One could probably argue that Floodgate, the Bay Area-based early-stage venture capital firm, punches above its weight. The roughly 15-year-old firm has about $500 million in assets under management — including a $150 million fund it quietly closed in January — and it only makes a handful of new investments each year. Yet with investments in Okta, Lyft, and Starkware, which have been valued at $8 billion in May, among other things, his focused approach seems to be paying off.
Writing so few checks, especially in a booming market, could prove frustrating for some investors. But over the years, it forced Floodgate’s small team to sift through several thousand locations and identify which ones they felt had the most potential. Today, co-founding partner Ann Miura-Ko and Tyler Whittle, a senior partner at the firm, have developed a new program to help student teams similarly develop an understanding of what big ideas look like. – and why most concepts aren’t great ideas.
To get more details on the program — and also to hear Miura-Ko’s current take on the early-stage startup scene — we spoke with her earlier this week. Excerpts from this chat, edited for length, follow. You can hear our fuller conversation here.
TC: This summer, you invited many students to work on startup ideas with you here in the Bay Area. Were you incubating businesses together? How did it all work?
AM: We went to a community of builders that we had created the previous year and [Stanford’s] engineer school [where I teach], and the IT department of a number of universities and said, “Hey, if you’re interested in being a future founder and you’re a great builder, then we’re interested in talking to you.” The main message was: “We don’t need you to have an idea to work on. We just want you to be an amazing builder with amazing curiosity. Partially, [that’s because] you must be able to quickly build and throw the product [sometimes] but you also need to be curious about the history of the industry you work in. . .
The goal is to help them identify big ideas. What is your definition of a great idea and how do you know when you see it?
I’ve come to realize that there are two types of businesses that can actually get really big. The first is: you have an idea, and most people already understand that idea, but you’re just operationally better, and therefore outperform everyone else. What I realized is that as a seed investor, we don’t really have an advantage investing in these companies because we don’t see enough deals to know who the best to manage this type of startup. So when the founders hear, ‘[You] need a little more traction before you make a decision,” it’s probably because you run a business that is more operations-driven, as opposed to the second type, which I believe is information-driven.
A knowledge-driven business is really about identifying what we call an inflection point, which has a few components. First, there’s some kind of change event that happened. It could be technical – CRISPR was invented – or a regulatory change event, like telemedicine across state lines is allowed, or it could be societal. The most common that people currently point to is simply working from home.
The change event makes a new feature possible, or it allows a product to be built cheaper or faster, or you can also have a completely different business model made possible. [For example] you get it licensed instead of having to pay for it on a monthly basis, or vice versa. Or the business ecosystem fundamentally changes.
When it happens, if you can tie it up [that inflection point and change event to]”So this is going to create fundamental attraction and adoption of my product in the next two to three years” you know now that seed investors should be [funding]. [And] it’s the kind of thing that we really want our students to really understand.
Do you fund these students?
Yes. We write checks for $50,000 to all the businesses, and then a bunch of them will just end up saying, “We’re not going to do this anymore,” and in that case, close up shop. [But] we had two companies that are [going concerns] with investments from us, then one that could actually take additional investments and one that [already] took an outside investment. And so we have four businesses that continue to operate out of 10.
How many stakes does that $50,000 buy you?
We’re still working on that for next year, so I don’t want to put a pin in what we’re going to do. But it is a SAFE note. And then for the follow-up funding, it varies according to the needs of the person and also [it’s tied to] when we invest in this company, so its valuation also varies.
Four out of 10 is a pretty good success rate. Were these students primarily from Stanford?
What’s really wonderful is that we had students from Stanford, but we had students from the University of Texas, with other students from Yale and Penn and the University of Texas, so it covered in made several different universities. . . and we’re really excited to try to expand to as many universities as possible. One interesting thing we learned is that Stanford students are very well educated when it comes to startups. The beauty of having Stanford students in this network was that our Stanford students drew other students into the networks that Stanford students are so lucky to have.
I remember talking to a 19-year-old Stanford student, probably 10 years ago now, who said he felt compelled to become a founder because of the school culture. Does this concern you?
Yes. That’s why I really carefully crafted it for you to have a way out. I think it’s so important to recognize that not everyone is meant to be a founder. And in fact, in the relationships that I have with my students, I will say to some students that I know very well, “You have these incredible skills that are so unique and that you don’t find in a lot of people you should go to a big company you will have so much impact there in fact I will directly advise students not to become founders [because] it is such a specific desire or [requires] a skill so specific to a specific time that, from my personal point of view, it shouldn’t be for everyone.
I agree with you. I think there is to some degree a major push for people who are technical [and] for people who have good ideas to go in this direction. But I really hope that by giving them that kind of exposure, they can find out if there’s a founder inside.
Out of curiosity, does Floodgate use scouts?
We don’t have a scout program. I guess our network of friends, family, and founders are technically our scouts. But we don’t have a financial plan like a lot of people. I have this kind of network of ‘non-partners’ that I meet on a regular basis – they are angel investors and small fund investors – and what we do is we will literally share three or four interesting companies that we have reviewed over the past two weeks. And then we share with each other how we would be diligent. And if other people are interested in discovering the company, we invite them.
Along the same lines, Y Combinator has just completed its last demo day. As a seed investor, do you follow YC closely? What do you think of the organization as it exists today?
I think they provide a great service to founders, and I think people who want to get exposure get [it]. I have a lot of respect for the product they offer, the community they offer and the way fundraising is made possible through it.
To me, it’s just a harder platform to engage with. If I only make two to five investments a year, and I’m asked to write a check with a rolling SAFE note, which if I sign tonight, you know, is an assessment and if I sign tomorrow, it’s at another, and [the founders] don’t even really know me, but they’re willing to sign with me – like, none of this sounds quite right. So the people I’ve signed up with are actually founders I knew before I even got into YC.
But I see why the founders love it and I think they did a tremendous job in the product and I wouldn’t rely on YC. I know every year some people say the classes are too big and everything is too watered down and expensive. But you know that in each group there will be one or two hits.