20VC Why The Days of Spray and Pray at Seed Are Over, How To Compete In A World of Sequoia Seed Funds & Why Price Doesn't Matter with Dan Scheinman, Angel Investor @ Zoom & Arista Networks



In this episode of "20 Minutes VC," host Harry Stebbings interviews prominent angel investor Dan Scheinerman, known for his investments in transformative companies like Zoom and Arista Networks. Scheinerman shares his journey from an 18-year tenure at Cisco to angel investing, emphasizing the importance of backing mature entrepreneurs and adopting a contrarian approach to identify overlooked opportunities. He discusses the changing landscape of tech acquisitions, the decline in IPOs, and the challenges of early liquidity for investors. Scheinerman also critiques the over-reliance on "pattern recognition" by venture capital firms, advocating for more diversity and a focus on the EQ of entrepreneurs over pure product metrics. He concludes by highlighting his recent investment in cybersecurity firm PsyCognito, praising its innovative approach and clear go-to-market strategy.

Summary Notes

Introduction to the 20 Minute VC Podcast

  • Harry Stebbings introduces the podcast and encourages listeners to engage on Instagram.
  • Harry Stebbings is the host of the 20 Minute VC podcast.
  • Harry Stebbings promotes the podcast's Instagram account for sharing the interview schedule and soliciting audience questions.
  • Harry Stebbings' Instagram handle is H. Debbings 1996 with two B's.

We are back for another week in the world of the 20 minutes VC with me, Harry Stebings and I'd love to see you on Instagram where check this out.

Harry Stebbings invites listeners to engage with the podcast on Instagram for updates and participation.

Guest Introduction: Dan Scheinman

  • Harry Stebbings actively pursued Dan Scheinman to appear on the show.
  • Dan Scheinman is a prominent West Coast angel investor.
  • Dan Scheinman's portfolio includes Zoom, Tango, Tom Foolery (acquired by Yahoo), and Arista Networks (which IPOed).
  • Dan Scheinman is also on the board of Arista Networks.
  • Prior to angel investing, Dan Scheinman had an 18-year tenure at Cisco, including roles as Senior VP of Corporate Development and General Manager of the Cisco Media Solutions Group.

But being such an admirer of our guest today, I for sure did hear here and I'm very excited to welcome Dan Scheinerman.

Harry Stebbings expresses admiration for Dan Scheinman and excitement about having him on the show.

Dan Scheinman's Background and Foray into Angel Investing

  • Dan Scheinman has been involved in Silicon Valley since the late 1980s.
  • He worked at Cisco after its IPO and witnessed its growth to $40 billion in revenue.
  • Dan Scheinman learned from both the positive and negative aspects of big companies.
  • After leaving Cisco, Dan Scheinman wanted to return to the essence of Silicon Valley: creating something from nothing.
  • Providing capital to help friends realize their dreams was a way for Dan Scheinman to contribute to company creation.

So, Harry, I've been around this world for a long time. I really fell in love with this notion, this sort of romantic and incredibly difficult notion of company building.

Dan Scheinman shares his passion for company building and his extensive experience in Silicon Valley.

Portfolio Construction and Angel Investing

  • Dan Scheinman challenges the belief in highly diversified "spray and pray" portfolios at the seed stage.
  • He observes that while company creation has surged, exits have been declining, particularly IPOs and large M&A.
  • Large companies are less interested in tech and talent acquisitions, which affects early investors.
  • Dan Scheinman focuses on finding companies that can provide disruptive returns for sustainable investing.
  • He believes in achieving big exits to provide the necessary returns to continue angel investing.

And the reality is that for a long time, the exits have been declining and they've been declining at late stage, because for whatever reason, ipos are down, large m and a is down.

Dan Scheinman discusses the decline in exits, which impacts the traditional portfolio construction strategy for angel investors.

Use of Secondaries in Angel Investing

  • Dan Scheinman is more traditional and cautious about participating in secondaries.
  • He believes that significant returns often come late in a company's journey.
  • Dan Scheinman prefers to support management teams through ups and downs without selling too soon.
  • He uses his own capital for investing and aligns with entrepreneurs for the long term.

So I tend to believe that a lot of returns are there late. If you can hold on for that last bit of return, it's where you see a tremendous amount of return.

Dan Scheinman explains his strategy for achieving returns by holding investments until later stages rather than selling through secondaries.

