The best place for junior VC's to hang is on the fringe

August 31, 2016
Jonathan Libov

Preamble:This post is a synthesis of some of the things I've learned while serving as an analyst at USV. Were these ideas and observations wholly my own, the title of this post would be "How I succeeded in venture capital". Moreover, this post was inspired by my very recent read of Tim Wu's "The Master Switch", whose ideas I cite liberally.

I joined USV out of a company called Appsfire. Appsfire began, in 2010, as an app for discovering apps. We operated on top of the App Store and Google Play Store and helped people discover and consume apps. In 2010, developers were figuring out all the atomic units and user experiences and ways of leveraging sensors and monetizing on mobile. What with the explosion in apps between 2008 and 2014, consumers could barely keep pace with all the fun and productive things one could do on an iPhone.

I was a Product Manager at Appsfire and so naturally spent a lot of time looking at apps. As something of a designer, I paid a lot of attention to the fineness of app icons and choices in typography. I knew a lot about how to succeed in the App Store on the basis of design and user experience; I knew too much about how to game or spend your way to the top of the App Store; I didn't know all that much about how startups really succeeded beyond a handful of clichés that most everyone acquired from reading tech rags.

So when I started at USV in September 2014, I was pretty good at spotting great apps, pretty naïve when it came to spotting great businesses (well, with perhaps one exception), and real effing dumb about venture capital. Reading Brad Feld's Venture Deals helped, though even for a few months, when someone in a Monday Meeting would utter a term like "Participating Preferred", I'd spend ten seconds in my head recalling the definition until I kinda sorta knew what the partner at USV was talking about.

At the end of 2014 it came time to write our reports for Q4 and facilitate the audits, which is when I really started to learn a lot. The analysts at USV spend about 25% of their time on administrative work related to the fund. A lot of analysts and associates I've met at other venture capital firms do not. I don't understand how those analysts and associates come to understand the muck of cap tables and fund financials without having waded in it. I am very grateful for having done that.

The other 75% of the job relates to figuring out how to deploy the fund's capital as investments. Within the first few months on the job I spotted two apps that were burning up the App Store charts. They both exhibited a lot of the rawness that matched the pattern of breakout hits. We brought them in to meet. Neither came close to a deal; good thing because both apps have slid down the charts ever since.

As it turns out, my joining USV coincided with the average number of apps that a US consumer downloaded per month dipping to somewhere between zero and 1.5. There have been hits along the way — Dubsmash for a while, and maybe now Musical.ly and Pokemon Go. Amino, a USV investment, is very clearly delivering something to mobile users that, more than three quarters of a decade into the App Store, they still lacked. But having discovered the right form for delivering the atomic units on mobile, we've essentially reached attention capacities. And so lots of things gets gobbled up by today's incumbents — Apple, Google, Facebook, Twitter, Amazon — before it gets mashed in the compactor. Or, in today's mature market, those apps get eaten by those new incumbents, like Kronos eating his young.

The Kronos metaphor is lifted from Tim Wu's "The Master Switch". The Master Switch is the story of how decentralized communications networks are initially developed by independents, only to be swallowed up by hegemonic economic corporations as the market matures. I wish I had read this book earlier in my tenure at USV, and would strongly recommend it to other analysts and associates today. The Master Switch could not more perfectly provide the context in which we find ourselves in today, approximately 12 years after the rise of the consumer web, a decentralized network, and eight years after the birth of the App Store, a centralized marketplace. The App Store has delivered tremendous value to developers and society; it has moved the world forward; but what with the App Store charts that extend the leads of the leaders — fewer and fewer of the top apps in the US are owned by new companies or don't rely on old IP — and the spectre of eventually competing with one of Apple or Google's own first-party services — think Spotify and Soundcloud competing with Apple Music, or any of the would-be A.I. assistants that need permissions for all the data that Apple and Google largely get without asking — this is a challenge for venture capitalists. I don't begrudge the App Store at all — quite the opposite, it has done the world an incredible amount of good — but as the explosive early era of the App Store has waned, it has affected the role of a venture capitalist, the job I stepped into two years ago.

I believe the thinning of the air in the consumer app environment is what has driven much of the enthusiasm amongst developers and investors for bots and virtual reality, enthusiasm which currently exceeds consumer interest. I was not an investor back in 2006, but from what I've drawn from the institutional memory at USV, this was not the case during the rise of consumer internet media. For one, blogs and other internet media were actually being eagerly consumed. For another, consumer media is a permissionless environment, whereas bots sit on top of platforms like Facebook which will extract much if not all of the value, and currently there's little reason to see how the incumbents will not own distribution of virtual reality. Which is not to say that there won't be a few valuable new bot or virtual reality companies, but rather that they're really additive interfaces to current internet paradigms (I failed to appreciate this for a while), and so opportunities will be fewer and further between. The excess enthusiasm for bots and virtual reality, I believe, is borne from a longing for the kind of wide open opportunities brought on as networked computing moved from the desktop to the browser to the phone, and digital photography moved from the standalone camera to the phone.

