Silicon Valley is a surprisingly clubby ecosystem: FC's Alex Mittal

Being an effective founder means questioning current paradigms, asking ‘Is there a better way to do this—and am I the person to do it?’

It’s that line of thinking that leads people to create disruptive companies, to solve problems that were thought to be intractable. Venture capital investing offers different challenges than those associated with tech entrepreneurship, but Alex Mittal, co-founder and CEO of FundersClub, approached the sphere of venture capital the same way he did as a tech founder previously: is there a better way to do this?

That line of questioning led Mittal and co-founder Boris Silver to build FundersClub in the way they did. They seek a VC model where dogma is less of a drag on the enterprise, and investment discovery can come from a wide network of smaller investors—mini LPs, in a way.

In building FC this way, Mittal and Silver seek to crack a real problem: plugging into the Silicon Valley network, which operates more like a business network from a century ago, based on who you know, not what you do or what you’ve done.

This is one of the insights that Laura Behrens Wu drew out of Mittal during a FundersClub Facebook Live discussion on March 30, 2017. Berhens Wu is the CEO and co-founder of Shippo, which offers an API to connect eCommerce businesses and marketplaces to a network of different shipping providers.

The standard convention for FC Live events has Mittal in the interviewer seat and a different Silicon Valley VC answering the questions, but in this case Behrens Wu was installed there, and it was she who got the chance to ask Mittal the questions.

Some of the key takeways from Mittal’s chat with Behrens Wu include:

• Silicon Valley is a surprisingly clubby ecosystem. Getting funded or even acquired, in many cases, has more to do with whom you know than how good your product might be. FundersClub sees one of its core missions as opening up the opaque world of Silicon Valley to its founders, getting them connected to what is an antiquated system in many ways.
• About 75% of FC’s investments are in the Bay Area, but that’s something that Mittal expects to decrease as time goes on. Silicon Valley has no monopoly on innovation; it happens everywhere.
• FC sees blockchain as one of the technologies that will shape the future. Says Mittal: “You might remember TCP/IP in the 1990s; I think this is it.”
• In the end, venture capital is driven by capitalism. Everybody likes a business that also achieves social good, but the best way to do that is to find a model that makes a ton of cash and also happens to achieve some good. One example of that is Wonderschool, which allows people who couldn’t have easily afforded good preschool for their kids to find it through an Airbnb-like platform.
• Founders needn’t have revenue to draw VC investment, but they do need some way to show that they’ve validated the model. Ideas by themselves, while necessary to move the world forward, are ultimately a dime a dozen.

Below, readers will find a version of the conversation between Behrens Wu and Mittal. While this conversation has been edited for clarity and, in some cases, brevity, it should be noted that this was a with questions from an international audience arriving in real-time. Many of the questions come directly from viewers. Behrens Wu's words in bold:

You used to be a founder as well before coming a VC. Why have you switched to the dark side? What's the insight there?

To address the "now that I'm a VC" point: I started out as a founder, I still consider myself a founder. Pretty much, being a founder is about identifying real problems that people have. Figuring out, is the existing way that addresses those problems efficient? Is that the right way? Or is there a better way? If not, then why isn't something else being done? If other people are doing something in that area, why isn't it clicking? So a lot of the questions you ask as a founder are the same questions you ask as an investor. And ultimately, big picture, at least when it works correctly, founders and investors are on the same team, right? They're basically both together trying to build amazing companies. And obviously it's the founders who are building the companies the investors are merely there to be signing up to help.

But in the abstract, my ambition has always been to move the world forward, create value, and help other people do that. So it's sort of a natural transition for me. There is the darker story though of what was the kick in the butt that actually lead me to join up with Boris Silver who's my partner and co-founder.

I had either the fortune or misfortune of raising a lot of venture capital for myself. You know, my prior businesses, one was an enterprise software company. The next one, the most recent company prior to FundersClub, was a touchscreen hardware business. The experience of working with amazing people. people on the investor side, affected me. These are angels and VCs. But I also was directly exposed to behaviors and patterns that I felt represented the inefficiencies of venture capital.

There are a lot of inefficiencies in VC. From which companies are surfaced to those who are backed and funded, there is a lot of groupthink in venture capital. It's not necessarily what you know. It's often about whom you know. These inefficiencies are on the discovery side and then there is the whole process of fundraising. It’s sort of repetitive, kind of a soul sucking experience. Then there is the so called value-add piece. Sometimes VCs overpromise in that area, and some do just the opposite. Sometimes it’s almost better to have a VC who does nothing at all than to have a VC who taking too much of your time as a founder. So it’s a delicate balance.

So it's sufficient to say I actually experienced some of the good and the bad and the ugly of venture and that fact was a very strong personal motivator to try and make a difference and lead me to what I do now.

