Fear of failure is par for the course with any investment activity where big risks can mean big rewards — or serious losses if you bet the wrong way. And for VCs who invest in early-stage startups, the potential for FOMO is arguably even greater than in other forms of investing, as limited trading data means much of the decision-making comes down to conviction or gut feel. On top of that, the speed of closing a deal has changed dramatically. Rapid-fire deal-making means investors now need to handle diligence in a world where the most attractive deals can open and close in a week.
The best investors actively work to recognize and immunize themselves from a herd mentality. This week on the Kauffman Fellows Podcast, we speak with two such investors: Lior Susan of Eclipse Ventures and Wen Hsieh of Kleiner Perkins. Continuing her duties as guest host of the KF Podcast for the month of October, Renana Ashkenazi (Kauffman Fellow Class 25) implores each of them to give us a peek behind the curtain as they share their unique processes for conducting due diligence, developing conviction, getting the team onboard, and combatting investment FOMO. Tune in on iTunes, Spotify, or Anchor.fm.
This season of the Kauffman Fellows Podcast is produced in partnership with Mighty Capital. Together, we unravel what truly makes a great VC investor.
Eclipse Ventures Partner, Lior Susan On Using Conviction for Unanimous Votes
Guest host Renana Ashkenazi (KF Class 25) chats with Lior Susan, Founder and Managing Partner at Eclipse Ventures. He created Eclipse Ventures to solve the unmet needs of entrepreneurs building full-stop start-ups, and currently works to bring the full-stack approach to legacy industries and build digital bridges to the physical world. The highlights of this episode are detailed below:
On hunting as a pack and gaining conviction
Eclipse requires a unanimous vote of all partners to proceed with an investment, so creating conviction among the partners is crucial.
“From the inception of the firm, it’s been a unanimous vote — any partner can kill a deal. So naturally, you need to create conviction not only in your mind but among the partnership. We hunt as a pack; all of the partners are involved in doing the diligence to build conviction.
For me personally, conviction is the first aspect of Eclipse as a firm and as a DNA. We have grown naturally from the first fund of $125 million, we are now close to $2.5 billion, and we didn’t really change the model. You will see in a lot of our companies that we potentially start with $5-$15 million checks in the initial one, but then lead four rounds in a row and now have a $200 million position. And I think it’s hard to do it when your conviction muscles are not very developed.
You have your model and then you meet reality. Essentially supply and demand, and right now there’s about 100x more demand than supply; there’s much more capital than great companies, and that problem is just getting worse by the day, and you need to take that exercise on how to build conviction and put it on steroids.”
On the importance of following your gut
In a high-tech world and a Silicon Valley-based firm, it might be easy to assume that Eclipse relies on tech for choosing deals. That’s not the case.
“In our case, it’s 90% art and 10% science. We don’t believe in AI for investing. That’s great, but it’s only supportive of my conviction that’s being built right here in my gut.
We are still investing in people. And for me, people are going to always be gut versus brain. But I think we have checks and balances because I’m not alone in making those decisions. I have six other partners that need to show two thumbs up.”
On overcoming the feeling that his instincts betrayed him
One of Lior’s partners started with the firm at age 85 and has always emphasized ignoring the losers.
“He trained us here to not spend time thinking about our losers. Just do not, it’s all about making rushed and fast and aggressive investment decisions. And I think it goes back to the instinct that it’s fine to make wrong investments as long as you make one that’s the right one. And I think it’s human nature to highly focus on what we did wrong because we will want to see if we need to change anything…when the reality is that in this business you focus on what you did right and go put all of your time and all of your money there.”
On dealing with FOMO
We all face it in many areas of life: fear of missing out. Competition and velocity of deals all create a sense of urgency to make the deals and write the checks, even for deals that are a poor fit or worse, a terrible idea. It can be tempting to use tools and frameworks such as a thesis to find the deals that seem to fit, confirming the thesis.
“When you build a thesis, you fall in love with your thesis. If you have a hammer you just look for nails, right? And because I have the thesis, I know what I’m looking for. Anything that sounds like it, I want to drop the hammer and go in. And to be honest, I made some mistakes on investing but I had such a strong thesis and I was just looking for something that sounds familiar that maybe I was too fast to shoot and didn’t really think through the traditional diligence.”