Tech and Talent Acquisitions

  • Tech and talent acquisitions have become less lucrative for early investors.
  • Companies like Facebook, Google, and Yahoo have become more discerning and less willing to pay existing investors during acquisitions.
  • Deals often involve retention bonuses for talent, with less consideration for early investors.
  • Dan Scheinman has observed a decline in tech and talent deal attractiveness, with many transactions barely returning capital or offering low multiples.

And they became more sophisticated in the sense that they said, hey, do we really need to pay the existing investors? What we really care about is the talent.

Dan Scheinman explains the shift in tech and talent acquisitions where acquiring companies prioritize talent over compensating early-stage investors.## Employee Retention Challenges in Tech Companies

  • Existing employees may feel undervalued when new hires receive substantial retention packages.
  • Companies have become more sophisticated in their approach to retention and have reduced the volume of deals due to internal blowback.

"Some of the existing employees felt, hey, why is this guy who hasn't done anything getting now this massive retention? And so what I have seen has been that both they have gotten more sophisticated in what they do and then that they have had this blowback internally that have made them rein in the number of deals, just the pure volume of deals they're doing."

The quote highlights the discontent among current employees when new hires are offered large retention bonuses. It also indicates that companies are adjusting their strategies to mitigate internal dissatisfaction by reducing the frequency of such deals.

Venture Capital Shift to Seed Market

  • Established venture capital firms like Sequoia and Founders Fund are returning to seed investing.
  • This shift impacts angel investors by increasing competition and necessitating a more focused investment strategy.

"Easier with that lack of liquidity and reduction in M&A, we've seen also recently a real return from the likes of Sequoia founders fund into the seed market again."

The quote reflects the trend of prominent VC firms moving into the seed investment space, which has implications for liquidity and the dynamics of mergers and acquisitions.

Strategies for Angel Investing Amid VC Competition

  • Angel investors must identify niches and opportunities that may be overlooked by large VC firms.
  • Being contrarian and focusing on unique investment theses can help angel investors remain competitive.

"So you have to be increasingly a contrarian in order to try and be successful in a world where Sequoia and others are going to be aggressive."

The quote emphasizes the need for angel investors to adopt a contrarian approach to find success in a landscape where major VC firms are actively investing in early-stage companies.

Venture Capital Engagement with Seed Investments

  • Venture capital firms may not always commit significant time to seed investments, which can lead to opportunities for angel investors.
  • Market dynamics can influence the level of VC engagement with their seed-stage portfolio companies.

"A lot of these VCs in the earlier mania didn't spend any time with their seed investments because it consumed a lot of time."

The quote suggests that VCs may neglect seed investments due to the time investment required, potentially leaving a gap for angel investors to fill.

Advice for Founders Considering Multistage VC Money

  • Founders should assess the true commitment level of multistage VCs at the early stages of their company.
  • It's crucial to understand the implications of accepting seed funding from multistage VCs for future funding rounds.

"The question at the end of the day is going to be? How really committed are they to you at the early stage?"

This quote advises founders to critically evaluate the dedication of multistage VC firms to their early-stage ventures before accepting investment.

Time and Energy Investment in Portfolio Companies

  • Angel investors like Dan Scheinman focus on business strategy and operational challenges rather than technical aspects.
  • Acting as a "chief focus officer," Scheinman helps startups concentrate on critical goals to prepare for future funding rounds.

"So I spend most of my time on the business side and on strategy."

The quote reflects Scheinman's role in guiding startups through strategic decisions and business challenges, leveraging his strengths to support their growth.

Runway and Leverage in Fundraising

  • Entrepreneurs should secure sufficient runway to have leverage in negotiations for Series A funding.
  • Having ample funds allows startups to reach milestones and maintain a strong bargaining position with investors.

"I believe that the reality is that you want as much Runway as possible in order to have as much leverage when you get into that a round."

The quote advises entrepreneurs to raise enough capital to avoid desperation during fundraising, thereby maintaining leverage with potential investors.

Investment Thesis and Contrarian Approach

  • Contrarian investing involves seeking opportunities that the market undervalues or overlooks.
  • Focusing on areas with less competition and where the current market sentiment is negative can lead to outsized returns.

"I am a contrarian. I'm an actual contrarian."

The quote illustrates Scheinman's investment philosophy, which involves taking a contrarian stance to identify and capitalize on undervalued opportunities.

Value Destruction and Founder Drama

  • Founder drama is a significant source of value destruction in VC portfolios.
  • Mature founders may present fewer risks in terms of interpersonal conflicts, potentially making them more attractive to investors like Scheinman.