So how is Funders Club different than other VCs? You talk about like finding or seeing some of the problems and inefficiencies and solving them, how is it different?

Sure, so I'll start with like some of the similarities. From a business model point of view, we're very much aligned with the traditional model. Like most VCs, our goal is to discover the world's best founders. I think you are one of the world's best founders. We want to arm these people with capital, to help grow their businesses but we also want to support them. Much of that comes in the form of help with recruiting and these sorts of things.

Ultimately our primary way of benefiting in our business model is what's called carried interest, which is a percentage of profits. So in other words we don't really make money unless the people we work with, our founders, do well. And so that's our primary motivation and reason for being. It's like partnering with people who go on create categories or redefine them in business that move the world forward. We try our best to help those founders grow faster to be more successful. And through that value creation, we capture some value ourselves. But I will also say that this is a multi-year process of learning and iteration. And so we're still getting better, and so I think that every VC, including FundersClub, can be self-reflective and think about how can we do our jobs better. So we're not perfect, in other words. I think we can do way better.

Makes sense. So where do you find your companies? I hear that every great VC firm has a lot of relationship capital in sourcing their investments. So where do your portfolio companies come from? And then you just mentioned great founders: what does it take to be a great founder in your opinion?

I realize I didn't full answer your first question, which is how are we different from a classic VC. Because I kind of emphasized a lot of the similarities but this feeds into that second question: how do we discover founders and how do they discover us? So obviously we're based in, you can't see it there, but we're in Silicon Valley in California. We're right now in downtown San Francisco, actually. And certainly there's a lot of great founders here, and our team is here. And we're meeting with people locally here in Silicon Valley. The vision we have of the world and really where the world has moved is that Silicon Valley does not have a monopoly on innovation, that it can happen anywhere, anywhere in America, anywhere in the world. And more and more so that is happening.

Even though something like 75% of our companies are based here, we're really building for the future. So we have a network of 19,000 people on the ground across 60 countries. These are our members, these are effectively extended LPs of ours, in VC-speak. And then we also have a growing portfolio of entrepreneurs in about 20 countries now. And so we have this network effect that we're bringing to venture capital, and that's one way that we're significantly different: traditionally VC has always been a very human capital focused, typical VC firms don't look at that as a product opportunity. We want to harness that network effect for best optimizing the discovery of great ideas and great entrepreneurs. In other words, how can we make it less about just who you know? We understand that sometimes it is about that. But what if there is a deserving company out there that isn’t connected? Shouldn't we know about it?

Our ambition is to have a big enough network that's in enough crevices of different industries, different geographies, so that we should probably know about companies that would otherwise go unnoticed until later. And you can kind of see how that might be useful for vetting and there's thing that we do back of house to help use that network for better understanding markets and businesses.

But you can see how you can actually take that network and have that help founders in a way that previously was not really a thing. Specifically if you have thousands of people who have the capital and the interest to invest in the next generation of successful companies—that cohort tends to track with people who are successful, who are plugged in, who have a vertical of very deep experience and knowledge. We've seen that lead to things like partnerships, new hires, I think we've hired some people from that network. I was just talking to a founder earlier today who ultimately sold his company, it was a great outcome for him and his team, and investors, and it turns out the person leading the M&A, on the deal team was one of our members. I only learned that yesterday. It's that kind of thing that we see as a unique opportunity.

And beyond the network, we take software very seriously, and so we have about a half a dozen people on our product, engineering, and design team who work in partnership with our venture team, our community team, others to look at software as core to the VC model. We want to build software that actually helps our founders. It's a long answer but that's little bit of how we're different, a little bit of how we discover our founders in a way that maybe is different from traditional VC.

So let's say you get a founding team into the door, how do you evaluate the founding team, the business, these are two separate questions. Like what are the metrics you looking at for the business and how do you know, or what is a great founder for you.

So I'll talk about the founder piece first because we at FC, we enter typically at the seed stage, and this is a stage where a lot can still go wrong. So who is driving the business is really important, obviously.

We look at the resonance between the founding team and the opportunity. And the reason that I say it in that way is because we have backed many first time entrepreneurs. If I were to say the experience of the founder it almost implies that we mandate that Mark Zuckerberg would have had to founded MySpace or something similar to get funding from us for Facebook, but we don't believe in that.

When you take that example, you know, Mark, previous to founding Facebook had started this hack at Harvard to actually make a real Facebook, but for Harvard. Previous to that, he had started and sold a music startup. So there were signs that the founder had what it would take to build a company that can meet a real purpose and do things that buck convention.

