It really pains me to write this post… but it has to be said. I was comparing my small personal angel portfolio and my investments at 500 Startups, and I noticed that on a percentage basis, the companies in my personal portfolio have been able to raise more money on average and more easily than companies in my 500 portfolio.
Why is that? My thesis in how I pick companies remains the same across both portfolios. All of the companies I pick are at roughly the same stage — all seed companies who have launched a product and have some semblance of traction, though this ranges quite a bit.
The #1 difference between my personal portfolio and my 500 portfolio is that my personal portfolio consists of all friends’ companies. And, all of those founders have pedigree. They haven’t necessarily had past earth-shattering success, but they went to elite schools. They worked at elite places, generally at fast-growth unicorns. One group isn’t necessarily smarter than the other, but the branding on people’s resumes have made all of the difference.
(Update: A reader asked me if I’m perpetuating the problem by only personally investing in founders with pedigree – great q, and see the comments below for the clarification on this.)
Here are just a couple of data points:
Take Company X, for example, in my personal portfolio. They have limited traction, especially given they’ve been around for nearly 2 years. They are in a space that is a bit crowded. I erroneously thought that it would be really difficult for them to raise money, but it was a walk in the park. They raised $3m+ with a whole group of name-brand investors!
Then take Company Y, a 500 company I’ve worked closely with for the last couple of years. They have really great traction and high consistent growth for as long as I’ve known them. They, too, are in a space that is a bit crowded. The team isn’t from the Bay Area, and they are college dropouts (but not like Bill Gates or Mark Zuckerberg). That said, they are really clever founders. Despite their results, it has been very tough for them to raise. They have raised some money, but it has been way more difficult than it should have been given that the business has great unit economics and results.
A few thoughts on all this:
1. Knowing all of this, the way to get quick markups is to just invest in a lot of teams with great pedigree. In the short term, this is how to show that your portfolio is doing well!
2. But in the long term — say several years, I wonder how the two portfolios will compare? My fear for Company X is that fundraising has been so easy for them, they won’t be able to achieve the traction they’ll need to raise a Series A. Investors may go gaga for their team pedigree now, but at the series A, they will not get a pass — they will be expected to show results. My fear is that they will be not be hungry enough to move quickly to hit series A benchmarks because they don’t realize the game will be different for them at the next round. Companies that have an easy time fundraising in the beginning tend to think that’s how it will always be. And this is dangerous thinking. If you’re in this situation, you should be very cognizant of this.
3. For my companies who don’t have founders with brand names on their resumes, my fear is that even if they have great businesses and can kinda bootstrap, they will be a bit undercapitalized. They need to be above-and-beyond persistent in getting to know investors so that they can bring in some money over time. Even if it’s tough to raise money now, eventually, business metrics will trump everything else at the later stages; that’s what investors will care about then. Founders who don’t have pedigree but are running great businesses will do better at fundraising later. So, if you’re in this camp, just hang in there.
At the end of the day, doing a startup isn’t about how much money you can raise. It’s about running a great business, and I’ll need about a decade to tell you which of my two portfolios has done better. But, you can’t deny that companies that can raise money are better equipped to compete. It troubles me that the elite truly have a leg up in raising money. When you think about it, this cycle continues because if investors want those fast markups to help raise their next fund in a couple of years, they should definitely invest in founders with pedigree; they will have great unrealized gains to show potential limited partners.
I truly believe in looking for strong business fundamentals and also believe that great founders come from all walks-of-life. And yet, when I make a bet on teams without pedigree, unless they are in a hot space, I know that they will have a really hard time raising money in the short term (and it will affect my short-term IRR as well). In these cases, I have to believe these founders have enough hustle to survive a long time with limited resources while accomplishing significant results. And if I don’t see the hustle and determination, then I just really can’t make the bet.
Wrapping this all up, I don’t have any solutions, but this is a serious consideration for the industry: how do you level the playing field for entrepreneurs?
Interesting enough, although statistically questionable.
The reason I say so is that no matter what the initial selection of startups is, the decisive filter is your judgement. Have you ever been in a situation when your pedigree friend has offered you investment yet you chose not to invest? I’d assume so.
So by the success of the final sample (your portfolio) we can’t tell whether it’s your great judgement or their pedigree that led to this rate of success. It’s possible that you’d invest in 10 startups that come from entirely different strata and be as successful.
Unless we have a sample where you literally invested in every startup your friends founded (which would eliminate the effect of the judgement) or a poorly performing portfolio you compiled using the same judgement among completely different strata of people (which would disqualify the effect of your judgement on the pedigree sample), your conclusion is not logically valid.
That said, pedigree is an asset as far as it creates an network and resources asset. This definitely affects process, talent acquisition and fundraising. More time to learn basics, more capacity to experiment and make mistakes, less punishment for errors, bigger credit of trust.
That’s fair, but to your point, actually, when I was angel investing, I didn’t turn down any friends… 😉
now, that definitely adds validity to your findings.
is it possible, out of curiosity, gather a sample of all the “non-pedigree” founders you’ve invested in over the years and see how they’ve performed?
Just to be clear, I don’t believe pedigree is correlated with more successful outcomes — just correlated with successful fundraising.
In looking at the hundreds of founders I’ve backed over the years — with and without pedigree — there is no correlation of success. I have both pedigreed and non-pedigreed founders who have gone on to build HUGE companies, and both groups have plenty of failure as well. The difference is in amount raised.
I think the question I cannot answer is — do I have founders who “failed” but would have been successful if they had been able to raise a bit more money (i.e. they don’t have pedigree but if they did…) I don’t know…
Oh, I definitely got that from your article; just wondered if that hardship affected the results somewhat noticeabl. It wouldn’t have been unreasonable, I can imagine situations where an extended time and effort required to secure the next investment could’ve tipped someone over.
Fairly enough, you made a sound judgement call to pick founders who were capable of compensating for it with their own devotion and resilience.
Same as you, I also think it would be great to find a way to let them have a similar chance to put that effort into something else. I’ve been studying D&I for a long time, but this angle is completely new to me – thank you for bringing it to light!
I also do have certain thoughts about leveling up the field, but they are extremely raw and probably naive: I’ve only been thinking about it for a short while (since reading your post).