In Defense Of Theranos

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This post originally appeared in TechCrunch.

Theranos was once hailed as a miraculous advance in medical technology, but is now reportedly “melting down” based onextensive reporting done by the Wall Street Journal’s Pulitzer Prize winning journalistJohn Carreyrou.

Walgreens, Theranos’ flagship partner, has announced it’s suspending their rollout of new labs pending an investigation of their technology and grocery giant Safeway announced that it’s canceling a roll out of Theranos clinics, a deal worth an estimated $350M.

I’m not an investor in Theranos, have never met Elizabeth Holmes, but I have co-founded two companies in regulated industries that required dealing with the FDA, EPA and other government agencies.

I feel for Ms. Holmes and believe the press accounts unfairly paint her company in a negative light. Innovation that involves sensitive medical technologies is challenging and provokes strong emotional reactions, but the reality is that the strongest criticisms of Theranos have more to do with business structure than their blood tests.

Theranos’ biggest “mistake” was running two businesses at once.

Rule #1 of startups is focus. Theranos is breaking this rule by running a commercial blood testing lab, similar to Quest Diagnostics and LabCorp, and a ground-breaking R&D company at the same time.

Getting to market quickly with off-the-shelf technology generates revenue and buzz. It also creates confusion—Do you focus on increasing revenue or spend on R&D milestones like clinical trials? And which story do you lead with? This internal confusion often bleeds through to the public.

Theranos is running two fundamentally different businesses. It’s one thing for an established company like Google to have a core business like Search and simultaneously run a self-driving car program. It’s harder for startups, even well-funded ones to do the same.

Compare Theranos to Moderna, another biotech Unicorn that is laser focused on trying to create a new class of RNA-based therapies. This Boston based company has nearly $700M in funding, and I’m sure they could launch a revenue producing product line, but that’s not their goal. As a result their profile may be lower in the press, but they’re not subject to any scathing reports.

That said, I have some sense of how I think Ms. Holmes is seeking to develop the technology. Like my experience at Brontes and Sample6, I suspect Theranos is building out a model workflow that combines the myriad pieces that it takes to run a blood lab. As innovations come online, you swap out the off-the-shelf traditional technologies with the proprietary breakthrough ones. This allows for a more rapid development of really hard, unpredictable science.

The Proper Way To Evaluate Theranos

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Let’s take a step back and review what Theranos actually offers to customers.

Theranos makes it more convenient to get blood test results by co-locating in neighborhood pharmacies. They also reduce the price of testing dramatically and present the results in a prettier, easier to read format.

Theranos uses traditional lab equipment to provide most of their results. Their eventual goal is to use proprietary “nanotainers” that will allow a variety of results to be produced from a few drops of blood.

That will be awesome, but in the meantime does it matter if your Bilirubin levels are monitored with a breakthrough technology or an industry standard as long as the results are accurate? Especially if they are easier to access, afford, and understand?

Theranos’ largest competitors, Quest Laboratories and LabCorp have combined revenues of over $13B per year. If all Theranos ever did was make that industry more convenient, faster, and prettier using standard tools, isn’t that impressive enough on its own?

Asked another way, how is offering accurate, more convenient tests, at a lower cost, using industry-leading technology—while simultaneously spending tens of millions on R&D that could further reduce the cost, complexity, and pain of blood testing—a bad thing? That’s a vision I’d invest in if given the chance (at the right valuation of course!).

Let’s Translate This into Tech Terms

This becomes even more clear if you compare the Theranos model to some products we’re all more familiar with.

Uber does to the taxi industry what Theranos does to diagnostics—it makes it more convenient and less expensive while providing a much nicer user experience.

Uber CEO Travis Kalanick has also stated he’d one day like to replace many human drivers with autonomous vehicles. Is Uber truly not worthy of all its hype because they haven’t yet cracked the code on self-driving cars? Should Uber also be criticized because they didn’t invent the smartphone? Or Black Camrys?

Theranos has been accused of a bait and switch because they use a competitor’s lab equipment to run most of their tests. Is it a moral failing that Netflix is powered by Amazon Web Services? Netflix has figured out how to add value on the back of a direct competitor’s infrastructure. Does this invalidate Netflix’s business model?

Of course not. We love Netflix because Orange is the New Black is awesome and their user-experience is amazing. This is essentially what’s happening at Theranos at the moment—boring tech is being repackaged and brought to consumers for a small fee.

Reviewing The Technical Case Against Theranos

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Let’s “fact check” the technical and medical accusations. The 2,689 word WSJ feature builds two significant cases against Theranos:

First, their “breakthrough” blood testing technology is only used on one of the 150+ tests that they offer. Second, their breakthrough technology gives patients misleading and potentially dangerous results.

Case 1: Theranos supported a misleading story around their tech. True, but startups by definition should evangelize a future vision.

That only one of the tests Theranos offers utilizes their proprietary “nanotainer” is disappointing. The New York Times’ Farhad Manjoo compared the revelation to discovering that Teslas actually run on Gasoline. This is true, but so what? This a clear case of hype outpacing reality. Certainly if Theranos was a public company, they would need to be more careful with guidance, but they’re not.

It’s also important to ask who has been hurt by Theranos’ story?

Customers? Early adopters who read press accounts might have been disheartened to find the vast majority of Theranos’ tests require blood to be drawn the old-fashioned way from a vein. And the company has since changed verbiage on its website in response to the criticism. However, patients always have the opportunity to seek care elsewhere.

Investors? Theranos’ investors could plausibly be upset that the tech they backed isn’t the primary driver or focus of the business, but I suspect they were fully aware of the reality of the current business and are betting on the future vision of the company.

