Mike Maples and Ann Miura-Ko on The Limits of Incubators, the Right Fund Size, and the True Meaning of “Pivot”
Last week we published the first half of an extended interview with Mike Maples Jr. and Ann Miura-Ko, the co-founding partners at Palo Alto, CA-based seed stage investing firm Floodgate. The focus in that part was on big issues like how Internet technologies are accelerating startup innovation, how investors have to adapt in response, and what types of entrepreneurs and business ideas attract the firm (Maples and Miura-Ko say they’re looking for “F-16 pilots” who can observe and adapt to changing conditions more quickly than the competition).
In the second part of the talk we got into some more concrete, nut-and-bolts questions—among them, the merits of the Y Combinator-style venture incubator model for launching startups and the difference between a true startup pivot and what Maples calls a “mulligan.” Maples also talked about why he wanted to grow his investing practice beyond angel scale and create a firm that would be “the absolute standard-bearer of early stage investing in a new innovation environment.” Here’s an edited transcript.
Xconomy: Sometimes investors say that they invest in teams, rather than ideas, or that they’re looking for great serial entrepreneurs rather than great product ideas. Y Combinator seems to put out that message a lot. How does that fit with your approach?
Ann Miura-Ko: A lot of people say they just bet on good teams, but I don’t think we’ve ever invested in a company that was just primarily a good team. There is always something about the insight they have that’s proprietary in nature.
Mike Maples: And we don’t necessarily look at being a serial entrepreneur as a positive. Just like some people try to convert it into a science, this idea that you can be a professional entrepreneur is a little bit suspect. Some people have shown they can do it, but the truly great companies get created by first-time entrepreneurs, and great entrepreneurs very often only have one great company in them.
You get some examples where that is not true. You can point to Evan Williams, who started Blogger, then Odeo [which grew into Twitter], but even those were both on the same vector—they were both about sharing and democratizing Web 2.0 content. Very few entrepreneurs are successful in multiple generations of technology or multiple eras of the technology business. It’s authenticity that we look for. Is this entrepreneur truly an authentic match to the opportunity?
X: What about this notion of the startup “pivot”? So often these days, that seems to be a euphemism for, “Oops, our first idea was wrong, and we still have some angel money in the bank, so we’re trying something completely different.”
AMK: That’s not what a pivot is. The whole concept of a pivot is to keep one foot grounded and move the other foot.
MM: I think people have dumbed down the term to mean “We failed the first time so we get a mulligan, let’s try again.” The real reason to pivot is when a great startup starts out saying, “I want to be one of the 15 awesome companies of this year.” And such a company is willing to continually ask themselves if they are on the path to greatness. If I am not on the path to greatness, then it’s axiomatic that I have to pivot. That is the thing that people miss. A lot of companies could be fairly successful in their current business, but the founder has the presence of mind to say that “Merely being successful is not enough, I have to be great.”
AMK: A pivot, for me, is taking one component of your business model and changing it somehow. There will be ripple effects on the other parts, but it’s really just one element that’s changing. We talk about pricing pivots, product pivots, a lot of types of pivots. But if you are scrapping the entire thing, that’s not what I’m talking about.
MM: If you’re scrapping it, we would advocate giving the money back to the investors and raising money again if you have a new idea. A real pivot, by definition, takes advantage of business knowledge. Neil Young has a good topic on this on Quora, about the pivot that Ngmoco did. Neil makes a very cogent argument about how they have changed from selling apps to the free-to-play model. If you can’t articulate what you have learned, and it’s not clear that you have a business, you may be better off saying “We ran an experiment and the hypothesis was invalid.”
AMK: Even Chegg, where they moved from a Craigslist model for colleges to textbook rentals, they were leveraging the insight they saw from the Craigslist model that people were buying and selling textbooks. The insight was that students are very price-sensitive and they would rather buy used textbooks, but there was not a great market for that.
MM: Going from Odeo to Twitter was another interesting example. Evan started out doing blogging software and then went on to podcasting. He discovered the art of audio recording created a barrier—that plus the fact that Apple was giving it away [Apple had created a huge directory of free podcasts as part of iTunes]. Then he went in the opposite extreme, making microblogs happen. Some would argue that you couldn’t have had a Twitter without an Odeo.
X: What do you think about Y Combinator, and about the venture incubator model in general? For entrepreneurs, is joining an incubator or an accelerator a good way to start a company?
MM: I’ve become more bullish on Y Combinator through the years. Early on, it wasn’t all that famous. We invested in a company called Weebly, which was one of the first Y Combinator startups, and it’s a great company and has done very well. But when I step back and look at incubators, the biggest problem they have always had is that whoever runs the incubator constrains the potential success. Historically, incubators have always been the extension of one visionary who tries to spin out a whole bunch of different companies. Very quickly, the limits to that become apparent and it stops working.
The thing Paul Graham did that was really smart was that he combined his visionary capabilities with the benefits of being able to select people from the outside world. Bill Joy once said you should always assume that the smarter people are outside your company. And that is what Paul got right. He understood that if you married the incubator idea with the idea of accepting applications from entrepreneurs throughout the world, you no longer had to be the person who generated the good ideas—you could become a picker of good ideas and good people.
