1Mby1M AI Investor Forum: Mark Phillips, Founder and Managing Partner at 11 Tribes Ventures (Part 6)

Sramana Mitra: The founders that are prized are founders who bring that kind of deep domain knowledge with which to build something differentiated.

Mark Phillips: Yes. You took the words right out of my mouth. As we look at our fund two portfolio, we’ve actually got eight companies in the portfolio today. Of the eight, six of them are first time founders that are coming from the industry. One’s coming from the hospitality space, and one’s coming from the supply chain space. Another spent a career in the regional bank and credit union world. Now he’s building something that is native AI enabled to help those credit unions better process business formation, wills and trusts for some of their clientele.

So, each and everyone has this deep and abiding industry expertise that is allowing them to quickly and efficiently solve a pain point and generate revenue for their customers.

This brings me to really the second point that we’re seeing. I’m curious how you react to this one.

Given where we are geographically located, we are seeing a really quick shift away from, at least in the founders, this “growth at all cost” mentality to a capital efficient cashflow breakeven and “I want to control maximum optionality for my business”.

Sramana Mitra: Good.

Mark Phillips: I think the question that begs for us as a fund is, you can’t have it both ways. You can’t have a very, very low batting average and companies that are choosing to go into this cashflow positive, more sustainable, profitable growth mechanism, largely because of that second component I just alluded to.

We have to be honest. As investors, we are ultimately capping the overall upside of the business when we encourage them to take less capital. So, what we’re building into our fund profile and into our fund modeling is actually a higher batting average.

In fund one, we believe we can achieve a 30-40% success rate across the portfolio underwriting the growth of these companies to an enterprise value of $100-$150 million at exit. I’ve had folks who have said, “Hey, that’s not venture.” And I respect that pushback. It is definitely something different than what traditional venture has looked like.

Sramana Mitra: People who know, know that most exits in software are less than $50 million exits.

Mark Phillips: Exactly.

Sramana Mitra: So, to play that game, to make money for everybody, including investors and entrepreneurs, to make money with a $50 million, under $100 million exit, you have to build very capital efficiently and get to $5 million revenue. But the trick there though, still to get that exit, there are two things you have to think about. One is you still need velocity.

Mark Phillips: Yes.

Sramana Mitra: How do you play that game of being very capital efficient, but still maintaining a certain amount of velocity that will make the company worthy of an exit?

That is the tricky part of playing this game that you are trying to play. I know a lot of investors who are playing that game. I’ve brought them on here many, many times. If you go to Udemy, I have a course called Alternatives to Unicorn Chasing ventures.

Mark Phillips: Yes, it’s good.

Sramana Mitra: So that’s that category, but you have to be mindful about the exit strategy and the velocity part.

Mark Phillips: I don’t think enough people talk about what you just shared there. The majority of software exits are sub $50 million and sub $100 million exits.

The actual statistic is, of all M&A activity in North America, over the course of the last 10 years, 96% of all exits occur sub $100 million in enterprise value.

That’s an overwhelming number. It’s that tension between lifestyle business and hypergrowth startups. What does the middle point of that spectrum look like? Those are the types of entrepreneurs and those are the types of businesses that we’re really looking to back.

Sramana Mitra: You are still probably looking for hypergrowth startups, but the reason being that to get an exit, you need growth. Otherwise, the people acquiring are not going to buy the startup. But you don’t invest gobs of money in building the channel. You use somebody else’s channel to scale. But you get it up to a point where using somebody else’s channel is going to grow you really fast.

Mark Phillips: That’s right.

Sramana Mitra: That is the game you’re playing.

Mark Phillips: That’s right. We are looking for hyper-growth founders who are building businesses that have the potential, but we aren’t injecting the rocket fuel – $10-$20million seed check that’s going to place, like I had described, unrealistic expectations on the back of the founder.

Sramana Mitra: Yes, that kills it. If you put $10-20 million out of the gate, then you cannot play this game. It takes a strong alignment, it takes a lot of conversations.

Mark Phillips: We actually have developed a handshake agreement. It’s a one page document that we’ve described and articulated as best as we can what we’re talking about here.

This tension between lifestyle business and hypergrowth mindset. What does it look like in the middle? We ask each of the founders we invest with to sign it. Interestingly enough, Sramana, we share it at about the 80% point of our diligence process. It’s actually killed a couple deals.

We send it to a founder, they read it, and they respectfully say, this is not the kind of business I’m looking to build. I want to go raise Andreessen Horowitz capital, I want to take this thing to a billion.

We shake their hand. We wish them all the best. It comes back to the whole theme of this conversation, which is build the business that’s right for you. I don’t have any judgment against those people. I wish them all the best.

Sramana Mitra: Your identity is tied to building a unicorn and being an Andreessen Horowitz funded entrepreneur, then that’s a different track.

Mark Phillips: Indeed, and it’s not wrong. It’s not the wrong track, it’s just not the track that we’re interested in. I think to answer your question, again, this is my last point.

I don’t think it’s a track that a growing and burgeoning swath of the entrepreneurial ecosystem is interested in. I think a lot of people are thinking more about sustainability, durability, and profitability.

We’re really excited to be on the front lines from an investor perspective of trying to back those types of businesses and those types of founders.

This segment is part 6 in the series : 1Mby1M AI Investor Forum: Mark Phillips, Founder and Managing Partner at 11 Tribes Ventures
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