The Media? The most aggrieved party is the press. No doubt many of the reporters who wrote glowing profiles of Holmes surely feel embarrassed for uncritically sharing the company’s claims, but as Google Ventures partner Bill Maris noted, he never met a reporter who actually got a test to verify the startup’s claims.

Case 2: Theranos is operating without sufficient oversight.

The insinuation that Theranos was using an untested technology to give patients life and death medical results, is much more serious. I haven’t seen much evidence to back it up.

They’ve satisfied the (tough) regulations: Theranos has had their proprietary “nanotainer” technology cleared by the FDA for use in the diagnosis of Herpes Simplex. Here is the 510k that Theranos submitted to the FDA that documents “substantially similar” performance compared to a competitive system when tested on 818 patients across 69 devices. There are 22 tables worth of data backing their claims. So Theranos’ core technology works—just not as widely as anyone would like. I’ve filed a 510K—they’re a lot of work, get quite a bit of scrutiny, and aren’t cleared by the FDA lightly.

They Use Industry Standard Tools: The remainder of Theranos tests are reportedly conducted on industry leading machines made by companies like Siemens, a global conglomerate founded in 1847 that has a market capapproaching $90B dollars—not exactly fly by night technology.

Patient Anecdotes are Innocuous: Some patients have reported varying numbers, but comparing two systems to each other at different times, using different blood samples, and different processes is not scientific—even if one test is done in a lab. In order to know which machine is more accurate you need to compare both to a calibrated reference system and the appropriate ISO standard.

Dozens of articles have been written insinuating that Theranos is dangerous, but in the outrage there seems to be very little in the way of objective evidence. Sure, a few doctors have gone on the record calling the technology into doubt. The FDA spent over a week inspecting Theranos, and while they found processes that need to be improved, they apparently didn’t find evidence of safety risks that merited closing them down. And remember, the FDA had no qualms about severely hampering fellow disruptor 23 & Me.

Are There Valid Criticisms Of Theranos?

Absolutely. But most of the criticisms the company face have to do with an inability to properly convey a message.

Would Theranos Have Been Better Off in Boston?

Boston’s software scene took a massive hit when Paul Graham relocated Y Combinator from Boston to Silicon Valley, but it has never been stronger in biotech.

There are hundreds of biodiagnostic companies in Boston, both startups and Fortune 50 multi-nationals, and the spillover effects from this concentration are real. In the same way you find the best hackers in San Francisco, Boston is home to the best scientists, healthcare savvy communicators, and investors.

The healthtech cluster in Boston also largely stays away from the tech echo chamber. They know there’s a real risk in turning on the hype machine. It got Holmes huge amounts of press, but the general public takes health standards very seriously. The minute there’s a question around a diagnostic or treatment, even if only backed by circumstantial evidence and innuendo, it becomes a PR nightmare, as Theranos is learning first hand.

Nonetheless, some of these companies outside the Valley would be wise to study the Valley’s approach to evangelism to raise more money and at higher valuations.

IT and Biotech Unicorns are a Different Breed

Theranos stands out from the rest of the Billion Dollar Club as one of a few biotech companies. It gets more press than its biotech contemporaries and is often mentioned alongside companies like Uber and Airbnb. But there’s a lot of difference between these startups.

Theranos has real technical risk. There are serious question as to whether the single drop of blood can provide diagnostic equivalence to conventional test techniques. The company is over twelve years old and haven’t cracked it—this is a very challenging technical problem. Furthermore, my experience with biotech innovation is that timelines are far less predictable than software or even hardware.

Perhaps the Billion Dollar club needs to add a volatility index due to the technical risk of this company relative to the many others. It’s a lot harder to value the underlying tech at Theranos because it’s highly technical and not public. Unlike Airbnb or Uber, which consumers can see and evaluate the product themselves, Theranos is much closer to a research project. I’m not arguing whether or not it’s worth $9B—I’m simply pointing out that the metrics to evaluate this business are far different than virtually all the others on the list.

Theranos Is A Good Reminder Technology Companies Can Fail

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There has been a generation of entrepreneurs, as well as VCs and journalists, that have known a world without execution risk. Innovation outside of code compilers is messy. Read the history of DuPont and you’ll find a litany of ambitious young chemists who literally blew themselves up mixing unstable elements. The early days of progress in the pharma industry are marked by catastrophes like Thalidomide that left a generation of children deformed.

Today our concept of tech failure is the “Fail Whale.”

Software has almost no “will it ever work” risk, but rather much more risk around customer adoption. Conversely, a test that can detect say cancer more accurately or sepsis more quickly certainly would be demanded by the marketplace if the clinical evidence is shown.

Developing hardware is at least 10X harder than software and biotech is 10X harder than hardware. It’s one thing to spend all night looking for a bug in your code, try searching a 30,000 square foot clean room for rogue bacteria that have been confounding experiments.

The pharmaceutical industry spends billions of dollars every year investing in drugs that just don’t work. It might be that studies show inconclusive results, and they get killed. Or that they kill patients, and are canceled. Billions of dollars, millions of manhours all lost as a matter of course. So unless and until there is serious evidence of Theranos putting patient’s health at risk, give Ms. Holmes a break.

I’d rather have Theranos and those like her out in the world solving these problems. Go on Ms. Holmes, Mr. Musk, and others. Let’s find those breakthroughs, even if we stub our toes, or prick our fingers, in the process

Wary Of The “Next Warby”

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This post originally appeared in TechCrunch.

Warby Parker is astonishingly successful, whether you judge it by the rave reviews of customers, its valuation or, more impressively, by the number of startups that compare themselves to the iconic eyeglass innovator. Over the last couple of years, I’ve met with dozens of entrepreneurs who have pitched themselves as the “Warby of ________.”