Also, I don’t think Y Combinator could have existed 10 years ago. You couldn’t have demonstrated anything meaningful in 10 weeks. Now you can. Although it’s a little bit of a free-for-all from an investor’s point of view. Everybody shows up at these demo days and people crowd around these companies. Overall he has created a very good model, and he tends to select entrepreneurs with a value system that we like. They tend to be product-centric, they tend to be very technical, they tend to be really focused on building something. Where some of the companies could use improvement is in some of the go-to-market aspects, and understanding not just what their product is, but what business they are in. Having said that, you have to assume now that in any one Y Combinator batch there are one or two meaningful, significant companies.
AMK: I think he’s managed to attract some really great talent. Even amongst my students, many who technically could go out to raise money on their own are opting to apply to Y Combinator, because they think it will give them the right kind of structure and the networks that really help them accelerate their companies. And I think that’s true. Any student of mine who comes and asks me if they should apply to YC, I give them a wholehearted yes.
X: Okay, but in addition to Y Combinator we also have AngelPad, Kicklabs, 500 Startups, and many others. Is there room for all of these incubators? Can they all have equal success?
AMK: The business of angel investing, incubating, and venture capital is what we call a business of exceptionalism. It’s never been scalable. Whether it’s a handful of VCs who are really awesome, or angels. There are going to be a handful of incubators that are really awesome.
MM: No matter what your strategy is, if you are an incubator or a seed fund like we are, or a VC or a mezzanine fund or even a public market investor, if you don’t have some proprietary strategy for getting into the very best tech companies, you don’t have a business. If you can’t, off the tip of your tongue, say what is your unique advantage that gets you into these companies, you lose. I think we are one response to the democratization of innovation that seems to be working, and I think that Y Combinator is another that is working.
There is one other related thought. Sometimes we talk about how business school doesn’t prepare people for technology entrepreneurship. Steve Blank even goes so far as to say there should be something called Entrepreneurship School. And in some ways Y Combinator is a version of that. But instead of getting a degree, you start a company. But what a true e-school might do on top of what YC does would be to teach a little more about board structure, governance, pivoting, and go-to-market—real, grounded knowledge. I don’t know if that will happen, but to me Y Combinator is a completely logical step on the way.
X: Mike, why go to all the trouble of starting a seed-stage investing fund? Why not just be an angel investor, or go to work for an established venture fund?
MM: Well, first of all, I couldn’t get a job at a venture fund that I respected, or I might have done just that. But when I got here [to Silicon Valley] and saw what was happening, I got totally uninterested in being in a big VC firm. I said “Somebody is going to create a true early stage firm and I hope I’m not too late because it’s so obvious.”
I had moved here from Austin, and had been an entrepreneur, not an investor, and an enterprise software guy, not a consumer guy. So not a lot of people were taking me seriously as a micro-VC. So, originally, I said “Fine, I’ll just invest my own money.” Some of my early deals started working, so I raised a fund. What was interesting was that when I raised my first fund, there were a lot of other guys out trying to raise microfunds, and I took a totally different approach. My philosophy was, the right fund size is whatever you can raise in 30 days. I went to a lot of guys and said, “Invest an amount where if you lost it all, you wouldn’t be furious at me.” In 30 days I was able to scare up $10 million, so that was the fund size. I looked at Fund One not as a sustainable model, but as a booster rocket. I said this is either going to boost me into orbit, in which case I will raise a proper fund, or it will be a failed experiment. And $10 million was a lot more money than if it had just been my own money.
In Fund One I had a pretty good string of beginner’s luck. Then for Fund Two, I raised from institutional folks, and that is when Ann came on. I think there are a lot more things we can do now. I always believed that somebody would create a firm that was the absolute standard-bearer of early stage investing in a new innovation environment. It was obvious to me back in 2005 that that was going to happen. I think we are better than most at that.
X: What’s the right size for an early stage investing fund?
MM: Less than $100 million. If you want to know a fund’s strategy, you have to ask one and only one question: How big is your fund? The typical fund does 25 to 30 deals. If you have a $300 million fund with 30 deals, that’s $10 million per deal. Or you can do 20 deals at $15 million. What ends up happening is that the size of the fund dictates all the decision-making. People say you can do super-early and super-late stage investing at the same time, but the fact of the matter is that you spend most of your attention where the money goes. So the constraint on the fund size is part of the discipline of being purely early stage. We are not a small fund so that we can become a big fund.
X: But there are many larger venture funds that have seed-stage investing programs. What do you think of those?
MM: It goes back to the F-16 story. If you spend all day flying B-52s, you may understand that F-16 pilots have a good business, but that doesn’t make you an F-16 pilot. You are going to get shot down against a real F-16 pilot. For the same reason, we don’t want to compete against Sand Hill Road. We would just get crushed.
AK: And as I was saying before, when entrepreneurship is democratized, fundamentally capital is also commoditized. So the question is what do you bring to the table in the learning and discovery mode? What is the set of services that you uniquely provide? Because we are purely focused on seed-stage investments, I think we are experts in that field.