Sramana Mitra: Your strategy is to not worry about the ones that are not really making it and will have to raise money with liquidation preference where you don’t have the negotiating leverage. Focus on the ones that will get to decent exit and you need three of those to make your fund economics work.
Charlie O’Donnell: Yes. I do 80% to 90% of my total investment upfront, which is a deviation from the way that most fund managers work on it. The way to think about my fund is, if you had a $100 million seed fund, what percentage of that fund goes into the seed round? If you’re following on three to one or four to one, you’re really talking about, at most, 20% of the fund and the rest of it was dollars when you double down on your winners.
Sramana Mitra: Those are not seed funds. $100 million funds are the small Series A funds that are filling in the gap of the real Series A that’s moving upstream. Right now, there are a lot of companies in the $50 million to $100 million fund size range that are trying to fill in that gap of the $1 million to $3 million Series A. It’s more the sub-$50 million that are doing the seed.
Charlie O’Donnell: Sure. Then if you’re saying that $100 million funds are not seed funds, you’re saying that First Round Capital and SoftTech are no longer seed funds.
Sramana Mitra: They’re not. They’re not doing real seed. They’re doing more of those small Series A. Series A is bifurcated to small Series A and large Series A. They’re doing the small Series A.
Charlie O’Donnell: You said it, not me.
Sramana Mitra: It’s a fact.
Charlie O’Donnell: At the end of the day, fund size definitely has an impact on the stage. It’s a matter of where you get that first check from. It can be very frustrating for a founder if funds you might have pitched five or six years ago for your first check says, “Come back. You’re too early.” I’ve never told a company that they’re too early. There’s a lot of companies that I don’t think have good ideas but too early is not something that is used in my world.
Sramana Mitra: How do you parse unicorn mania? Everybody thinks they’re going to fund a unicorn. First and foremost, there aren’t that many unicorns. Unicorns, by definition, are rare. If 500 micro VCs all want to fund unicorns, that’s a mathematically untenable equation.
The next question is, as a seed investor, you could get buried under later-stage liquidation preferences if you are playing this game of ultra-heavily funded companies. How do you protect yourself?
Charlie O’Donnell: Maybe New York is different. It does feel in the last six months that the late stage valuation chasing game seems to have died down a bit.
Sramana Mitra: It has slowed down.
Charlie O’Donnell: We’ve seen several companies go public and come down from their private valuation. I feel like the chase for the big valuation number is not as much as it was before. The other driver of that is Uber, frankly. For five or six years, there’s a huge story on the valuation of this company that got disproportionate coverage.
I’m not a late stage investor, so I don’t have any insight into their financials. But it still seems to me that whenever they go public, most of the investors will be satisfied. It does seem that we’ve reached a point where we’re not going to see eight more rounds of ever increasing valuations.
For me, I don’t really think that I could predict which companies are billion-dollar companies versus which companies are standalone’s. If you can pick a winner, you’re essentially picking something that’s a $250 million exit. What you get above that is either they happen upon a trend or they’re just funded to be big. If you look back to a company like Twitter, Twitter clearly has some value in the social ecosystem. Was it predictable to have $10 billion of value?
If you keep funding a company and you keep pouring dollars into features and sales people, you can certainly fund a company to be larger. That’s a different track. That’s not something that a VC can predict at the outset.
Sramana Mitra: That’s happening. It has happened. It is also called Death by Overfunding. We’ve covered quite a bit of that. In some cases, these are very unfortunate scenarios where a perfectly reasonable company that could have had a reasonable level of success unnecessarily died due to this overfunding and over-aggressive attempt at executing at levels that it was not structured to be.
Nasty Gal is a very good example. The company bootstrapped to $100 million in revenue and then it died.
Charlie O’Donnell: Sure. To answer about your earlier question you had about selling into rounds, it’s a fair question. If one of my companies raised a round at a billion-dollar plus valuation and it was only three years in, that would be amazing. For a $15 million fund, you have to seriously ask yourself whether you should be taking the money off the table at this point.