by Scott Kupor
For the sake of keeping this book focused on understanding how venture capital works, we are going to assume you have what it takes to get a meeting with a VC who invests in your market. So let’s time travel a little and cut straight to the scene where your first meeting with a VC is booked.
What Goes into the Pitch?
Before you show up for your meeting, let’s demystify the pitch process by remembering and applying some of the things that we’ve talked about already in this book. Recall that we talked about what motivates VCs and how they evaluate investment opportunities (not the least of which is remembering that they are humans, a lot like you, and they are looking for a good financial outcome).
On the motivation front, VCs are incented by their LPs to produce outsize returns (“alpha” in the finance world) relative to the alternative uses for which LPs might invest that capital. The implicit bargain between the LP and the GP (the VC) is that LPs will lock up their capital for ten or more years to give the GP the time to realize those returns in the form of acquisitions or IPOs of portfolio companies. And remember our batting average analogy—most of what VCs invest in will not yield much, if at all, in the way of financial returns. It is those few home runs that return ten to twenty-five times, or more, of the VCs’ invested capital that will make or break their business.
So your job as an entrepreneur is simple: Convince a VC that your company has the potential to be one of those outliers. That’s it. Piece of cake, right? Okay, so, how can you do that? Go back to the first principles we discussed earlier about the evaluation criteria VCs are likely to apply to early-stage investment opportunities.
Pitch Essential #1: Market Sizing
Let’s start with market sizing, because it’s really the first and biggest factor that you need to help a VC understand. It is your job to lead the VC to the water. It’s your job to be a patient and inspiring teacher here. Don’t assume the VC understands the market or its potential size. You need to paint the picture for them that enables them to answer the “so what?” question. That is, if I invest in this company, and the CEO and her team do everything they say they are going to do and build a nice business, can that business be big enough to really drive an outsize return to my fund? Will it ultimately be big enough and material to accomplishing my objectives as a VC?
We mentioned Airbnb earlier in the context of discussing market size to illustrate that the answer to this question might not always be obvious. Now let’s look at Lyft as a way to show how you can best position market size as an entrepreneur.
When Lyft was getting started (Lyft actually started as another company called Zimride, a long-distance ride-sharing company), it wasn’t obvious how big the market for ride-sharing could be. A lot of people evaluating the financing opportunity started with the existing taxi market as a proxy for market size and made some assumptions about what percentage of that market a ride-sharing service could reasonably capture. That line of thinking was perfectly logical, but the entrepreneurs didn’t stop there.
Rather, they made the case—convincingly at least to us at Andreessen Horowitz—that that line of reasoning was too myopic. Instead, Lyft argued that the taxi market was too limiting because people made assumptions about the availability of taxis, the security of taxis, and the convenience of hailing taxis in choosing whether to in fact order a taxi. If you closed your eyes for a moment and imagined a world in which everyone was walking around with a fully networked supercomputer in their pockets with GPS tracking, which is exactly what a smartphone is, then the market size for on-demand car sharing could be much larger. After all, drivers who couldn’t afford to purchase a taxi medallion could just use their own cars to increase the supply of available drivers, and this increase in supply would therefore dramatically increase the convenience of utilizing the service for consumers. Increased supply would drive increased demand, which would in turn drive more supply into the market. You get the picture—a true network-effects business.
Network effects of course don’t exist in every market, but this line of reasoning could be (and has been) applied to lots of pitches to VCs. For example, if cancer screening techniques improved to the point that they are materially less invasive and have a higher predictive value relative to current screening modalities, people might get cancer screenings as part of their annual physical exams, and the market for early-stage cancer screening could become orders of magnitude bigger than it is today. That was a key part of the investment thesis when we invested in a company called Freenome, which is using machine-learning technologies to identify early-stage cancers from blood tests.
Many startups are going after existing markets, which may themselves already be quite large. In that case, your job as an entrepreneur is to fit yourself into that market and explain what macro trends are evolving in that market that create an opportunity for you to own it.
An example from our portfolio is Okta, which is a now-public company that we first invested in back in 2009. Okta is an enterprise software company that provides a way for companies to consolidate log-in credentials for their many software-as-a-service (SAAS) applications. For example, many modern companies use Gmail, Salesforce, and a variety of other internet-based SAAS applications, each of which has its own method of logging in and authenticating users into the applications. Okta provides a unified portal whereby a user needs only to log in to Okta once, and then Okta passes those credentials through to all the SAAS applications for which an employee is granted access.
When we invested in Okta in 2009, such a solution already existed. Microsoft had developed a software package called Active Directory that did what Okta was proposing to do, but for traditional applications that were managed and maintained inside the IT environments of most major companies. And they were by far the market leader.