Disrupting any category is difficult, but the consumer goods space can be one of the hardest, given the entrenched competitors, myriad channels and the need to appeal to ever-changing consumer tastes and trends. In the past, VCs rarely ventured into areas that seemed more like consumer packaged goods (CPG) than pure technology, but these lines have blurred. Some of the biggest successes here in the NYC tech scene sell glasses (Warby), mattresses (Casper) and razors (Harry’s/Dollar Shave Club).

Many of the “Warby of X” startups are attractive. The products are generally well designed. Their marketing strategies seem plausible. But so far, we haven’t invested in any. I fear that many of the more recent consumer product-oriented startups put too much stock in their ability to build a brand, or — even worse — their ability to hire an agency to build the brand for them. Strong marketing is certainly necessary, but not sufficient for building venture-scale businesses. These companies have all found something more significant, usually the industry structure itself, to exploit to their advantage.

When discussing these companies, people too often focus on the design and not enough on the deep understanding of the market structures they exploit. Slick messaging and innovative industrial design capture consumer attention, but it’s the founder’s focus on outsize profit margins that captures VC interest.

Warby Parker: Wedging Into A Vertical Market

Eye care in the U.S., and most of the world, is dominated by a Italian company called Luxottica. You’ve probably never heard of them, but they control 80 percent of the market for eyeglasses. They’ve locked up licensing deals with Oakley, Prada, Dolce & Gabbana and basically every other high-end brand to design fashionable specs. They manufacture their own glasses and have purchased or partnered with the best category retailers, including LensCrafters, Pearle Vision and Sunglass Hutto dominate distribution. They even provide optical insurance!

Like Apple, Luxottica has vertically integrated to such a degree that it’s very difficult for anyone else to compete. Luxottica has a near monopoly on eye care, and their scale makes it difficult for anyone to wedge their way into the value chain. Anyone who wants to compete needs the will, capital and connections to recreate the entire supply chain. This strategy has performed beautifully. Luxottica earned revenues of $7.6 billion in 2014 and took 68 percent in gross margin.

The eye-care market is especially difficult to crack because of the necessity of prescriptions. In the past, eyeglasses were generally purchased at the site of one’s eye doctor. Moving a prescription was cumbersome, and these eye docs often made it difficult to transfer it. No wonder the waiting rooms of many docs were filled with frames — in essence, they were running a retail practice coupled with a medical office. Because Luxottica owns many of these storefronts, they’re able to capture margin at every step of the process.

People too often focus on the design and not enough on the deep understanding of the market structures they exploit.

What Warby was able to capitalize on was the increasing ease and comfort modern consumers expect when shopping. Warby has innovated the ordering process — with online and offline try-ons, 60-80 percent cost reductions and easy returns, they were able remove the friction of buying specs online. Warbycould undercut Luxottica on cost and offer a unique aesthetic, while still retaining healthy margins.

This isn’t the case in most markets, and it isn’t easy. Warby had to go “full stack” from Day One, building, branding and shipping their glasses, but it earned Warbya healthy valuation for its efforts. Nonetheless, these important, yet idiosyncratic aspects of the eyewear industry don’t neatly cut and paste into other categories.

Casper: Innovation In Logistics

Eyeglasses and mattresses seem to be completely different product categories, but the market dynamics are very similar. The $9 billion U.S. mattress market is essentially controlled by two private equity firms who bought up the most valuable brands in the market. The companies that ran these businesses cost-engineered the products to make them cheaper to produce, for instance, by making mattresses singled-sided — which forces more frequent replacements. Mattresses are big and bulky, and rely on specialty retail locations staffed by salespeople that make used-car salesman look honest. Still, limiting competition and channels meant margins were protected. Until Casper came along.

Casper cuts through this knot by shipping a full-sized mattress in a conventional box via UPS or courier. Its memory foam design and innovations in packaging allow the mattress to be shipped without the typical hassle of scheduling a delivery, having moving guys traipse through your home and plop a mattress in your bedroom. The mattress is heavily compressed and packaged such that it expands when opened and serves as a compelling brand touchpoint — just watch one of the thousands of unboxing videos on YouTube — it’s worth it!

Casper has been able to create a differentiated product at a low cost, figure out a better way to sell and deliver, all while keeping margin along the way.

Harry’s: Owning Production Cuts Out Middleman

Like the market for glasses and mattresses, the $3 billion U.S. razor market is huge and concentrated, with Gillette and Schick accounting for 70-90 percent of sales. However, the razor business uses a completely different playbook than the one established by the mattress barons.

The two leading razor makers invest a small fortune in R&D, figuring out how to put more blades on every flat surface on the razor, adding battery-powered features and “track balls” to create the perfect “shave.” They then protected these innovations, as well as the simpler ones that actually make their razors useful, with patents — which cause prices to spiral upwards. Razors have never been better, but that fanaticism for follicle removal comes with an obscene price tag.

Enter Harry’s and Dollar Shave Club. Both companies found razors that were “good enough,” secured manufacturing relationships and built brands around them. They stripped all the extraneous stuff, sought a direct-to-consumer relationship and have captured significant market share as a result.

Most innovative companies would shy away from competing with the likes of P&G or Schick. Not Harry’s. Instead, they purchased a world-class blade production factory in Germany. They realized that while they could disrupt the $5+ retail cost of competitive blades, they needed a high-quality product. People (and their skin) are sensitive when it comes to shaving. Additionally, I suspect Harry’s has to work carefully to avoid infringing on patents, but their success of late has certainly given the big guys a bit of a market-share haircut while earning sharp valuations.

“This For That” Isn’t Enough

All three of these businesses are characterized by a small number of competitors, structural impediments to market entry and consequently high margins. Not every business shares these dynamics. The fashion market is well served, and margins are compressed at most price points. Consumer products, without benefit of a unique and defensible IP, have a difficult time in the market. Basically, if a product can be sold on Amazon, you can be sure the margin will asymptote toward zero.

