm.

• The relationship between founders and venture capitalists varies case by case.
• Nikhil believes founders should not dismiss junior team members, as they may offer valuable insights.
• He advocates for giving everyone a chance and evaluating based on the quality of the conversation.

"You're better off as a founder, judging based on the actual conversation you have, which sometimes may be a lot better with the youngest person on the team versus the managing partner of the firm."

Nikhil discusses the importance of not prejudging interactions based on hierarchy within a VC firm, emphasizing the potential value that junior team members can provide.

• The investment in Canva by Shasta Ventures was an exception on many fronts.
• Despite breaking traditional rules, Canva showed early signs of product market fit and strong user engagement.
• The decision to invest in Canva was based on its potential, despite unconventional aspects.

"The Canva investment for us at Shasta was an exception on so many different dimensions... It had no revenue yet... but it broke a lot of the traditional rules and so we thankfully decided to make that investment."

Nikhil recounts the decision to invest in Canva, highlighting how the company's early traction and user growth led to an investment despite it being an atypical case.

• Product market fit is a critical inflection point for startups.
• Once a startup achieves product market fit, many challenges become less significant.
• Startups should focus on finding product market fit before scaling.

"I think we actually really underestimate the momentous weight of product market fit. Once you have that, so much else goes away."

Nikhil emphasizes the transformative impact that achieving product market fit has on a startup's trajectory.

• Larger funds have the flexibility to be less price-sensitive due to their size.
• Smaller funds may face challenges in competing with larger funds for hot startups.
• Nikhil prefers the constraints of a smaller fund, believing it leads to better investment decisions.

"I actually think it forces us to make better decisions, and I think there's a laziness and a lack of great decision making that can come from having a bigger fund."

He discusses how the constraints of a smaller fund size can lead to more diligent and strategic investment decisions compared to larger funds.

• There has been a trend of larger funds being raised and then a recent shift towards smaller funds.
• Nikhil predicts a few firms will downsize their funds to optimize returns.
• He notes the challenge of such a strategic shift given industry narratives around fund size.

"I think a handful will, and I think there'll be a very smart handful that will. But it's a really difficult and painful decision to do that."

Nikhil speculates on the future of fund sizes in the venture capital industry, acknowledging the difficulty for firms to reduce their fund size despite potential benefits.## Difficulty Building Star-Studded Businesses

• Nikhil Basu Trivedi (Speaker A) expresses skepticism about the viability of building businesses around star-studded teams and hot areas like AI.
• He highlights the preference for investing in teams with a working product and early customer resonance, often outside of trending sectors.
• Nikhil notes that their firm avoids investing in seed rounds that require significant capital expenditure, such as those funding foundational AI models.

"I think it's very hard. That's why more often than not, the companies that we invest in are not the star studded team with that type of round."

The quote illustrates Nikhil's belief that it is challenging to build successful businesses solely around high-profile teams and sectors, emphasizing a product-driven approach to investment.

• Speaker D discusses the misreporting of funding rounds, explaining that large rounds are sometimes based on uncapped notes, with only a fraction of the reported amount being priced.
• The conversation highlights a lack of understanding among journalists regarding the structure of rounds and the savvy of founders in such negotiations.

"There's definitely been some in Europe where 100 million dollar rounds are reported on $250,000,000 valuations... but actually only 20 was priced at that."

This quote points out the discrepancy between reported and actual funding round valuations, revealing a gap in financial reporting accuracy.

• Nikhil discusses the critical need for companies with long runways but lacking product-market fit to find a way to resonate with the market.
• He emphasizes the importance of momentum and a winning culture in startups, linking these to the ability to attract top talent and perform optimally.

"Those companies have to find some product market fit somewhere to deserve to exist for a longer period of time."

Nikhil's statement underscores the necessity for startups to achieve product-market fit to justify their continued operation and use of invested funds.