But what Okta convinced us of was that there was a change in the existing market landscape that created an opportunity for a new company to take over. Traditionally, the number of applications that an enterprise could deploy was limited by the amount of available IT staff in the enterprise; every application had to be implemented and supported by the internal IT staff of the organization. What the advent of SAAS applications enabled was the lifting of this constraint and thus the potential for a proliferation of applications within the enterprise. The marketing department could now use applications that were different from those used by sales or engineering or HR, precisely because these were SAAS applications that were managed by the SAAS vendors themselves versus by the enterprise’s internal IT staff.
This proliferation of disparate applications, Okta suggested, would give rise to the need for a new way to manage access to and security for these applications. And thus a new company could be created to take advantage of this market opportunity. We bought the argument and invested in Okta. It’s now a more than $5 billion market capitalization public company because their vision of how the market would develop was in fact correct.
Sometimes as an entrepreneur you have the hard job of positing the creation of a market that develops as a result of a new technology. For example, we were seed investors in 2010 in a company called Burbn—that is the correct spelling, and they were not creating a new adult beverage. Burbn originally started with a different product focus but ultimately developed into a photo-sharing application for the iPhone. The iPhone, of course, had been invented only three years prior, and the smartphone category was not nearly the size that it would ultimately become.
So the market-size challenge in this case was to build your argument on two assumptions: (1) this iPhone thing would really become a dominant global computing platform, and (2) photo-sharing would be a killer app for the platform. People of course had shared photos before the advent of the iPhone, but that market size would never get a VC excited about this investment. So for a VC to make the investment decision, she would need to forecast that iPhones would be big and that photo-sharing would be enabled in a way by this ne
w technology platform so as to create its own big, new market. And then you’d have to assume that there would be some way to monetize photo-sharing. This last piece, I think—if most VCs are being honest—was a complete unknown at the time, but it was not a crazy hypothesis that if you can amass billions of photos that are being shared among millions of people, there ought to be some way to make money from that.
Lucky for us at Andreessen Horowitz, we took the leap on market size and invested in Burbn. Two years after we invested, Facebook acquired the company—now named Instagram—for $1 billion.
Pitch Essential #2: Team
Next up in your pitch, and what matters to the VC, is team. Once you’ve established that the market opportunity is in fact big, the real question for a VC now becomes “Why you?” That is, “Why do I want to back this set of entrepreneurs versus waiting for the next set that might walk into my office tomorrow tackling the same idea?” After all, ideas are a dime a dozen; execution is what sets the winners apart from the pretenders.
Recall that there’s not a lot for a VC to diligence at any early stage; much of the analysis is qualitative. But team is one area where VCs can truly dig in.
As uncomfortable as it may be, you need to spend a significant amount of time in your pitch talking about you as the CEO and the rest of your team. In particular, what makes you as a person uniquely qualified to win the market? Some entrepreneurs are hesitant to do this, and believe that touting one’s own abilities is a form of self-aggrandizement. But VCs don’t see it that way; rather, they view this as a way to learn about the unique set of skills you have that will make you best suited for the opportunity at hand.
It’s not an exercise in boasting but rather an exercise in helping the VCs assess your fitness for the role you are proposing to take on. Thus, you should relate your prior accomplishments or experiences to the current business you are pitching—what do they say about your likelihood of success in the current venture? Don’t be shy to talk about your failures—after all, experience is what you get when you don’t accomplish what you set out to do—and relate what you learned. VCs love infinite learners.
In 2010, we invested in the Series A round of financing for a new startup called Nicira. The company was a pioneer in the area of software-defined networking—essentially the idea that much of what hardware had traditionally done in networking (dominated largely by Cisco) could be done via software. We believed in the market opportunity, so the logical question to be addressed was whether this team was the right one. After all, we knew that, given the size of the opportunity, the market would attract multiple companies into the space.
Martin Casado was the consummate founder for this business. He had spent his early career at the CIA building out the foundations for software-defined networking and then went to Stanford to earn his PhD in the same area. His doctoral thesis was the seminal paper on the topic. There couldn’t have been better founder-market fit. And so we invested in Nicira, which was ultimately acquired by VMware for $1.25 billion. And then after spending several years at VMware running the business division into which he was acquired, Martin joined Andreessen Horowitz as a general partner.
We talked earlier about Okta in the context of our market size discussion. In addition to going after a great market, Okta was founded by two individuals with a perfect fit to their market opportunity. Todd McKinnon, the founding CEO, had spent most of his professional career running engineering at Salesforce, the pioneer in the SAAS market. Through this role, he experienced firsthand the challenges that many of Salesforce’s customers were having in managing the various SAAS applications they were using. His partner and founding COO, Frederic Kerrest, was also a Salesforce alumnus, having spent his career there learning how to sell the SAAS value proposition to potential customers. The combination of these two skill sets—a deep technical understanding of the problem to be solved, coupled with the knowledge of how best to develop the right sales and marketing strategy (we often call this strategy “go-to-market”) in a still nascent SAAS market—made Todd and Frederic the ideal founders to back in this space.