"Founder drama would have to be way up there. When you look, where does founder drama occur?"

This quote points to the prevalence of founder-related issues in venture capital and suggests that investing in more experienced founders might reduce such risks.## Founder Drama in Startups

  • Young teams often lack prior work experience together, leading to concerns about roles and team construction.
  • Even mature teams can experience severe conflicts, such as founders wanting to see each other dead.
  • Less founder drama occurs in teams where members have prior work experience together, leading to established roles and hierarchy.
  • Reducing time spent on founder drama increases productivity for investors and companies.

"They didn't have prior work experience and they didn't understand how to construct a team, and they spent a lot of time worrying about their roles in mature teams."

This quote emphasizes the challenges inexperienced teams face in defining roles and constructing a cohesive team, which can lead to significant internal conflict.

"I spend probably 20% of my time or less on founder drama, and that provides a huge productivity uplift to me and to the companies."

Dan Scheinman explains that by working with more experienced teams, he can minimize the time spent on resolving founder conflicts, which benefits both his productivity and the companies' progress.

Seed Investing Philosophy

  • Seed investing involves a blend of art and science, with a focus on the entrepreneur's qualities, such as grit and drive.
  • Assessing an entrepreneur's ability to hire and inspire loyalty can be more important than the product or market at the initial stage.
  • Dan Scheinman's investment in Zoom was driven by his strong belief in the founder, Eric Yuan, rather than the product specifics.
  • A great leader is believed to be capable of achieving success regardless of market dynamics.

"And the art is you have to be able to look at that entrepreneur and say, do they have grit, do they have drive?"

Dan Scheinman describes the 'art' aspect of seed investing, which is the ability to assess an entrepreneur's personal qualities that contribute to their potential for success.

"When you have a great person, I believe they're going to get to great places."

This quote captures Dan Scheinman's investment philosophy, where the entrepreneur's capabilities and character are prioritized over the initial product or market conditions.

Emotional Quotient (EQ) in Investment Decisions

  • Dan Scheinman claims that 70% of his investment decisions are based on EQ and his personal belief in the founder.
  • While the industry often focuses on the 'science' of measurable factors, Scheinman believes that the 'people' aspect is more crucial for success.
  • Despite industry trends, personal conviction in an entrepreneur's qualities remains a key driver in his investment strategy.

"But truth is it's 70% of it is really the EQ because this is all about the people."

Dan Scheinman reveals that a significant portion of his investment decision-making is based on emotional intelligence and personal connection with the founder, rather than just analytical data.

Deal Frameworks and Preferences

  • Dan Scheinman expresses a preference for price rounds over convertible notes due to their simplicity and clarity.
  • The safe (Simple Agreement for Future Equity) is preferred as a second option because it mimics a price round.
  • Scheinman criticizes convertible notes for their potential complications when conversion does not occur as planned.

"My preference is a price round if possible. And so I tend to like the safe because it mimics a price round and it's generally simple and clear."

This quote outlines Dan Scheinman's preference for investment structures that are straightforward, favoring price rounds and safes for their clarity in investor rights and obligations.

Price Sensitivity and Investment Strategy

  • In his experience at Cisco, Dan Scheinman found that in successful deals, the price was not a significant factor compared to the impact of the people involved.
  • While excessive bad deals can harm aggregate returns, missing out on a highly successful deal is considered a greater loss.
  • Scheinman acknowledges the difficulty in balancing price sensitivity with the potential for high returns, especially during market highs.

"One, in the best deals, price didn't matter because your returns were so incredible that negotiating over price just didn't matter."

Dan Scheinman shares insights from his time at Cisco, where the ultimate success of investments was not heavily influenced by the initial price, but rather by the people and their performance.

Reserves and Follow-on Investments

  • Angel investors should have the financial strength to support startups through initial challenges.
  • Scheinman debates between investing in follow-on rounds versus seeking new disruptive seed deals.
  • Founders of successful startups may prefer not to offer pro rata to angels to make room for new investors.
  • The decision to reserve financing is complex and varies based on the potential returns and the specific circumstances of each deal.

"I do believe that the angel investors, you want to have a coalition of folks who can carry you in the event there's a stumble."

Dan Scheinman discusses the importance of having a supportive group of angel investors who can provide financial backing during a startup's early stumbling blocks.