• Nikhil shares his experience with conversations about returning money to investors, emphasizing the importance of founders feeling like they're winning and have momentum.
• He suggests that founders assess whether they've been fixated on an ineffective strategy for too long and if it's time to pivot or return capital.

"Do you want to feel like you are winning? Do you want to feel like you have momentum? Because that's what we want you to feel."

The quote captures the essence of investor-founder discussions about the psychological and strategic aspects of pursuing a startup's goals versus considering returning funds.

• Nikhil prioritizes early signs of product-market fit (traction), followed by the team (people), and then the market when making investment decisions.
• He shares his willingness to take more risks on the market and prefers to see tangible early success in a product before investing.

"I've always been traction. Early signs of product market fit. First investor, then people, and then market."

This quote reveals Nikhil's investment philosophy, which places the highest value on early indications that a product is meeting market needs effectively.

• Nikhil describes how he looks for early signs of a beloved product, such as high user retention, word-of-mouth growth, and passionate customer feedback.
• He mentions unconventional methods like analyzing App Store reviews and YouTube comments to gauge product reception.

"It is those early signals that you've built something that people love using."

The quote highlights the importance of early user engagement and satisfaction as indicators of a product's potential success.

• Nikhil values founders who can articulate their main business challenges with clarity and vulnerability.
• He believes that the ability to be transparent about what is working and what isn't is a characteristic of successful founders.

"What's the main challenge topic or discussion topic that you want to have in our first board meeting right now?"

Nikhil uses this quote to describe a question he asks founders to evaluate their transparency and understanding of their business's current challenges.

• Nikhil reflects on his own insecurities as a founder and investor, acknowledging the pressure to prove his firm's success.
• He strives for authenticity in how he conducts himself and makes investment decisions, aiming for his firm to reflect his and his partner's true selves.

"I think there's an insecurity that comes from not yet having delivered in distributions many, many multiples of what I've invested."

Nikhil's quote reveals his self-awareness and the internal pressures that come with establishing a new venture firm and the desire for significant returns on investments.

• Nikhil explains his firm's investment decision-making process, which allows for differences in opinion but requires at least one partner to be strongly supportive and no strong opposition.
• He discusses the rationale behind allowing some middle ground in investment decisions, citing past experiences where initial skepticism was proved wrong by a company's success.

"One of us has to be a four, one of us has to be strongly supportive to make an investment."

The quote outlines the decision-making framework within Nikhil's firm, emphasizing the need for at least one partner to have strong conviction in a potential investment.## Investment Decision Making

• Investing in pre-product startups can be successful, but it's less common.
• Stretching on price can lead to conflicted feelings about an investment.
• Personal feelings about the investment's value can impact overall support levels.

de a decision to invest in something that was pre product, but that actually turned out to work.

This quote indicates that while there is risk in investing in pre-product companies, it can result in success.

I liked it, didn't love it, but then I didn't like the price, and so I was netted out as a two.

The speaker expresses a nuanced view on an investment where the product was satisfactory but the price point was not, leading to a moderate level of support.

• Disagreements are common but commitment to the firm's decisions is critical.
• Footwork doesn't attribute investments to individuals, fostering a team approach.
• Both partners actively participate in early board meetings and communication with founders.

For Mike and me, it is very easy for us to disagree, but very seriously commit.

This quote emphasizes the importance of commitment to team decisions despite personal disagreements.

We actually don't even do attribution at the firm.

The lack of attribution to individual investments promotes a unified team identity.

Both of us being on the text threads with all of our founders, and both of us showing up to those board meetings in year one is reflective of that commitment to actually work together.

Active collaboration between partners in the early stages of an investment demonstrates a strong team dynamic and commitment to founders.

• Decisions are sometimes made based on individuals' ability to sell internally.
• Intellectual dishonesty and internal politics can lead to dysfunctional decision-making.

There are partnerships where decisions are made based on the ability of individuals to sell internally.

This quote highlights how internal salesmanship rather than merit can influence investment decisions.

