Venture Capitalists at Work: How VCs Identify and Build Billion-Dollar Successes


Whereas entrepreneurs focus on identifying and solving these burning pain points, venture investors try to find those extraordinary entrepreneurs who are trying to solve potentially huge problems in a meaningful way. Venture investors tap into their tremendous network of contacts and “pattern recognition”—the art of leveraging lessons drawn from past successes and failures to identify a combination of factors and behaviors that may point to promising markets, entrepreneurs, products, business models, and so forth. Together, these build a “prepared mind” or “gut feel” about the emerging market opportunities created by the tectonic shifts in customer behavior and the enabling technologies that can be successfully applied to those shifts. Entrepreneurs are true visionaries, and venture investors are great pattern recognizers with an experienced toolkit of how to build companies—and how not to build them. Successful start-ups are created when a trusted relationship and line of communication is established between the visionary (entrepreneur) and the pattern recognizer (investor) for two-way knowledge transfer.

The Rabbit Hole is written by Blas Moros. To support, sign up for the newsletter, become a patron, and/or join The Latticework. Original Design by Thilo Konzok.

Key Takeaways

  1. The key to start-up success is purity of motivation. The most successful entrepreneurs tend to start with a desire to solve an interesting problem—one that’s often driven by a personal frustration.
  2. Successful entrepreneurs also have this ability to articulate a roadmap for the sort of things they want to build over time. We rarely do business with a company where there’s a six-month roadmap and then it’s all done.
  3. People with “great DNA” see problems—and they roll up their sleeves and try to solve them. It takes a very special person to do that.
  4. I invest in stubborn entrepreneurs who chase huge opportunities
  5. Maples: I think the tech business is just fundamentally characterized by—Darwin had a term for it in evolution, “punctuated equilibrium”—where the world is evolving a certain way and then bam, it changes completely and fundamentally. You can even see this in the fossil records. Where the fossils progress at a certain rate, and then bam, there is a whole new layer of sediment that looks fundamentally different. The theory is, maybe there was a flood that wiped everything out or some new organism adapted and survived and crowded the old organisms out. I think to make money as an investor in the tech business, you have to find those. If you cannot find any of those ever, I think it is hard to argue that you have a business.
  6. Maples: We do not even think that much about our portfolio. Every company we look at, is there a chance it could be something huge if things go our way? To us, there is nothing else. There is no other question that matters. There is no other analysis that we care about. That is all there is.
  7. Most of the best deals that we have done would not have survived the scrutiny of a partnership.
  8. We do not look at serial entrepreneurship as a positive trait. We look at authenticity and unconventional, proprietary insight as the key difference.
  9. The thing I have found most interesting is that the best deals we have done are the ones where we decided the quickest—which is counterintuitive to me. I would have thought that the ones where we did the most diligence and the ones where we thought about it the most would be the most successful, but in fact, that is not the case.
  10. He said all the successful companies he has seen have this one following factor: they have a leader who gets the team excited by offering them focus and the clarity of what to do.
  11. Here’s the reason there are so many good companies that come out of PayPal: They had an intense, competitive environment internally and obtained really smart people. They managed to attract people who are smart and really competitive, which are makings of good entrepreneurs usually.
  12. Shah: Where does that product-market fit show up in a short period of time? Zachary: In consumer internet, it is user engagement.
  13. I To me the Zen of hiring is firing.
  14. Shah: What is a key to attracting and retaining great talent to build an A team? Dalton: It really boils down to appealing to the most basic human emotions. You want people to have pride in what they do and you want people to create some intrinsic value as a result.
  15. the real question is, why will your product stand out? One way to measure that is when people get emotionally excited about product, you know you are on the right path.
  16. You really drew a great distinction here that a start-up’s job is to create that distinct value, and if it is big enough, someone is going to pick it up one way or the other.
  17. Customers are great at giving you feedback by buying or not buying your product, but they suck at telling you what they want. That’s really the only way to understand if something is working—have them pay for it.
  18. When you present to a VC, your approach should be, “I am comfortable right now. I want your money to scale up.” VCs love that.
  19. the way we say it is, “making a dollar by taking ten away from the leaders.” [A start-up that is] shrinking markets. Shah: “Making a dollar by taking ten.” Tell me more about that. Morgan: Think of the media industry. You take ten dollars away from television advertising and make one dollar in internet advertising and it can be just as effective, so it is shrinking markets.
