Weary of ‘Fruit Fly’ Consumer Startups, Andreessen Horowitz Raises Series A Bar

The classic example was PicPlz and Burbn (renamed Instagram after the pivot), the VC in question was a16z

http://thenextweb.com/insider/2012/04/23/ben-horowitz-on-why...

Re AirBNB, (a) we are an investor in AirBNB, and (b) the founders are extremely sharp product people and technically very deep. The CEO is a designer by background, like Ben Silbermann at Pinterest, another investment of ours. Both are hypercompetent product people with deep technical chops.

I don't think it proxies that well. As the article points out, a16z raised a $1.5 billion fund, some top-tier firms might come close, but most of the mid- and bottom-tier VCs operate with the fund sizes in double-digit millions.

Also, for a highly contested B round, A round participants or brand-name VCs will get preference over a generic nondescript firm with a Sand Hill Road address.

Somebody from YC might correct me on this, but I think a16z's participation in automatic round upon admittance to YC comes with drag-along rights, which they can choose to exercise at either A or B rounds. So they don't have as much of a problem of missing on quality dealflow that others will miss on if they choose to skip A rounds.

In my own words: consumer startups more and more have this very interesting "lightning in a bottle" effect where sometimes they take off like crazy and sometimes they just don't. I give full credit to the teams that figure out how to get the flywheel spun up, but it is also important to realize just how many highly capable founders are hard at work trying to get traction who don't. There are a lot of really excellent founders pursuing consumer ideas that just never work -- that's why companies like Yahoo and Google and others can do so many acquihires. So, if we have the theoretical ability to invest in a given category -- remembering that we can only make one primary venture investment per category -- in either the A or B round, we find it often makes sense to let other firms fund the A rounds before anything is proven and wait to see the early signs of lightning and then step in hard at the B. The end markets are so large for the winners that the investment returns in the B can still be outstanding, and we can still offer a lot of useful help to the companies at the B stage such as talent sourcing.

In contrast, enterprise startups are much more (take your pick) tractable, execution centric, brute force, predictable (as startups go). If you back a killer founder with a great engineering team, with a great idea, into a big market, the odds are high that magic will happen -- a very interesting product will get built, early customers will adopt, and value will be created. In other words, the link between founder/team competence and success is more direct. One thing that helps a lot is that whether the product will be adopted by customers or not is far less of a mystery -- you can simply go talk to the likely customers ahead of time and they will give you a very good indication. That plays well to our market development program where 1,200 big company management teams are coming through our office every year -- we ask them what they think about new ideas and they tell us. So here, backing the A round when possible makes more sense.

None of this is religion -- we still do plenty of consumer A's and enterprise B's. We just think it's useful to talk about these things in public so that entrepreneurs know before they come see us how we are thinking about things -- it optimizes their chances of getting to the right outcome with us (whatever that is).

    Andreesen Horowitz is loosing the
    ability to identify impactful startups

I don't know if anyone can properly guess if a consumer startup is going to get traction until it does, especially in the mobile space. That said, they did manage to get a 312x return on their seed investment in Instagram (which they declined to invest in a second time as explained here: http://bhorowitz.com/2012/04/22/instagram/)

A-H offers seed investments to YC companies in order to get a foot in the door with the small fraction who will succeed. Offering blanket seed investments confirms that they really don't have any idea at first either. There's nothing wrong with that, it's just the nature of the beast. (http://venturebeat.com/2011/10/14/andreessen-horowitz-to-giv...)

When you get down to it, if you have a $50m fund, you might want to invest in ~10 A-rounds at ~$5m each. If you have a $1.5bn fund however, do you really want to invest in 300 A-rounds?

Nope. The best way to spend your time is looking at the bigger, later investments. You probably still only want to have roughly the same number of total investments to oversee. So if an A-round company is gonna take the same amount of attention as a B-round or later, you shouldn't waste even a second of your time considering them.

It's nothing to do with ability to identify, just correctly prioritising the time the VC's have available to them.

For the classic, pure, viral, social and/or user-generated content businesses -- that will probably be monetized with advertising -- the generic headline metrics like daily/weekly/monthly active users and engagement/retention rate are important. There are just so many new products that attempt to be the next Facebook/Twitter/Youtube/Pinterest that showing that you are already punching through the noise is pretty important.

For two-sided marketplaces (the next eBay/Etsy/AirBNB/Uber) it's most important to have a real theory about how you're going to get both sides of the flywheel spun up. The traction doesn't need to be gigantic but there needs to be a real plan. We still see too much handwaving in this category -- it is REALLY hard to spin these up from a standard start and most simply languish and die.

For ecommerce and ecommerce-like busineses (the next Fab/Ziluly/OneKingsLane/Zulily), the most important thing is showing a model, with initial proof, of how the cost to acquire customers is less than the lifetime value of those customers. For example, in recent years it has become harder to build these businesses based on Google keyword advertising -- search volume isn't growing very fast, and lots of people are trying to acquire customers in most categories, and so keyword ad rates often get bid up to just past the point of unprofitability (the delta is the amount of excess funding going into businesses in these categories). So creativity on customer acquisition -- and showing that in economic terms -- is key.

I think that a credible team with any of this in reasonable shape from a seed round is not going to have trouble raising an A in this environment. But for those that have already raised an A, it has become really critical to have these factors nailed (whichever are appropriate) to be able to raise a B.

Finally, probably obvious but worth saying -- investors are all over the map on all of this stuff all the time. It's very valuable to be able to prequalify investors for interest and knowledge about particular categories -- and frankly IQ and judgment -- prior to meeting with them. Good advisors and angels can be very helpful with this. This is also why we try to be transparent on these topics (such as with Scott's interview) -- better for us and for entrepreneurs to know how we think before they walk in the door.

Good luck in jail!