Author fusion-by-fresco-capital

What is the best startup ecosystem? There’s no shortage of reports trying to answer that question. Take your pick for 2015.

We crave these lists because our education system, culture and business world have all taught us to appreciate the value of competition. And it does have some value.

My Answer
When asked personally, I would always start with the SF Bay Area as #1. Although some locals refer to it as three distinct ecosystems, it’s really a single ecosystem with bad traffic. The data supports the #1 ranking, but just as important is my personal experience on the ground. Things generally do work faster and better in this ecosystem.

But I was wrong.

The Nature of Networks
My change of heart started because I was constantly being asked to rank startup ecosystems in Asia, where the answer is not obvious and the competition is intense. Beijing, Singapore, Hong Kong, Bangalore, Tokyo, and many more contenders. Which is the best?

To answer that question, first let’s take a detour to discuss networks. Twitter is not about 140 characters, it’s about the network of people. A smartphone can be used on its own, but the real value is being connected to the network. Uber could not exist without a network. We automatically understand the power of network effects for companies and people.

Most of the energy in building startup ecosystems right now is focused on local optimization in order to be better than the competition. To climb up the rankings. But this quickly reaches diminishing returns precisely because of local constraints. Opposition to immigration. Housing prices. Traffic. If this starts to sound familiar in your city, it’s because these are common challenges in almost every major startup ecosystem in the world.

A New Perspective on Ecosystems
Instead of focusing primarily on local optimization, startup ecosystems should spend more energy on building connections to other ecosystems. Fortunately, this process is already happening and startups are leading the way by growing their teams remotely, connecting with cross-border capital and finding global customers. But it’s still the early days in this trend and more can be done at the overall ecosystem level.

As we know from personal and business experience, becoming more connected across diverse worlds is a powerful way to increase value.

Similarly, when two startup ecosystems are more connected, they both receive more value because it is not a zero sum game and those connections will then feed back into the local ecosystems. They will both be better off on an absolute basis, and of course also move up in the rankings.

We know that network effects don’t stop at the local level. Instead, positive feedback loops continue to increase across the network as it scales.

This system perspective exposes the reality that our current ranking system is missing an obvious point. The #1 startup ecosystem in the world is not the SF Bay Area, or any other individual ecosystem, but instead the overall network of connected startup ecosystems.

The network is the ecosystem.

For entrepreneurs, there are always way too many things pushing and pulling in different directions. Being able to prioritize is key. But everything seems important. Everying seems urgent.

Start with the basic basics.

First, survive. Seems obvious, but if all your advisors and investors are telling you to go big, and they’re really smart people, it’s easy to forget about this most basic rule. It’s good to fail small and fail fast. But also make sure to survive the failure. It’s no good to fail if you can’t get up again. The most successful founders have an uncanny commonality: the ability to survive.

Second, explore. True exploration feels like zero progress. Everyone around you will tell you to focus. To stop messing around. To get on with it. The problem is, you need to find it first. This takes time and mistakes. In theory, this is all about fail fast, fail small. In reality, this is slow and painful.

Third, build. Once you find it, there’s something to build out properly. Don’t mess around. Yes it’s fine to test assumptions. But now is the time to build. Usually, it’s easier to start small. Find a great solution to a small pain point. Then use that to grow bigger.

Of course, there are many other things to do. Plenty of details to manage. Issues to consider.

But start with the basic basics.

Survive first. Explore second. Build third.

One of the worst parts of investing in early stage companies is saying no. A lot. We say no more than 100 times for every 1 yes.

Since our investment philosophy is people first, some assume that people are our only filter. They believe yes means we like the team and no means we don’t like the team. But that’s not the case. We also need to have conviction about the business and market plus of course need to be comfortable with the deal structure. As a result, there are many times when we say no even though we like the team a lot. That’s not fun for the team, or for us.

So why do we bother to give a clear no? Why not simply hang around on the sidelines with a maybe? Especially since it’s probably better for us, just in case the deal becomes hot and we can jump in at the last second.

Because that’s not fair to the team. We hear too many stories of investors playing games with entrepreneurs, resulting in wasted time. In addition to being fair with time allocation, we also try to be clear with feedback and give specifics of why we are saying no. If we have done serious work on the opportunity, by definition it means that we have been impressed by the team, and so we try to make this feedback useful for them. Once again, too many investors give a one line no, without any context for the decision.

Although there are no short term benefits for saying no clearly, we strongly believe that there are long term benefits for us by taking this approach. Great teams appreciate clear feedback, good or bad. When teams are doing due diligence on us, they inevitably speak to others who have received a no from us and how we act in these situations is a reflection of our overall approach. Great teams are smart enough to appreciate the connection.