  20. The thing that puts us most at odds with an entrepreneur is when you have to dig the bad news out of them. The best entrepreneurs are always the ones who come to you quickly and tell you, “We thought X, but not X actually occurred and here is what we are going to do about it,” and then give you a plan. As opposed to the ones that hide it from you for two to three months or even hide it from themselves. I think that is really one of the things we look for. That sort of integrity.
  21. Does a better go-to-market strategy win over better product? Morgan: Yes, the better go-to-market strategy wins over the better product.
  22. Shah: What would be your advice to someone trying to build a high-capital multiplier or a billion-dollar company? Morgan: Keep sensitive, in everything you do, to the pain points you feel. Where you feel that pain, see how you can solve it. That is the key.
  23. Culturally, what is one thing you have paid most attention to? Rashid: We had a company meeting every Friday at five-thirty, where I got up and I talked about things which most companies and CEOs usually don’t talk about. And, I did that to show transparency. I talked about the current state of affairs, future plans, projections, ideas we were thinking about. And I made it a point to let them know, “Look, most CEOs will not tell you these things, but I just want you to understand I am telling you because I trust you.” I also told them, “Guys, if a leak happens, you have to understand that I can’t do this anymore.” They knew that I trusted them. They valued that immensely. In the history of this company, there was never a credible leak from the company itself.
  24. the entrepreneur has to be receptive of the value that the VC really brings to the table—the knowledge and network and the been-there-done-that scenarios.
  25. A real VC, a real VC firm, is structured as a service provider to the entrepreneur for the purpose of helping them build their business. There is nothing passive about it, and it is no surprise that private equity firms have had such a hard time going downstream to venture investing.
  26. The great companies are leaning forward. The personality of the company is naturally inquisitive and naturally aggressive.
  27. The way you really know you are winning is that you are defining what success in the market is.
  28. But the factor that enables you to have the greatest effect on the company’s ultimate success or failure is the communications channel between entrepreneurs and investors. As in physics, “complex adaptive systems,” are highly affected by their initial conditions. Shah: That is why, for kids, so much focus goes on building their mind right during the initial few years. Weller: I would say the same is true of a company.
  29. I look for somebody who in the meeting is actually looking to get something out of the meeting from me, other than my check. It’s good to get a check. I understand that’s what they’re trying to get. But I like it when they come in there and they’re actually hoping that I’m going to tell them something interesting. I’m going to ask them some challenging questions. I’m going to do something that changes how they think about things. And they’ll ask me, “Well, how do your companies solve this? What do you see?” And when they’re asking me, or if they say to me, “Hey, you know, I saw that in your portfolio you’re an investor in Nominum, and you’re an investor in Reputation. I really want to meet those guys because I have an idea that I think we can work with each other.” People who are, again, coming in trying to squeeze all the value they can, I love that of them.
  30. I look for people who are not so motivated by the money, but are really driven to build a big company. The more years I am in this business, the more I look for that.
  31. Remember, a start-up starts with nothing. It has no foundation. If the founder seems ambivalent or ephemeral, then there isn’t something grounded upon which to join. What new hires are looking for are consistency and depth. What integrity actually means is being internally consistent and whole. It suggests depth. A person develops deep integrity by reflecting upon his or her situations and experiences and abstracting out the things that really matter. Those facets that matter are woven into this consistent approach on how to engage in the world.
  32. Another reason momentum is really valuable is that it helps cement a culture of performance and effective action. Start-up teams have an initial amount of bonding energy. That bonding energy dissipates every time there is a disappointment. You have a limited amount of time to hold together a team to accomplish something. Every time you have a micro-success, it contributes bonding energy.
  33. At the end of the day, you cannot force a market. But you can be very clear about what premises you are making and what bets you are making. Do everything you can to execute against those bets.
  34. Shah: And what is the first sign you see that someone is just the wrong hire? Scanlan: Productivity. If their team is more productive with them as a part of it or less productive. We had some people that we put in management teams or in management situations where productivity was better without them. And that’s not a good situation. But, you know, those situations are thankfully few.