In many cases, venture capital probably is the wrong funding tool — something like Kickstarter is a better fit.

If you’re going to pitch a VC a business in the mold of Warby or Casper or Harry’s, do the work to make sure you’ll enjoy similar kinds of structural advantages. Ioften ask entrepreneurs what’s unique about their industry — not how is it similar to eyeglasses or mattresses but, rather, how it’s different. Founders should bathe themselves in the nuance of an industry by attending trade shows and talking to insiders.

If you don’t have these advantages, you might get early funding, but you will have a much harder time earning the valuations those companies have enjoyed. In many cases, venture capital probably is the wrong funding tool — something like Kickstarter is a better fit.

The Gap Between Successful Startup And “Also-Ran” Is Razor Thin

It’s not surprising that investors and entrepreneurs have taken notice of their success. VCs and founders can act a bit like lemmings. The key thing to remember is that each of these businesses has unique characteristics, and simply picking a long-ignored category and following the playbook created by these startups is by no means a recipe for success — or funding.

This isn’t to say startups in more competitive markets with thinner margins can’t take lessons from Warby Parker, Casper or Harry’s. In addition to picking great markets, the teams behind them have put on a master class when it comes to building brands and executing their businesses. Mattresses were comfy or cost-effective before Casper, but they were never cool.

These companies have demonstrated that you can build a healthy business on the back of high net promoter scores and by leveraging emerging marketing channels like podcasts and YouTube. Still, it’s just really hard to build a venture-scale business in most markets absent a structural misalignment.

Im not saying we’d never back a CPG-focused startup, but we’ll need to see founders who understand the razor-thin difference between successful startups and also-rans.

How to Pitch Your Oddball Startup to VCs

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Five years ago the prospect of an eyeglass company, a coworking space and enterprise chat app each being worth over a billion dollars would have struck most people as absurd. As software eats the world we will see more companies in these “weird wonderful spaces and unusual places.” This creates new challenges for founders and investors.

At Founder Collective we like backing weird stuff. That is the goal of venture capital after all — to break convention. Sure, we’ve backed “traditional” startups like Buzzfeed, Seatgeek, and Periscope. But we’ve also invested in satellite booster rockets, a robot pharmacy, and an Internet of Things-enabled wine service. These businesses sounded weird when they were first pitched and only now is their disruptive potential being recognized.

Our belief is that the next great opportunity can come from anyone, in virtually any industry. That said, breaking through with an atypical business is harder than pitching a new consumer app or SaaS service. If your startup is slightly off the beaten path, here are some tips for framing your story:

Escape the Bucket

If you’re pitching a business in an unusual space you need to clearly point out the non-obvious truth you see in the market. You need to explain why this industry that seems weird to the average individual is actually a massive opportunity. Explain what everyone else is missing.

This is hard to do. Chris Mims of the Wall Street Journal is one of the smartest tech journalists working today. Yet a big investment from an industry-leading firm in an atypical category, hair extensions in this case, was a cause for confusion.

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Chris Sacca manages one of the best performing VC funds in the history of the business, was an investor in this particular company, and even he didn’t completely get the potential impact of the idea at first.Screenshot 2015-07-28 16.09.36This is just a small illustration of how people in tech have a tendency to bucket things. Our industry sees thousands of new ventures every year. It’s human nature to group things together to simplify the analysis. It’s easy to benchmark a B2B SaaS company. Mobile photo apps lend themselves to analysis via a myriad of metrics. It’s a bit harder to evaluate companies that sell costume jewelry.

The way to escape the bucket is to show how flawed the assumptions of the bucket are. For example, I remember when I started my dental technology company, many investors said “dental is a terrible category. Everyone’s lost money there.”

Yet when pressed for examples, the investors pointed to failed roll-ups of dental practices. That had nothing to do with the digital scanning and 3-D printing solution I was trying to bring to market. We had to highlight the flaw in the investor’s logic to get them to see the opportunity.

Demonstrate Domain Expertise

I’ve had the pleasure of backing seasoned entrepreneurs who were getting the band back together to dominate an industry. I’ve also backed founders who are second generation stewards of a business started by their parents. These founders had a preternatural understanding of the markets they were in and could use this domain expertise to explain why a seemingly unsexy part of the economy could be the source of a billion dollar company.

You don’t have to be a lifer to show this kind of knowledge. I’ve met people getting into new fields who managed to learn every SKU their competitors put out by heart. They could argue the merits of esoteric material choices in terms of aesthetics and durability. For a smart entrepreneur, a couple months of cold-calling and a few tradeshows can help you scale the learning curve quickly.

Create Curiosity

It may seem contrary to conventional wisdom to think that the entrepreneur should leave the VC with homework. This is where the savvy pitch woman can hook the VC.

I often invest in businesses where I leave that first meeting thinking that the founders are special, but where I feel like I want to learn more about the market opportunity. I love it when an entrepreneur presents a non-obvious truth, provides references, and challenges us to check it out after the meeting.

When my own homework validates their proposed thesis, I start to lean in. The more I find myself Googling markets and trying competitive products, the more likely I am to invest.

Make your VC Comfortable being Uncomfortable

One of the few drawbacks of being a VC is seeing dozens of copycats for every novel company that’s achieved some success. We hear “We’re the Uber for X,” “The ClassPass for Y,” “The Airbnb for God knows what.” Here’s how a couple founders in our portfolio stood out with special ideas:

Transfix

When Transfix pitched the idea of automating freight brokerage. I didn’t even know that those two words could be paired in the English language!

Founders Drew McElroy and Jonathan Salama told me about “deadhead” rides where 16-wheelers would return from a trip empty and unprofitable because they were unable to find freight easily. How thousands of brokers and drivers used phones, fax machines — even cork bulletin boards — to coordinate shipments of stuff around the country. These insights opened my eyes.