Fear not, that wide open new paradigm does exist. What's happening today on the Bitcoin blockchain and other new blockchains is incredibly exciting and intellectually consistent with Schumpeter's model of creative destruction and the cyclical history of communications networks. If you still view Bitcoin as a techno/anarchic/utoptian/libertarian model for consumer payments, you haven't been paying attention.

I am reluctant to present the following chart because, taken at face value, would appear to undergird the argument for Bitcoin as an alternative to fiat currency. And yet it's too striking to omit:

Bitcoin market cap

This chart supplies one retort to the question of "Where are all the killer apps for Bitcoin?": Bitcoin has remained a resilient, growing network in spite of the lack of consumer applications. I suppose the cynicism around the lack of killer Bitcoin applications is related to overenthusiasm for bots and virtual reality: The latter suffers from overextending the model of creating value consumer services, the former suffers from impatience for those consumer services to arise.

Another retort is that blockchain companies today are creating systems that are more resilient and even natural than current internet networking paradigms. They're also exploring fundraising models that are in many ways more meritocratic than the models that today's incumbents followed. It may be happening on the fringe, but here's one view of what wireless telephony looked like around the turn of the twentieth century: Rural, makeshift, and nothing if not fringe-y.

Early wireless telephony Source: Saint Louis Post-Dispatch, January 12, 1902

The very same pattern appear in the history of radio, television, and the internet. Go read The Master Switch.

This is certainly not to say that, in this mature market, the only great opportunities are in blockchain. But those opportunities are also fringe-y, in a way. This is the essence of USV's current focus on niche, or market-specific networks. Only a few years since decent smartphones fully saturated Western markets, we see networks springing up in industries that were once poorly networked, like trucking and medicine, or enabling new behaviors, like digital nomadic life, or enabling new ways of financing one's life or business.

Fringiness, if you will, is in many ways vital to the business of venture capital. Sure, there is a large segment of investments that are wholly mainstream from the start and can be found by some combination of being in the right place at the right time and good execution (e.g., Uber) . But there is a large segment that capitalizes on the arbitrage of thought, culture and research. It is through this lens that investments like AirBnb, sketchy and fringe-y at their inception, seem so obvious in hindsight. I view it as arbitrage because investing, naturally, isn't merely the business of putting money in great companies, but rather putting in money at great companies at great prices. Inasmuch as a venture capitalist has developed ideas and conviction about how the world will develop, hanging around the fringe is an opportunity to participate in big opportunities that are priced well because the majority of other investors haven't caught on yet.

I am generally loathe to offer advice on my blog (meet me in person, though, and I'll pontificate until I’m blue in the face). However, it is in this context that I'd offer some straight-up advice to junior VC's: Mingling with other investors is a good thing — it's important, to some degree, to keep tabs on the network of investors and investments — but you must challenge yourself to isolate the investors with whom you want to keep up with. If you don't do that, if you fill up your calendar networking with everyone and anyone, you're at best costing yourself time to research and understand a market, and at worst filling your mind with ideas and trends that don't help you arbitrage on unseen, unrealized value in the world. Finding the right balance is not an easy thing to do. I often found myself praising the wisdom of other investors who agreed with my ideas while questioning the foresight of those who didn't, which is not altogether different from re-affirming the politics of those who are already in your Facebook and Twitter feeds. To break the cycle, look for historical analogies and patterns to help validate or invalidate your ideas.

But more importantly, talk to people who are building things. Don't just talk to founders of investible companies, but also talk to people who are experts in their field or following modes of thought that contravene mainstream thinking. Play with their API's and go deep in forums, even if there's no investment in sight. Mess around in the corners of the internet.

Just as wading in the muck of cap tables and share purchase agreements is the best way for an analyst to learn the mechanics of venture investing, wading in code and API’s and forums is the best way to discover the things that others have not discovered yet. To frame it more practically: This will help you identify the opportunities that others don't appreciate yet, and that will help you to invest at attractive prices.

Lastly, it is important to emphasize who this post is aimed at: Junior VC's. The partners at your firm benefit from having established networks that will pass along interesting, valuable opportunities. Your job is to complement those investments with the ones they and their network would not see because they're don't fit the patterns they're accustomed to. You have more freedom than they do to mess around on the fringe. Don't waste it.

It is a difficult job. As I described at the beginning of this post, I was naïve when I entered this business. Two years later, I have graduated from being naïve to being dumb, because now I am no longer so naïve that I fail to realize all the things that are happening in the world of technology that I don't yet understand. The license to study these things is what makes it such a privilege to work in venture capital.