Understandably, not everyone is going to have a PhD in the area in which they want to start a company, but you do need a convincing story as to why you are the best fit to start a company in a competitive market. Perhaps the business requires a certain skill set in sales and marketing that you have mastered in a previous role. Perhaps you encountered the very market problem you are endeavoring to solve organically through your own experiences and felt compelled to build a company around this idea. Or maybe you have a special skill that enables you to tell stories in a compelling way—not tall tales, but a way to articulate a vision that is likely to lead employees, customers, and financiers to want to come along for the ride.
We were fortunate enough to see the pitch for the Series A round of Square, a financial services payment company that has gone on to become a $25 billion public company. Unfortunately, we were not lucky enough to make the decision to invest in that round. What did we miss?
Well, at the time of the A round, Jack Dorsey, the cofounder of Twitter, was not the CEO of Square. Instead, his cofounder Jim McKelvey was the CEO. Jim was a friend of Jack’s from his hometown of Missouri and had previously been a professional glass blower. Jim was frustrated by the fact that he could sell his wares by accepting cash only at the country fairs where his finished products were featured. Jim and Jack thought there should be a way to enable credit card transactions for small, often sole proprietor, merchants. Thus, the idea for Square.
Great organic founder-market fit: the solution was derived from a personal experience of hardship, around which the entrepreneur felt compelled to build a company. However, we didn’t know Jim nor did we have a good way to evaluate his skills as a CEO for the company, and we wondered whether Jack might prove to be a better long-term CEO for the business. And so we passed on the A round.
But we failed to appreciate two things.
The first was that Jack would realize that the best way to maximize success of the business was for him to become the CEO, something he effected a few short months after the Series A fund-raising. The second was that the star power that Jack possessed could provide the company unfair advantages in the marketplace. For example, Jack was so well-known that he was able to secure a spot on The Oprah Winfrey Show and use that as a way to tell his story to a broader audience; essentially, it was free marketing available only to someone with his brand appeal. He also was able to get directly to Jamie Dimon, CEO of J.P. Morgan, and convince Jamie to bundle the Square dongle with the J.P. Morgan credit card business in a way that generated tons of Square customers at very low cost. Again, not everyone is Jack Dorsey, but think about what skills, and advantages, you uniquely possess that will prove valuable to the ultimate development of your business.
Once you’ve successfully convinced the VCs of your fitness to the market opportunity, you still need to help them understand how you are going to build the right team around you. No matter how great a product genius any founder may be, she can’t build a large business without employees and other business partners.
So what makes you a natural-born leader, or a learned leader, that will cause people to quit their jobs and come work for you; cause customers to be willing to buy your products or services when there are many safer, established choices available to them; cause business development partners to want to help you sell your wares and penetrate new markets; and, of course, cause funding partners to want to provide you the capital to do all of the above? Maybe you’re a repeat entrepreneur and thus can point to having done all of the above before. But many entrepreneurs are doing so for the first time, so think about other leadership-like opportunities you’ve experienced before that might be good indicia of your ability to be a CEO-leader.
We talk a lot at Andreessen Horowitz about storytelling skills as a good indicator of potential success in an entrepreneur. And to be clear, we ar
e using the word “story” in its purest sense; that is, the ability to captivate an audience (whether that audience is employees, customers, partners, financiers, etc.) and take them along for the proverbial ride. We are not talking about the negative connotation of storytelling, taking people on a proverbial ride because you’re hoodwinking them.
True storytelling is a remarkable talent in so many endeavors, but particularly in a startup, where you have so little actual proof of success in the early years on which people can base their decision to join the company. Great CEOs find a way to paint a vision for the opportunity that simply makes people want to be a part of the company-building process. These same skills will help you land your first (and future) VC financing partners.
Pitch Essential #3: Product
Your product plan comes next in pitching the business opportunity. We mentioned earlier that no VC expects you to be clairvoyant about the precise needs of the market, but they are evaluating the process by which you came to your initial product plan. VCs are fascinated to learn how your brain works. We want to see the idea maze. What data have you incorporated from the market; how is it more aspirin than vitamin; how is this product ten times better or cheaper than existing alternatives?
VCs understand that your product plan is likely to pivot as you get into market and test a real product offering against real market needs, but they want to be comfortable that your process of evaluating the market needs to date is robust enough to enable you to adapt appropriately to changing market demands. Walk them through your thought process and demonstrate that you have strong beliefs, weakly held; that is, that you will adapt to the changing needs of the market but remain informed by your depth of product development experience.