"I generally have tried to say, okay, I'm going to focus back on seed deals because I think those offer higher potential returns than investing in the a round of some of these companies."

This quote reflects Dan Scheinman's strategic preference for seed deals over follow-on investments, based on his assessment of where the higher potential returns lie.## Importance of Analytics in Business

  • Michael Lewis's "Moneyball" is highlighted as a significant business book.
  • The book emphasizes the importance of analytics in assessing talent in the sports industry, which is applicable to other sectors.
  • Dan Scheinman believes in the necessity of combining traditional observation with data analysis for better decision-making.

"Michael Lewis, Moneyball. It is one of the great business books, business fables of all time. It's really about the rise of analytics, and it takes an industry, an old industry, baseball, which I love, sports, and it basically says, looking at them through your eyes only yields a certain set of data. You have to look at the data as well."

The quote explains the central theme of "Moneyball" and its advocacy for data analytics in addition to traditional scouting in sports, which can be extrapolated as a business principle.

Personal Growth and Strengths Focus

  • Dan Scheinman recounts a transformational experience from basketball camp, emphasizing the importance of playing to one's strengths rather than over-focusing on weaknesses.
  • The lesson learned is that accentuating strengths is more beneficial than trying to eliminate weaknesses.

"And what I came to realize is it's not about focusing on your weakness. It's a waste of time and you never get good. It's about always accentuating your strength. Deal with your weakness, but don't try and eliminate your weakness."

Dan Scheinman reflects on his personal growth, concluding that it is more effective to enhance strengths than to attempt to completely overcome weaknesses.

Value of Experience in Entrepreneurship

  • Dan Scheinman holds a contrarian belief that older entrepreneurs can be as innovative and driven as younger ones.
  • He argues that their experience leads to efficiency and value creation.

"I believe that older entrepreneurs have the same or more fire sometimes than the younger entrepreneurs are as technically adept or more than younger entrepreneurs. They drive value because of their experience. They're actually more efficient, both in spend and in thinking than sometimes the younger entrepreneurs."

Dan Scheinman expresses his unconventional view that age does not diminish an entrepreneur's capability or drive, and that experience can lead to greater efficiency and technical adeptness.

Investment Decisions and Founder Dynamics

  • Dan Scheinman discusses his approach to investment, particularly when he perceives a founder is not considerate of investors' interests.
  • He shares an example where he passed on a deal due to escalating valuation without significant changes in the company, which he interpreted as a red flag about the founder's attitude.

"And what I take that as a sign that the founder doesn't really care about the investors. Really, because, okay, we started out at a 5 million valuation, now we're at a 15 million valuation, heading towards 20. And not that much has changed other than he's sensing there's a lot of interest."

The quote illustrates Dan Scheinman's cautious approach to investment when a founder seems to prioritize valuation over investor relations, which can be a signal of potential issues in the partnership.

Angel Investing Strategy

  • Dan Scheinman advises aspiring angel investors to have a clear investment thesis.
  • He emphasizes the importance of knowing what types of deals to pursue and to avoid, and being able to defend one's investment thesis.

"And I think to be a successful angel investor, you have to understand that clear thesis, and that clear thesis has to tell me what kind of deals you won't do, as well as what kind of deals you will do."

The advice underscores the necessity for angel investors to have a well-defined investment strategy that guides their decisions and helps them avoid unfocused, risky investments.

Diversity in Large Funds

  • Dan Scheinman advocates for increased diversity within large investment funds.
  • He believes diversity can improve the breadth and depth of market understanding and enhance the core investment thesis.

"I would like to see large funds become more diverse. I'd like to see them become more gender diverse, and I think it would be good for them. And I think it might also enhance their core thesis and it provide them more breadth and depth in the market."

This quote emphasizes Dan Scheinman's view that diversity is not just a social imperative but also a strategic advantage for investment funds.

Investment in Psycognito

  • Dan Scheinman describes his recent investment in Psycognito, a cybersecurity company.
  • He was impressed by the founder's presentation and unique approach to identifying system vulnerabilities.
  • The founder's understanding of product-market fit and fundraising goals was particularly compelling for Dan Scheinman.

"And he understood. My job here is product market fit. My job is to raise an a round and these are the metrics I'm going to get to in order to prove product market fit and in order to raise an a round."

The quote highlights the importance of a founder's clear vision and strategic planning in gaining investor confidence, as demonstrated by the Psycognito founder's approach to building and funding his company.

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