I think there's a lot of stuff that can bleed out from that selling process.

The selling process can lead to negative consequences that affect the partnership's dynamics and decision-making.

• Exceptional companies warrant breaking conventional advice, such as waiting a year before making a deal.
• The speaker advocates for investing in companies believed to be outliers.

exceptional companies deserve exceptions.

The mantra suggests that rules can be bent for companies that show exceptional promise.

• Footwork prioritizes relationships, the push towards excellence, and LPs' mission values.
• Diversity in LPs is important to avoid over-reliance on a few major investors.
• The firm avoids any single LP having more than 20% of the fund.

Three things that we thought about when we raised our first fund, and we actually ranked lps based on these three dimensions.

This quote explains the criteria used to select LPs for their investment fund.

We don't have a single lp who's more than 20% of our fund.

Limiting the stake of any single LP reduces the risk of undue influence on the firm's decisions.

• A small number of LPs are willing to be the first to commit to a new fund.
• The firm's approach includes leveraging relationships and showcasing support from respected individuals.

That group of lps is very small, it's probably ten lps 15, our biggest lps are not lps in my prior firm.

This quote indicates the rarity of LPs who are willing to make early commitments to new funds.

here are all the people who've in found said that they want to invest in the fund.

Demonstrating early interest from respected individuals helps to build credibility with potential LPs.

• There's a difference in motivation and energy among venture capital managers.
• It's challenging for LPs to assess the intangible qualities of VC managers.

There's a difference in hunger and energy and drive that some managers have that others don't.

This quote suggests that personal attributes of VC managers can significantly impact their success.

We were heavily scrutinized on us as people, because so much of our strategy is really just about Mike and me and our ability to make decisions in the partnership that we have.

The speaker notes the importance of LPs assessing the personal qualities of VC managers when making decisions.

• Sourcing is challenging for a small generalist firm.
• Firms must prioritize time spent on sourcing new companies.
• Platform value-add services are not always effective in scaling companies.

My worst right now that I feel is on the sourcing side.

The speaker identifies sourcing as a current weakness, highlighting the difficulty in covering the market comprehensively.

I firmly believe you have to spend the majority of your time on those things to be able to find the next great one.

Time management focused on sourcing is critical for discovering exceptional investment opportunities.

most of those platform offerings are about scaling the firm themselves versus about actually scaling companies and really helping companies get to the next level.

The speaker is skeptical about the effectiveness of platform value-add services in genuinely helping portfolio companies grow.

• Simple businesses with unique insights can be highly successful.
• Market tailwinds can contribute significantly to a company's value.
• Missed opportunities can be a source of reflection and learning.

I actually think my biggest hit, least as I can best predict it, is not canva on a dollar gains perspective and on an IRR basis as well.

The speaker reflects on a successful investment in the pet food space, noting the importance of market dynamics.

I wish I could have been in both canva and Figma.

Reflecting on missed opportunities, the speaker expresses regret for not investing in Figma due to a bias towards seeing product-market fit before investing.## Embracing Lack of Control in Parenthood

• Parenthood brings a loss of control over life, with many aspects becoming unpredictable.
• The joy of parenthood is found in the randomness and surprises it offers.
• Adjusting to the lack of control and embracing it can be challenging but rewarding.

"Well, first I would say you think you have a bunch of control over your life, and you kind of do have a bunch of control over your life right now, but tomorrow you suddenly are not going to have a bunch of control over your life."

This quote emphasizes the drastic shift in control one experiences when becoming a parent. It sets the stage for understanding how parenthood changes one's approach to life and planning.

• Parenthood challenges structured individuals to become more adaptable to change.
• It is necessary to embrace spontaneity and adjust plans frequently.
• Despite these challenges, parenthood is considered an incredible gift and a unique life experience.

"You're a very structured person. It's challenging to embrace randomness and spontaneity and change your plans."