When they started to tell me more about the $800B industry and their backgrounds, the more confident I became that dramatic change was possible with technology. A technology they were uniquely suited to create.

I had no knowledge of the long-haul trucking business, but the team made it easy for me to see how their weird business actually fit into a well-understood pattern.

MoveWith

I thought every permutation of business model pairing fitness studios and tech had been tried. But Apple alum Holly Shelton had an insight that fitness buffs are more loyal to their instructors than the studios they paid dues to.

She told me about instructors who had almost religious followings — in fact many of them referred to their classes as their “tribes.” She challenged me to try one of the classes in Boston. After I did that homework, the insight was more than concept, it represented an opportunity to empower instructors to host classes and monetize their tribes, as opposed to the gym studios that typified the fitness business model.

Finally, Flaunt your “Weaknesses”

If your startup challenges conventional wisdom in some way — like if you’re building a tech business in Winnipeg — don’t try to hide it. Flaunt it. Talk about why building a startup in the “call center capital of Canada” is a huge (non-obvious) advantage.

Think about Warby Parker. The company is light on tech, but they didn’t tack an app onto their service for the sake of checking a box. Instead they focused on design, direct marketing, and customer service. It worked out pretty well in the end.

Similarly, when Founder Collective invested in Uber six years ago, many of our peers thought it was bizarre. Why would you invest in car dispatch, they asked? Needless to say, we don’t get asked much anymore.

The rise of the thematic VC and what it means for founders

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This post originally appeared in VentureBeat.

Thematic venture capital funds have come into vogue over the last decade. Firms used to be generalists and VC was an artisanal craft largely organized by stage and fund size. Today there are hardware funds, B2B funds, and funds with very explicit theses around the types of companies or founders they invest in.

Corporations have funds. Incubators have funds. The venture market has come to parallel the ETF market with a proliferation of investment flavors and vehicles. Funds have even been raised to address highly specific trends, platforms (e.g. iPhone Fund, Facebook Fund, Google Glass Collective), even numerology.

Part of the reason for this proliferation is that themes are tremendously useful. They provide guideposts for the investors and help differentiate themselves to entrepreneurs. Union Square Ventures backs startups that showevidence of network effects. This operating philosophy, paired with the team’s excellent track record, has led to amazing returns.

Similarly, the Foundry Group, Collaborative Fund, and IA Ventures use core themes to define their investment approach. This allows funds to truly go deep in a domain and develop an encyclopedic knowledge of the players and technologies. Additionally, because they’re explicit about their focus, it is easier for entrepreneurs and co-investors to identify whether they would consider a given investment or not.

There are also domains that require hyper-specialization. Biotech, for example, requires a deeper understanding of science than other fields given the risk, timelines, and the very different set of metrics by which they’re evaluated. VCs need to have an innate sense of the market since biotech companies rarely have revenues when they go public or get acquired.

Despite this, I still believe firmly in the “un-thesis” for seed investing. At the early stage, the trends have yet to avail themselves, and thus it’s hard to pre-determine what type of startups to invest in. This is where the VC adage about “pattern recognition” breaks down.

I believe that the successful elements of an early stage company are far more similar than different. Passionate founders, markets ripe for disruption and the ability to recruit great talent. As the line between tech and mainstream industries blur, as with Uber and Airbnb, the chances of innovation coming from almost anywhere has increased dramatically. Its not just coding prodigies and Ph.D.s starting companies anymore. Art schools haveminted more mega-unicorns than MIT in recent years.

As an investor, I’m “stage focused, sector agnostic.” My own experiences and overlaps across three different start-ups in three very different industries, inform my view that company creation is quite serendipitous and random. But it’s more than that — here’s why.

Themes get thrashed by macro factors

Historically, themes tend to get thrashed by macro trends. KPCB made a hard turn towards cleantech, and evenraised a fund around it, only to watch the price of oil plunge as fracking and domestic reserves came on the scene. Cleantech is certainly an area of much needed innovation and hopefully we’ll see more Teslas and Opowers in the future, but most cleantech bets haven’t proven to deliver great venture returns.

Near Field Communication was once a hot theme in VC circles, but poor reception for NFC left a lot of LPs unhappy. The semiconductor market has had boom and bust cycles that have made many casualties of VC funds. The same is true of telecom. And A16Z and others announced they would invest in a consortium of Google Glass apps, only to have the product line disappear.

A thesis is often VC branding

The venture capital market has become increasingly crowded. When Founder Collective was started, there were a handful of seed funds, now there are hundreds. VCs are all competing for a finite amount of cash from limited partners. In order to stand out and raise money, VCs without a proven track record often come up with elaborate theses for why they will be able to attract founders and create double digit IRRs.

In a bull market like the current one, these themes resonate with LPs looking to deploy capital. However, fund lifecycles are typically pegged at 10 years. Many things change in that period. Almost any thesis crafted in 2005 would have been rocked in 2007 with the rise of the iPhone.

The thesis might still be viable with significant adjustment but would force the managers to explain the change in investment strategy to their LPs.

Themes can blind investors to great ideas

The big challenge with thematic investing is crafting something that is broad enough to catch outliers while being directed enough to drive decision making. Let’s play a little game and try to identify themes that could have predicted the biggest Unicorns.

Before Airbnb had a $20 billion valuation, it was a punchline, famously dismissed by almost every VC in the Valley and NYC. Airbnb is an incredible embodiment of the social/mobile/local theme that was captivating investors’ attention at the time. But to VCs in the moment, it just looked like an update to decidedly uncool companies like VRBO and HomeAway.

Hardware, is awfully broad to be considered a theme. A VC saying they’re investing in hardware emerging from the experts in the Chinese supply chain might have helped them spot DJI or Xiaomi, but they’d have missed Warby Parker. Getting into any one of those deals could be transformative, but you see how easy it is to miss great companies.

