10 things I learnt from a Silicon Valley investor course

My colleague Khaled Talhouni and I attended an investor training course in California to gain a better understanding of how VCs in Silicon Valley operate, how they make their decisions and drive their pipelines, and what their perspective is on investing in emerging markets such as MENA.

'Insiders Guide to Silicon Valley Investing’ was the first course jointly run by 500 Startups and the Stanford University’s Center for Professional Development, and it turned out to be the most useful series of events that I’ve attended to date as an investor in the tech sector.

Held in Silicon Valley, IGSVI was a two-week-long collection of lectures, seminars, in-depth discussions, pitches, and visits to various investment firms in the Valley. We got valuable insights from Dave McClure and Bedy Yang from 500 Startups as well as Mike Lyons, Pedram Mokrian, Mike Lepech from Stanford, with decades of collective experience investing around the world.

The following is my attempt to break down 10 take aways outlining why venture and angel investing in tech startups works differently in the Valley from elsewhere in the world.

The value we got from our trip is incalculable, the next one is coming up in November and I would recommend it to anyone who wants to get a better grasp on this asset class, regardless of their level of experience.

1. Emerging markets all look similar to most traditional VC firms in the Valley

For most VCs in the valley, their investment model works because that is usually where the cycle is fulfilled, meaning, that is where companies are bought and sold and VCs generate returns. Emerging markets, while interesting and fast growing, remain an afterthought since mergers and acquisition (M&A) activity, and liquidity, don’t occur as often. In fact, most Valley-based VCs invest the majority of their capital in Valley-based startups.

2. The game changes instantly outside the Valley

Outside the 20-mile or so radius that is known as Silicon Valley, startups are different beasts. Valley-based startups are able to attract more money based on a different currency - users and eyeballs. At least at the early stages of a business, even without having a clear monetization plan per se. This is contrary to how they’ll view startups beyond this radius venture firms tend to value companies based either on revenue, or a clearer path to revenue.

The spread of capital across the different US States. (Image via Pitchbook)

3. VC is only working for a select few firms

Venture capital is a lucrative asset, with the average internal revenue return (IRR) being 27 percent for a US fund. However, it is important to note that this is highly driven only by the top 20 VCs, who continue to vastly outperform the remaining funds in the asset class. In fact, only a handful of VCs regularly make it to the top 20 year after year, where most returns in VC are generated.

4. The asset class will remain on the fringe for Limited Partners so long as liquidity is a challenge

Funds flowing to venture firms are a small percentage of the total funds going to private equity firms, and in turn, private equity money is a tiny fraction of institutional investments. Venture capital will remain an asset class that is on the fringe so long as returns are concentrated with a handful of funds and liquidity remains locked for 5 to 10 years into the life of the fund.

To attract more money, it is important to start creating more liquidity for VC firms, beyond M&A and IPOs, for example by actively pursuing partial secondary share-sale strategies (selling portions of equity to follow on investors, often at a slight discount). The problem however, is any money not going into the company could be money that helps exponentially grow it. It’s a payoff but the balance needs to be found, it doesn’t need to be a zero sum relationship.

5. VCs compete heavily over access to the‘hot’ startups

The reason only a handful of VC funds regularly outperform the rest is because they are able to attract the top startups. And they can attract the top startups because they are willing to compete to drive up the value of them. This can create the illusion of a bubble.

In the Middle East it’s the opposite. The startups are the one’s competing over VCs and angel investment.

VCs and Angels, in the Valley and outside, need to go out of their way to prove they can provide value (to look for comparisons check 500 Distro Team, Andreessen Horowitz’s opps team, Sequoia Capital’s Grove). Jason Calacanis said that his pitch to startups is simple - if you’re a Software as a Service (SaaS) company he guarantees your first 500 customers; if you’re building a consumer product he guarantees your first 10,000 users. He is able to generate deal flow comprised of the best startups, like Uber, Tumblr, Thumbtack, Circa, and others.

6. You have to build your exits

This is not a buyer’s market. You have to actively and constantly build relationships with potential acquirers - it could take a good year or two of relationship building before you can make an exit.

7. The 500 Startups model is revolutionary

Dave McClure is a genius who is obsessed with numbers. His model is relatively straightforward: invest in as many companies that pass the basic criteria as possible, at the seed stage. Considering how hard it is to find winners at that stage, you will need to ‘spray’. Then, double or triple down on the emerging winners, as they will be the ones bringing your upside. This is a Micro-VC model and its revolutionary, and while not yet proven, could open up a new asset class for potentials LPs.

8. 90% of value is in the money

The best thing an investor is does is write that check - the rest is secondary. So it’s not them that make or break a startup, it’s their money and what the founders do with it. The remaining 10 percent is the access the startup will get to the investors’ network - unless an investor just wants to stay out of the picture, this is the best thing they can do for a startup.

9. Government R&D budgets are necessary