The quote reflects on the personal struggle of adapting to the unpredictable nature of parenthood, particularly for those accustomed to structure.

• Having a child strains the relationship with a partner due to reduced time for each other.
• Parenthood provides a shared purpose and can strengthen the partnership in various ways.
• It brings clarity to what matters most in life and relationships.

"Yeah, it certainly makes things harder on a bunch of dimensions. The cliche thing that people say, which is you just have less time for each other, is absolutely true."

This quote acknowledges the common experience of having less personal time with a partner after having children, highlighting a universal challenge of parenthood.

• Parenthood affects time management and investment decisions due to the increased value placed on time.
• Being a parent may lead to reduced productivity but also requires presence and efficiency during work hours.
• Balancing work commitments with parental responsibilities is a struggle many parents face.

"It does in the sense that my time obviously matters more than ever. And that's only going to continue being the case in my life."

The quote reveals how parenthood has heightened the speaker's awareness of the importance of time, influencing his professional decisions and personal priorities.

• The speaker feels content with the timing of having children, having accomplished much in their 20s.
• There is no regret about the age at which they became a parent.

"I don't think so. I was 32 when we had our daughter Shreya, and I got a lot done in my 20s."

This quote conveys satisfaction with the speaker's life progression and the timing of starting a family, suggesting a personal sense of fulfillment.

• The speaker has become skeptical about AI-first investment opportunities due to hype and competitive noise.
• Concerns include overvaluation, market saturation, and the ability of foundational AI models to fulfill use cases without additional application layers.
• The speaker notes the importance of discerning between genuine enterprise adoption and superficial testing of AI products.

"AI as being a very, very interesting category to I honestly don't know if there's great AI first opportunities for us at footwork to invest in and that's because of just the insane hype cycle around it at the moment."

This quote captures the speaker's shift in perspective regarding AI investment opportunities, emphasizing the influence of market hype on investment strategy.

• The speaker criticizes the use of assets under management (AUM) as a metric for venture capital success.
• Smaller funds often outperform larger ones, making AUM a vanity metric.
• The speaker values metrics that reflect actual returns over the size of funds raised or enterprise value of portfolio companies.

"I think AUM is the stupidest thing to talk about as a venture firm, because back to what we were talking about earlier, small funds outperform larger funds."

The quote criticizes the focus on AUM in the venture capital industry, suggesting that performance should be measured by returns rather than fund size.

• The speaker regrets participating in pro rata investments that were not sufficiently de-risked.
• The firm has reserves for strategic follow-on investments and to support portfolio companies when necessary.
• The speaker emphasizes the importance of being disciplined with reserve deployment, especially in a challenging market.

"Doing our pro rata in companies that quickly raised another round at a huge step up from where we first invested, because fundamentally there was very little derisked."

This quote highlights a past mistake in investment strategy, where the speaker reflects on the importance of risk assessment before committing additional capital.

• The speaker expresses respect for Union Square Ventures (USV) and IA Ventures for their collaborative approach and disciplined investment strategy.
• USV, in particular, is admired for its quiet success and lack of self-promotion during significant events like Coinbase's IPO.
• These firms are recognized for knowing their strengths and maintaining investment discipline.

"USV doesn't get the credit that it deserves. It should be in that pantheonic greatness that sort of sequoia and benchmark are typically put in."

This quote shows the speaker's high regard for USV, suggesting that its achievements and approach to venture capital deserve more recognition.

• The speaker envisions Footwork growing by adding one or two equal general partners.
• The firm aims to maintain a focus on supporting exceptional founders and companies over the next decade.
• Success is defined by the impact and scale of their portfolio companies, not just financial returns.

"We hope that we get to work with a handful of katrinas, of Melanie Perkins from canvas, of Jonathan Reggae's, from the founders dogs. We hope to work with a handful of those folks over the next ten years."

This quote outlines the speaker's aspirations for Footwork, emphasizing the desire to collaborate with transformative entrepreneurs and build lasting companies.