  35. We have clearly seen this with Steve Jobs. These leaders tend to be tough bosses because they have a big picture and a small picture in their head at the same time—strategy and execution. They are highly critical bosses. They are very demanding, but the companies tend to win because there is this comprehensive leadership, not just the theoretical, big vision. They understand intuitively the execution model. It means that in their head they have this smaller assumption set that unifies everything. They are able to expand that over time.
  36. As I mentioned, they have a holistic picture of a whole company in their mind. As the company expands, their holistic picture expands itself. This ability to holistically think out a company from the product to the customer to whatever. It does not mean they are great engineers or necessarily great sales guys or great financial guys, but they can holistically keep building a bigger and bigger picture of a whole company. For companies where you get a founder and CEO like that, it makes the succession plan very difficult because it is a very, very unique leadership skill.
  37. What you see in these very successful companies fairly early is a higher repeatable sales model. You also see them zooming into first place.
  38. What are some of the key aspects of execution to get a billion-dollar outcome? Winblad: Number one, you really, really have to deliver high value to your customer.
  39. Go see your customers. Go early on. Have really tight engagement with your customers early on and listen to them. If they say this is interesting, but I want that instead, you have to move in that direction. It is really letting the market drive what you offer versus you coming up with great inventions for the customer.
  40. I wish that every CEO was really perfect in telling their company story. If they do that, they can raise money, they can sell products, and they can build partnerships. Can they really tell the story of their company—who we are, why we are here, and why we are valuable. That sounds pretty easy. It is hard.
  41. We have a reasonable formula here. When things surprise us on the upside, as they did with AdMob, they normally continue to surprise. We describe it as “market pull.”
  42. It certainly helps if you have all the right viral features built in, but it is particularly interesting when the product itself is not very good or is not very viral … and people are still talking about it.
  43. The best, well-thought-out products have virality built in and around them.
  44. Besides the virality and viral channels, what else stands out to you in a great product? Lee: Engagement. Do I go back and use the product on a consistent basis? Is the experience such that I am getting value out of it consistently? It does not have to be every hour or every day, but is there something there that is new and insightful on at least a weekly basis that is going to bring me back in?
  45. What gives you an early sign that a company is getting off track? Lee: Adoption and engagement. That is what matters. If people start talking about the product less or they are using the product less over time, those are two big signs that there is a problem. Really great products continue to show linear growth in both adoption and engagement.
  46. Think about how an idea from a twenty-eight-year-old kid in Chicago [Andrew Mason] turned into a multi-billion-dollar business. That was not possible five or ten years ago. Opportunities like this are a possibility because the markets are so big. If you believe in the product, you believe in the use case, and you have the right team—you should ride the opportunity as long as you can. Returns in venture capital are driven by your big winners. If you have something that is playing in a big market and is a leader in that category, and it can run for a few years, you have to let it run. That, I think, is the right thing to do.
  47. There were tons of lessons, but I will pick three key ones. First, we recruited for talent, not experience. Second, we launched quickly and iterated. The third lesson is to not be greedy. We basically raised money whenever we had the opportunity. It felt like we were always fundraising. It resulted in much more dilution for everyone, but that is the only reason we were able to survive as a company.
  48. The best investments are in companies that are fundamentally good, but that nobody thinks are good. This directly applied at Facebook, which is what allowed us to have the opportunity to invest, making the angel investment on Peter Thiel’s behalf, at the $5 million valuation.
  49. Tell me more about how you look at market timing. Howery: Typically, if we see two companies pitch the same idea to us in one week, we will not invest in either. At that point it is too late. Too many people are focused on it already. It is going to be too hard to be the winner at that point, as another team probably has a good lead and it will be hard to compete against them. It is a much better strategy to invest in a company before it is clear what category the company belongs in.
  50. I think many entrepreneurs, at least many first-time entrepreneurs, pick an idea that seems “manageable” or “less risky” than other ideas. In fact, these “safer” ideas may actually be riskier than bigger ideas. The problem is, an idea that does not seem risky to you probably doesn’t seem risky to lot of other people. Given how risk-averse our society has become, it will actually invite more competitors, and so it is going to be much more difficult to win in that market than it first seems.
  51. Yes, I take a different view when it came to my role as CFO and COO. Don’t just reduce risk and cut costs—make it everyone’s job to maximize expected value while reducing risk. Also, a lot of people think in terms of tradeoffs, of either/or. But anybody can do the either/or calculation. The companies that win are thinking