Kleiner Perkins, Wen Hsieh, On His Framework for Achieving Conviction
In this episode, Renana Ashkenazi hosts Wen Hsieh, Partner at Kleiner Perkins. Wen specializes in hard tech investing, focused on startups that use hardcore science and engineering in their software. Wen considers himself a cofounder-type investor as he is willing to roll up his sleeves to build the company. The highlights of this episode are detailed below:
On his criteria for achieving conviction
As an investor in hard tech, Wen has certain criteria that lead his journey to conviction.
“The first of course is not violating any basic principles of physics or chemistry, because no matter how much conviction you have, you can’t violate those rules. Even if you have a black turtleneck, if you jump off a building, you still fall at 9.8 meters per second squared.
The second bucket we tend to think about is sort of a hierarchy of investment potential. First here is that the market exists, because no matter how enthusiastic you are, it’s hard for an individual VC or one small company to create a market, right? Is the advantage that you think is there sustainable? Because you can be very enthused, you can have a lot of conviction, but the advantage may not be enduring. I think bike-sharing in China was a good example. There are basically no barriers to entry. That’s the second criteria.
The third is that the team needs to understand the market and advantage. Oftentimes you have people who have a very superficial knowledge of the industry dynamics, and I would say that biofuels are a good example. In the early days when we funded biofuel ventures, the scientists or the entrepreneurs knew biofuels; however, they didn’t understand the distribution system of fuels. This ultimately was a key part of their demise, because they couldn’t get their biofuels into the normal fuel distribution system. So the third criteria are entrepreneurs who understand the market.
I would say the fourth criteria is that the terms are reasonable. You can have conviction and passion, but if you have to pay a billion dollars you’re going to need a $10 billion outcome to give an average venture return. So the terms should be reasonable.
And the fifth, I would say is the passion of the investor, particularly the sponsoring partner. You can divorce your wife or your husband, but you can’t divorce a portfolio company. So if you sign up for it, you’re in it for a 10-year haul, so you better be pretty passionate about the entrepreneur, the market, the technology, the team, and everything.”
On the value of a prepared mind
Working deliberately is appealing to some and not so much to others. Wen is in the camp of using a deliberate approach.
“There are ventures that I’ve been looking for for a while, for example, in robotics, where I want commoditized hardware. I’m looking for a large addressable functionality, not a robot that just picks one thing but can pick a variety of things. I’m looking for low cost to compete with labor, I’m looking for a SaaS-type business model.
So, if you have these criteria that you’re looking for, and you see the venture, your mind is prepared. And with a prepared mind, your velocity to conviction, and even your degree of conviction will become more pronounced.
On how process facilitates conviction
As we all know, velocity has increased in VC over the last few years, which is a challenge. Smaller firms may adapt more quickly, and large firms may not. Is increased velocity positive?
“I think it’s hard to deal with, especially for bigger firms that traditionally have more process. And you can argue whether the process is good or bad. But I think a process helps you build conviction, but the process is also communication. It brings your other partners up to speed. And ultimately, if you make an investment, you want the firm signed up, right? Because that’s a key part of the value-added.
But admittedly, it’s very hard. A prepared mind for sure is helpful. I would say that where I’ve had to be in a rush, but I’ve still made the decision in a shorter time with similar conviction, a lot of that was helped by the prepared mind. And knowing what I was looking for or having spent time in the sector.”
On how time compression favors the prepared mind
Velocity is a double-edged sword. Firms without clear direction can end up chasing deals that they don’t understand, or that don’t adhere to any sort of business model.
“I think that the time compression to decision making will not favor those that are just sort of spraying and praying. They are looking around randomly for stuff because they’ll find it harder to get to conviction, or potentially they might make bigger mistakes because they don’t really understand what they’re getting into. But for the prepared mind, I think that the time compression is an advantage.”
On the value of team
The statistics show that we are more often wrong than we are right in this line of work. Wen found a way to shatter statistics.
“We are in a business where we are typically more wrong than right, and maybe the best we can hope for is not making the same mistake twice. This is where a team is very valuable. One can’t expect in his lifetime to have covered all mistakes. But as a team, you might be able to help each other cover 80% of the mistakes that one might see in a venture.”