So, even though it’s no fun for anyone, we will continue to say no a lot. Even to teams we like. Knowing that it’s the right thing to do for them and for us.

Venture capital is a risky asset class. So it would seem to be prudent for investors in venture capital to focus on the largest funds.

After all, by definition of their size, large funds have convinced other investors regarding their skill. This is social proof. Large funds should benefit from their additional management fees being deployed for additional resources. This is economies of scale. Large funds should get higher quality dealflow. This is network effects.

Altogether, this is the power of a strong brand. The expectation is that size and quality are related.

Let’s inspect the data. One of the most comprehensive recent studies was done by Silicon Valley Bank on 590 venture capital funds in the US using data from Preqin covering funds of at least US$50mln in size with vintage years from 1981 to 2003.

There was was a clear difference in performance. Large funds, defined as >US$250mln, struggled to generate attractive returns, with only 3% returning at least 3.0x while smaller funds, defined as US$50-250mln, did much better with 22% able to return at least 3.0x. In addition, the gap was consistent across all measures of return. On the flip side, the risk of getting less than a 1.0x return was lower among small funds.

Since there is potential for some cycle specific issues to impact the data (large funds were mostly raised during 1999-2000, the worst time to invest), a second approach was used comparing fund sizes in each vintage year. The conclusions were even more skewed in favour of small funds. In this case, larger than median funds were never able to return at least 3.0x while smaller than median funds were able to return at least 3.0x during 31% of the time. Once again, the gap was consistent across all measures of return while the risk of getting less than a 1.0x return was lower for small funds.

Why do smaller funds have consistently higher returns and lower risk? The first point brought up by Silicon Valley Bank is better alignment with investors. “As the managers of such funds earn relatively less from management fees, they have a stronger incentive to focus on portfolio performance in order to generate wealth through carried interest.” (Weber & Liou, Silicon Valley Bank).

There are several other possible causes, many of which relate to the fundamental challenge that running a US$500mln fund requires extremely large, and rare, exits to make a difference while running a US$50mln fund allows for more flexibility in the size of exits needed to generate high returns.

Does this mean that all large venture capital funds are bad and all small seed funds are good? Of course not.

What it does mean is that, statistically, managers have to be exceptionally skilled to generate excess returns at large funds. In fact, the same team running a large fund would probably be able to generate higher returns at a small fund. Conversely, as small funds get larger than US$250mln, investors should start to become more worried about the negative impact of size on performance.

For investors in venture capital funds, these are some sobering conclusions. It means that playing it safe and investing in large funds is actually a higher risk, lower return proposition. Conversely, investing in smaller seed funds results in a better return and a lower risk of earning less than 1.0x. When it comes to venture capital, small is the sweet spot.

I think it is just beginning to dawn on me how significant of a step I took when I decided to leave my job at Goldman. I’m a year and half into my P.F. (post-finance) life and, for a variety of reasons, it’s just hitting me now. It seems sufficient time has passed such that the public has deemed me beyond the point of no return and they are starting to marvel at my apparent insanity. I’ve been asked with increasing frequency: “How did you do it? How did you figure out how to leave and not look back?” There’s also the fact that my bank account is dwindling and I’m marvelling at my own apparent insanity. I still don’t regret it for a second, but the reality of changing my lifestyle has certainly settled in.

Additionally, as the buzz around the startup community in Hong Kong grows, I am talking to more and more people who are working in finance, consulting, or other corporate jobs, and secretly dream of one day leaving to pursue some other passion. Though many credit money for being the primary reason for not taking that leap, I think it’s something else — or at least a combination of factors. For me, it was both a lack of direction and a lack of confidence in my own abilities. I thought, if I did leave my job … what is that ‘other’ passion that I would pursue? I have always been interested in a lot of different things, but I never had that one thing that I loved so much or that I couldn’t live without. I am not obsessed with one industry, one product, one activity that would make it glaringly obvious what I should pursue.

And from a practical standpoint, what would I even be able to do? I’ve always been kind ofgood at a lot of different things, but never excelled so much at one thing that I had no choice but to go after it. If anything, my strength would be general business skills, which is why I dream about starting or running a company one day. Even still, the only jobs I had in my adult life were… bank teller, smoothie/sandwich girl, tour guide, a little data entry, and Equity Derivative Sales. Not really the most applicable background if you want to start a company.