  52. technology is not kind to gatekeepers
  53. Ron showed me that investing is a lot simpler and harder than people think. It’s simple but not easy. The only thing that matters is your reputation. Everything else is a second-order effect.
  54. Our preference is for founders solving a problem for themselves.
  55. What are three things you as an investor wish every entrepreneur knew? Lee: Firstly, at the early stage, optimize for value add and not dilution. Secondly, be very self-critical and thoughtful about what constitutes “value add” for your start-up. And thirdly, think about where you want to be in 18 months, which is usually the amount of time funded for a seed round, and your biggest risks are in getting there. Every investor you add to your team should help you with mitigating those risks. If an investor doesn’t add value, don’t let them invest.
  56. The better the quality of the board and the investors, the better the quality of the management team.
  57. The number two reason that projects are late is that something key that was assumed would work, didn’t work. This is solved by pushing the test of every critical unknown up as early as possible in the schedule.
  58. Oddly enough, you would think that the CEO would be the superset of the creator of things. But rather, the CEO must have discipline and know when and how to say no. Otherwise, you just end up with a company that isn’t productive and can’t get the necessary things done.
  59. An interesting exercise is to walk into a company and ask three people what is the purpose of the company. If you get the same answer from all three, it tells you that the CEO is doing their job. A good purpose statement is, “We want to put a computer on every desktop.” This tells a lot: the customer, the size, the cost, maybe even the shape, etc. It’s very clean and provides guidance.
  60. Also, asking the obvious stupid questions is effective. Getting everyone together and asking really stupid questions works surprisingly well. Trying to be the really smart guy in the room usually fails.
  61. The best tool to cut through the noise is gross margin. The bottom line is that the price is a message from the marketplace. Listen to it and believe it.
  62. If you want to start a company, you really have to go to people who will talk to you. Entrepreneurs have to go out to get objective feedback on their ideas.
  63. have a triangle in my head—functional skill, raw intelligence, personal turning radius. Smart, hard-working, and paranoid together kind of radiates raw horse power. I stick with team and culture.
  64. An ideal start-up has a gifted founder. What does it mean to be a gifted founder? Well, they are coming from a unique situation that allows them to perceive an opportunity in a way that is different from other people. They can turn that perception into a vision of what they are trying to build. They can communicate that vision to others and then get other people excited about it. That is really the essence of the founder. Another aspect of the ideal start-up is that it defines its own market. It’s not an entry into a market that has already been defined by others, but it actually creates a category, creates a market.
  65. Maybe not disrupting a market per se. There may be markets to the left and to the right that are affected, but really I think more value is created when the company ends up becoming synonymous with its market. It defines the category in such a way that it’s not just a better implementation of something that has been done before, but in fact is something completely new. Often, this means new vocabulary has to be created. There is an educational aspect to the sales process, but if you get that right, there is a lot of lasting value and defensibility.
  66. What are some of the signs that you are way too early? Wagner: The key sign is when you’re spending all your time educating the market and the market never seems to be much readier. There is always an education phase when you’re doing a market-creation type of project. But if that education is never drawing to a close and you’re in constant education, then you know that the market isn’t ready. There are ways to deal with this, which is fortunate because it is so common to be early. If you have a capital-efficient business model, you can survive being early, at least some amount of being too early, because you’ll recognize it. If you’re not burning tons of capital, you have some flexibility.
  67. What are three things that you wished as an investor that every entrepreneur knew? Wagner: Focus is essential. Recruiting is the main job, and listening is one of the core skills. And I don’t mean listening to venture capitalists. I mean listening to the market. Shah: What are the most common blind spots you see in the entrepreneurs? Wagner: The most common blind spot will be some insecurity that prevents them from recruiting the best of the best. Another blind spot would be a confirmation bias, which means that they pay attention to the data points that support their existing point of view.

What I got out of it

  1. Great perspective from a number of different venture capitalists and how they think about the space and their role in it

In the Latticework, we've distilled, curated, and interconnected the 750+book summaries from The Rabbit Hole. If you're looking to make the ideas from these books actionable in your day-to-day life and join a global tribe of lifelong learners, you'll love The Latticework. Join us today.