You can connect the dots retrospectively, but VC is a volatile business and great companies come from odd spaces.

I faced this challenge when I was becoming a VC. Two of my biggest successes involved taking technologies from a university lab and bringing them to market. I knew, though, that I couldn’t spend my entire career scouring the labs at universities sourcing deals. Branding myself as the “university spinout” guy didn’t feel like a viable long term strategy for success.

In the end, the best advice is to play your game. In other words, we VCs would do best to play to our respective strengths rather than limiting ourselves to narrow themes.

Image Credit: Arthimedes/Shutterstock

Don’t Let Your Investors Buy All The Options

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This post originally appeared in TechCrunch.

One of the most pronounced misalignments between investors and entrepreneurs is around the concept of “optionality.” I’m not talking about stock options, but the freedom to choose from a variety of different strategic and tactical options when running your startup.

I learned, the hard way, that the founder has to create his/her own optionality or your startup is at the whim of your investors. The more shots on goal you have, the more likely you’ll be successful. Paradoxically, more funding means fewer shots, and less optionality for you.

When you first start the company founders have ultimate optionality. You can hire who you want, and pivot a hundred times until you’ve found the right business opportunity. You can even decide to walk away if it doesn’t feel right.

As a former startup founder I noticed that as my companies raised multiple rounds of funding the investors gained options, while mine narrowed. The balance shifts. You can’t fireyour investors, but they can fire you. With every dollar a startup takes, investors are buying explicit and implicit options in your company and, at times, it seems investors maintain all the options.

For example, if you’re fortunate enough to take $20 million in venture capital at a $100 million valuation, you can no longer sell the company for $80 million even if it’s a windfall for management.

Optionality also presents in more prosaic ways. You’ll need board of director approval for pretty much all senior level hires or major purchases. While there’s good reason for this, namely good fiduciary control, it can become cumbersome. Most boards will generally follow management’s recommendations, but you are in a position of asking for permission, not proactively deciding.

Running Out of Options

Optionality is worst when things aren’t going great. Consider a business that’s going sideways. Revenue is growing, but not at a rocket-ship pace, and the company is in need of capital to continue operating.

Unless you can get a new investor to set the price of the round, existing investors have enormous leverage (or optionality). They can decide to make a bridge investment, entirely at their option. Some funds will increase the valuation in recognition of progress the company has made. Others will use the opportunity to buy more of the company in a down or flat round. Or they may decide not to follow-on at all, sending a disastrous signal to market.

How to Maintain Optionality

So how does the entrepreneur manage to gain optionality while still subject to the venture capital markets? Here are some of your levers:

Managing the burn

The ultimate form of re-acquiring maximum optionality for the entrepreneur is to reach profitability. For early-stage tech companies, that may be a long way away, but you can control your burn rate.

Burn rates dont grow linearly; they tend to grow geometrically. This is because when you hireyour first VP of anything, he/she often will want to hire a director who at some point will want an analyst.

Budgets go up as more people are there to spend them. The most effective way to manage the burn is to set hard caps on numbers of staff, spend that gives you ample buffer between fundraising. The more dependent on the capital markets you are, the fewer degrees of freedom you have.

Managing the board/investors

Managing a board full of strong personalities can be tricky. But it’s important to build strong, individual relationships with each member of your board.

Get to know them socially, ideally even their spouses and families. They are your partners, just like your co-founders. Provide regular updates so they feel engaged and mentally and emotionally invested in the company beyond their financial commitment.

I recommend that founders bring on an independent board member who can contribute significantly to the company, but also can be a friend and supporter to management. If the board and investor group feel closer to each other than the founders, there is a greater likelihood of group-think. This can be harmful when you need one investor to step up in times of, say, a bridge note or when you have to make a controversial decision and need a base of support.

Stay close to prospective investors/buyers

The adage “keep your friends close and your enemies closer” echoes true in the startup world. Bringing optionality to your company is about creating a network or ecosystem around you beyond those that are directly affiliated with the company.

Shrewd founders know the key players at potential acquirers. They’re not actively selling the company, but, as with fundraising, it pays to have relationships going in so that if the company does begin a sales process, it is easier to generate multiple offers.

We tell most of our founders that you’re always fundraising. Keeping warm relationships with prospective investors is also beneficial in that it gives you an alternative to inside rounds, or at the very least can help increase an outside round. There are times where friendly investorswill provide a term sheet at a higher valuation as a show of support, even if they know full well that you’re unlikely to take it.

I used highly curated distribution lists for company news at my startups. I had a broad list in which I’d share general company news (always listed recipients as BCC). I’d often include prospective acquirers on that list, but made sure to avoid any specific details about the company.

That note would also get sent to candidates we were pursuing and other VCs we might want to approach in the future. The much more specific (and more frequent) email update when to shareholders, employees and key partners.

Venture debt

When used rationally and conservatively, venture debt provides an alternative source of capital. While some board members may argue that debt is bad for the venture, it enables the founder to open up the dialogue about equity.

It provides a foil. For example, I’ve heard founders say “You’re either a buyer or seller; if you’re not willing to provide equity capital, I’m going to take on debt.”

Raise money when you dont need it

One of the most effective times to raise money is when you need it least. The founders who wait until there is only a few months of cash left in the bank inevitably find themselves in a weak position and with limited optionality. The best time to raise money is on the heels of momentum, such as a strong sales quarter, or when you closed a marquee customer.

Advocate for yourself.

Like the fundraising process, the perception of leverage and optionality is often driven as much by confidence as business metrics. Ultimately without the company founders, the value of the startup is surely zero. At the right moments, seek opportunities to engage the discussion about re-ups, or increases in options.