When I would share this frustration with people, their answer was always, “Why don’t you just go to business school? You can figure it out there.” But I didn’t want to take two years to go to business school to “figure things out.” My frustration with my then position was that I didn’t feel like I was really doing anything. It felt like I was just spinning my wheels every day. If I went to business school, I was only delaying the inevitable. It wouldn’t actually solve my perceived lack of productivity.

I really believe this is a fundamental desire that lies within every one of us. A desire to break free of our constraints and get to a place where we can truly contribute, where we can build something bigger than ourselves, where we actually matter. It is natural to seek the satisfaction that comes from seeing tangible results of something real that you did, an idea you came up with, connections that you made — that satisfaction is indescribable. I think it’s fundamental because it means you have a sense of agency — the ability to contribute, to create, to choose is precisely what makes us human. So, I suppose it’s ironic that so many of us are waiting around for someone to tell us it’s okay to take control of our lives and to make a conscious choice to be free. We don’t actually need to rely on other people to get a taste of creation. It’s ours for the taking, we just have to go after it.

So, then, how did I get started? It didn’t happen overnight. But, even though I had no idea where I was going to end up, I did take some small steps to set myself on a different path. Here are some little things I did that I’d recommend for anyone lusting after a change. These seemingly minor changes are what allowed me to subtly, passively, subconsciously formulate my escape plan.

1. Expose yourself to your other options in the corporate world by signing up for notifications for job listings. I had never looked for a job outside finance, I had no idea what was even out there. There’s a lot of riff raff, but at least you’ll have a sense for your “practical” alternatives and the skills/background they would require.
2. Sign up for Escape the City. This was first thing I signed up for after all the traditional newsletters. Getting exposure to non-traditional options will open your mind and help you consider something you’d never even thought of before. I didn’t think I’d move to sub-Saharan Africa to work for an NGO, but who knows? It got me thinking out of the box.
3. Make sure you subscribe to both of these things using your PERSONAL E-MAIL. Or, maybe don’t, and your employer will find out and make your choice for you.
4. Beef up your LinkedIn profile. Add your experience, your background, ask for recommendations. This puppy is pretty powerful and recruiters spend hours trolling for candidates with certain backgrounds. You never know who might reach out to you. I got my first startup interview for a role at ZocDoc after someone randomly contacted me through LinkedIn.
5. Talk to your friends. Tell people you trust that you’re looking for a change and that you’re unhappy. If you’re still unhappy and complaining years later, they’ll hold you responsible and subtly push you to make a change (if they’re good friends, that is).
6. Start writing cover letters and doing interviews with start ups or other random industries you’ve vaguely been interested in. Telling you now, you probably won’t get the job (I got lots of rejections before I joined GA) but you’d be surprised how much value you get out of talking about your skill set, listening to how you sell yourself to others, testing how far you’re really interested in taking things. That way when the right thing comes along, you’ll have a clear picture in your head of why you want it and how you can contribute.
7. Sign up for Meetup.com, commit to some random activities, and meet some people in different industries. Try out some new things, listen to other people’s paths and stories, expand your realm of possibilities. It’s so inspiring to meet other people who are passionate and eager to share their interests.
8. Go to a class or sign up for a course at a place like NYU School of Continuing Ed or General Assembly (I’m not just saying this, I’m serious. I did this before I worked there). You’ll gain a practical insight into other industries, you can make some solid connections with the instructors and other leaders in the field, and perhaps most importantly, you’ll get exposed to other people that are searching just like you are. You may think you’re special — and you probably are — but that doesn’t mean you have to be alone. Because the reality is you’re not alone. There are so many other people out there looking to make change but aren’t ready yet, or don’t know how yet. There are also a lot of people out there that have made the change, and they’ll make it seem a lot less scary.
9. Get involved in a project, whether it’s through friends, through a hands-on/project-based course as mentioned above, or even through Craigslist. It doesn’t have to be your own, it doesn’t have to be your dream passion project, but you’ll get to exercise your mind, test and come to understand your own capabilities, and you’ll feel amazingly empowered to see that you can accomplish something meaningful out of your office. It will remind you what human agency tastes like, and you’ll have no choice but to go looking for more.

So, there you have it. It’s a long list, but it’s pretty easy to do. It won’t force you to do anything you’re not ready for, but it will help you passively prime yourself for success. You’re just warming up your muscles for your leap so you don’t sprain, tear, or break anything. Before you know it, you’ll find yourself at an impasse where it feels natural to just jump. I can tell you from experience, it will still hurt, but as long as you’re properly prepared it’ll be a really good kind of sore.