The best time for this is when the business has had some success and the founders are nearing the end of their vesting schedule. Sometimes the right move is to take money off the table so everyone is aligned around playing for a bigger exit opportunity. Running a startup is among the hardest jobs on the planet so when things are going well, dont be afraid to take a little credit.

In the end, most investors dont want to exercise too much judgment over their options. They want to be led, rather than lead. Options are viewed primarily as downside protection; levers to be pulled only in case of emergency. As a company founder, dont forget you need yourown levers, too.

FEATURED IMAGE: MARTIN CHRISTOPHER PARKER/SHUTTERSTOCK

Handshakes and Hashtags: Two Key Ingredients for Networking Success

I never believed the refrain “who you know is as important as what you know, ” but, from Hollywood to Wall St to Silicon Valley, it’s hard to say there isn’t truth to it. For all of our connectivity, business is still built on interpersonal relationships.

When I first got to venture capital, I assumed we were all assessed by our IRRs. Surprisingly, a critical framework by which investors assess my industry is by a concept called “network centrality.”

Shockingly, this is what we called “hanging with the cool kids” when I was in high school (or grade school for that matter). In this context, the term is defined as a measure of how much you are an “influencer” and how well connected you are to other influencers. The theory goes that the more connected the VC, the more (and perhaps better) dealflow she/he sees. I’ve seen LPs literally build maps of VCs and their connectedness to others and the tech ecosystem at large. For example, see Endeavor Organization’s NYC Tech Map.

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Just like putting off contributions to your 401K, neglecting your network is a career-ending mistake.

Your network is perhaps your most valuable professional asset. So, just like you manage your 401K and 529 plans, building a networking strategy is a good idea. Today, there are more tools than ever to make it happen.

Hashtag Networking

Mark Suster recently wrote an excellent post about how to build business relationships online, from blogging to tweeting, and engaging with new people (without being a stalker!). He credits many of his closest professional relationships to this type of online introduction.

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Successful networking, whether online or off, requires that you demonstrate substance — domain expertise, credibility, etc. and sociability — that you’re enjoyable to be with. Too many forget the last part.

Online, you can start a conversation with almost any person, in any industry, anywhere in the world. You can chime in on topics (via twitter or comments on a blog post) and listen to experts on others you know nothing about. Unlike in the real world, where you can find yourself in a conversation that’s over your head, online interactions are all upside. The anxiety of saying the wrong thing is lessened online, where at worst, you don’t get any responses (fortunately Zuckerberg has yet to add the “dislike” button).

Building your online persona and engaging with others ismarketing” or an “air game”. Historically, we thought of marketing as public relations or advertising. Only businesses and professional athletes could afford to market themselves. Nowadays, the individual (VC, entrepreneur or other professional) has to have a solid air game. Building your online presence greases the skids for networking in the real world, just as PR and TV ads help sell products.

Handshake Networking

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Press flesh, break bread, or any two words describing human interaction, not facilitated by a screen or keyboard will work. Photo Credit: Julia Taylor.

While connecting with others with tweets and comments is quite valuable, I believe handshakes beat hastags. Basically, if you’re going to invest in building relationships online, you should have a similar “sales” or a “ground game” to go with it. It’s easier than ever to demonstrate substance and sociability, but the landscape is noisy. Marc Andreessen tweets over 160 times a day. Rising above this noise is critical and that’s why its best to combine both the the air and ground games.

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For more background on this infographic, read this post at CB Insights.

We all know those uniquely talented people who can strike up a conversation with just about anyone at a party (some of my college friends, you know who you are). If you were like me, it isn’t as comfortable connecting with total strangers.

One of the most difficult aspects of meeting people is breaking the ice. By building your profiles, writing blogs, posting on FB and tweeting, others can know about you before you actually meet live. One of the best professional ice breakers these days is “I like what you wrote about in your blog.” It’s always wise to read someone’s online profile before meeting them, even if its just a potential chance encounter. Flattery will get you everywhere, and there’s no question that entrepreneurs that show evidence of having read my stuff score points.

As a VC, I think about my sales strategy as often as my marketing approach. We’re humans — emotional and psychological beings. The expression “to break bread” is as old as the bible but the meaning hasn’t changed. Today, we might more often say “grab coffee” but the meaning is the same which is to bond over food and drink and get to know one another on a human level. There are certain elements of a person that just can’t be understood solely from online interactions (even online video). For this reason, I always prefer to meet entrepreneurs live, my second choice is Skype/Hangouts and (the very) last resort is the phone.

A few quick tips for networking in today’s world (whether online or off):

  1. Take a point of view. Develop your narrative. Politicians have their talking points. So should you. One of my old mentors said “I pay you for your opinions.” Sometimes being contrarian on a topic can help gain notice online. I’ve encouraged younger folks looking to interview for startup or VC jobs to have points of view on particular companies or industries. If you think Bitcoin is a fad, say it. Be sure to back it up too.
  2. Ask good questions. Make sure you have some questions chambered, e.g. What’s the biggest challenge you’re facing, why did you attend the show, etc. Be engaged, listen, and don’t just try to sell your book. One of the key benefits of face to face meetings is that people let down their guard.
  3. Create lists of people you want to meet. I’ve created target lists of people I want to meet, and lists of people that I haven’t connected with in some time. Just like sales, you need quarterly targets. Find ways to get introduced to people you don’t know — don’t be afraid to ask someone to introduce you or even try an InMail on LinkedIn.
  4. Play to your strengths. If you’re more comfortable with the written word, invest in blogging and building your online presence. If you find real world schmoozing more to your taste, invest there. Either way, remember that both activities support one another in showing substance and sociability.
  5. Break Bread. I host a variety of events — including founder breakfasts to foster meeting new entrepreneurs in a less pressure-filled setting. These founder breakfasts are hosted by myself and a few friends. Each of us invite people the others don’t know and it makes for great connecting and often fantastic conversations.

Before You Make That Pivot

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This post originally appeared in TechCrunch.

According to Eric Ries, a pivot is a “structured course correction designed to test a new fundamental hypothesis about the product, strategy and engine of growth.” The rise of the Lean Startup methodology, however, has led entrepreneurs to indulge and glorify the pivot without fully weighing the consequences. Changing course opportunistically is a key part of starting a company, but the best startups only pivot when absolutely necessary.

As an investor, I love the lean startup methodology. In the early days, the risks of large pivotsare small and the upside can be huge. Entrepreneurs should be focused on developing MVPs and proving or disproving hypotheses.

This changes once you take venture capital based on a particular strategy. The clock starts ticking and in my experience, pivots past a certain point can often be painful.

The Pivot, the Restart and the Hail Mary

Like “burn rate” the word “pivot” has been overused, often incorrectly. In basketball, a pivot is when one foot moves and one stays on the ground. Take another step and you’re called for traveling. The same goes in businesses.

Burbn becoming Instagram is a classic pivot. When the team behind the podcast platform Odeo recapitalized and changed course to create Twitter, it was a restart (a wildly profitable restart, but a restart nonetheless).

Recently, I’ve seen startups with millions of dollars raised moving to radically different markets or tech platforms, relatively late in the game. These feel more like Hail Marys. Perceived “sunk costs” and the entrepreneurs’ fear of letting down their team, family and investors drives this behavior. Often the founder embarks on the new plan with less diligence, insight and passion for the problem than their original business.

Why Are You Pivoting?

Before making any changes, understand the motivation for the pivot. Do you feel like youhave a viable product, but you misjudged the go-to-market plan? Did you underestimate the complexity of the product you seek to build? These may be perfectly good reasons to pivot.

Or, have you learned that the thesis you used to attract an all-star team and millions of dollars in venture capital is fatally flawed? All entrepreneurs have these moments of doubt, but sometimes it’s more than emotion, it’s truth.

Be honest with your advisers, trusted investors and senior team. reassess your options. There is no shame in starting a company that fails to change the world, but a badly handled pivotcan cause more damage than hitting the stop button.

Prepare for the Fallout

When I was starting Brontes, my cofounder Eric Paley and I were commercializing a 3D-scanning technology invented at MIT. Our original focus on industrial applications caught the attention of a prominent VC who scheduled us to present to several partners at a future meeting.

In the intervening period, we pivoted. We started researching the dental market, spending time at the Harvard Dental School, discussing partnerships with companies like Invisalign and talking to dentists. Our conviction on the dental opportunity increased.

We pitched this dental strategy at the VC partner meeting and it was a total disaster. We hadn’t properly guided our sponsor through the thinking behind the change and they didn’t invest. Brontes ultimately sold to 3M for $95 million dollars, proving that pivots can pay off. Nonetheless, I’m grateful that we pivoted to dental before taking the VC money or the outcome may have been quite different.

Manage Your Employees and Investors Through the Pivot

Six months after co-founding Sample6, I began considering diagnostic applications rather than the original application of the technology. After spending time with customers to validate the diagnostic approach, I casually floated the idea with one of our engineers. To my surprise, he had been thinking about the very same thing and explained how diagnostics would actually be easier to build and potentially more valuable.

The decision to pivot is largely in the hands of the CEO. Below are some of the best practices I’ve learned along the way.

Socialize the idea informally to trusted advisers. Pivoting might have been on your mind for months before you even consider implementation. Slowly and deliberately share the datathat’s leading you to consider a pivot to your inner circle of managers and investors. Don’t distract your sales team. Some teammates may fear for their jobs, rather than consider what’s best for the company. Ask one or two trusted senior engineers to think through new development timelines. In many situations, savvy colleagues will come to the same conclusions you do.

Pivot fast and burn the boats. Once you have decided to pivot, do it quickly and cleanly. Straddling the old and new business is all too tempting, but not a good idea. Employees will be confused and the team will be stretched between two very different strategies. It’s never easy to kill the original dream, or any revenue associated with it, but startups can only execute on one plan.

Making a big change? Offer your investors their money back. If you’re making a dramatic change, the right move is to offer their money back. Most won’t take it. Good investors have backed the team no matter the change. But the offer shows an honest understanding of the scope of the change, and gives investors a chance to redouble their commitment.

You also might be asking your investors to write another check, or minimally, makeintroductions to new investors who might be more aligned with the idea. If the pivot fails,you’ll want their help negotiating an exit. If you ever plan on raising money again, or are looking for a gig at a venture-backed startup, their recommendation will be critical. Be careful with these relationships.

Signs It’s Time to Pull the Plug Rather Than Pivot

If you’re looking at a restart, or Hail Mary, ask yourself these questions first.

Do you have fewer than six months of funds? If so, manically focus on profitability or start looking for acqui-hire options or a sale of the intellectual property. Paul Graham has called this period in a startup’s life the “Fatal Pinch,” and massive changes at this point tend to look more like death throes than thoughtful recalibration.

Need to replace more than 30 percent of your team? At the early stage, team chemistry is critical and firing a third of your key contributors will mangle morale. And if you need to recruit new technical leads, just start over.

Are you pivoting more than a ballerina? If you don’t have a compelling vision to motivate your team, or you’ve lost faith, don’t try to fake it. Time is more precious than money. Just becauseyou have some money left in the bank doesn’t mean you should spend it.

Sometimes the best thing you can do is pivot. Other times, banging your head against the wall because you believe it’s your life’s mission, despite the fact that the market is telling youotherwise, is an even bigger mistake. The self-aware entrepreneur knows when to hold ‘em, went to fold ‘em and when to pivot ‘em.