So we're looking for founders who resonate with the opportunity. We're looking for founders who, toward that last point I was making, about sort of going through brick walls, who have that resilience, that relentlessness—because start ups are really, really hard. Everything that will go wrong, will in fact go wrong. So that resilience is very important.

There's actually a lot of other things that we look for specifically we look for technology enabled businesses, technology differentiated businesses, and so we often will gravitate toward teams who have that competency in house. So it's something we consider of the utmost importance: that technical core competence.

And then when it comes to the business itself, I did mention money. Obviously we also consider it necessary for a startup to be in a market that is big enough to justify a VC investment. I have a blog post on that, fundraising advice for founders raising for the first time. My first piece of advice is to consider not raising money from VCs. Venture capital is a very specific type of money, it's the type of capital you would want to raise if you believe you can build a billion dollar business. And the reason why is those are the expectations on the other side. Investors are expecting to see a return on their investment, and most business aren't successful. More often than not, startups will not end successfully. So to make up for that, you have to have companies that are so successful that they make up for all of the investments that were not.

And so what that translates into a business now, for the founders in the audience, is looking at your market and saying if you could sell this product to 100% of the people out there—you may not be able to do that—but if you could, what would that be worth? Maybe that's for businesses that monetize through revenue. For business that are about attention, so Facebook originally, or Snapchat, then it's more about looking at, ‘Okay, what is the likelihood of this business capturing like, a mass market attention?’

So we look at market predominately. First it has to be there, and I mentioned the team as well, the team has to be there and I already discussed that it’s very important to us. And then for us specifically, we're not family and friends money, we're an institutional investor, so we're looking for the founders to have validated that this is better than just a good idea. Ideas are ultimately necessary to move the world forward, but they’re ultimately a dime a dozen. What is really pivotal is talking to users, talking to customers, and building what they want. Which sounds obvious, but frequently it's something that you kind of realize after a little later. It's not about what you think is good, it's what the market thinks is good. So we're looking for early product-market fit.

So to quickly jump in here, I'm seeing a question from the audience that's about if companies should be making money before going to VCs or not. Can you speak to that a little?

Sure, so I assume that question means that by making money it’s referring to generating revenue. The history of startups in VC shows that generating revenue for a certain type of business isn't a prerequisite to raising venture capital. So I think you have your answer, no you don't have to wait until you're generating revenue to approach VCs. But it really depends on the business, obviously.

So if you are a business that is, for example, in the enterprise SaaS space. It is much more likely than not that most VCs who invest in SaaS businesses would expect that you're generating revenue. And not just generating revenue but actually scaling revenue, have some sense of customer acquisition, some sense of contract value, LTV, some sense of how this scales over time. So you're talking about a relatively sophisticated level of understanding of the business side of what you're doing, from a making money point of view.

With things like Facebook and Snapchat, it's more about the metrics that show if the app is really compelling. Is this really drawing in eyeballs, and people's time? And that would be measurable through things like engagement, retention, growth of daily and weekly activities, the ratio of new users added and so forth. So it depends on the expectations for your type of business specifically, so there's no one size fits all.

So there are some questions here about where are your startups located, how many of your startups, or what's the percentage of your startups being in San Francisco, and then outside of the Bay Area. And then how do you deal with the concern that some ecosystems are considered "weak"?

I mentioned earlier that we don't think that Silicon Valley has a monopoly on innovation and great startups. That's totally been proven to be the case. And so 25% of our companies are not located here, in Silicon Valley. And I expect that percentage will grow over time. And not to over look other folks in this space, but as a pertinent example, for example, Sequoia Capital has a number of affiliated funds outside the US and ultimately as an organization, I think consistently have put way more capital overseas than they have in Silicon Valley-based companies over the last several years.

There is, however, a perception problem with other areas and the strength of their tech—right or wrong—and there’s also the reality of downstream capital risk. What I mean by capital risk is, when the company gets bigger, will it be able to attract investment or an exit in the market it’s in? What founders and investors who have built good businesses have to ask: “Is a buyer who's big enough to pay a commensurate price for the company in your market?”

One of the things we help our entrepreneurs with is helping to orient them with how the Valley works. It's insider baseball, it’s kind of clubby. And so breaking that down for founders who may not have any of that context is part of what we really try to do. For people not from here, simply providing that knowledge is very differentiating and helpful.

In Silicon Valley, you bump into entrepreneurs literally anywhere you go. But that’s not true everywhere else. When I started my companies, I was outside of the Valley. I've been here for almost a decade now but prior to that was in the East Coast. So FC tries to provide a peer group that helps to calibrate founders, give them encouragement, help them with motivation and advice that comes from experience.

Yeah, I completely agree with that. With Shippo, me and my co-founder were both from Germany, we moved here, and even before FundersClub invested, it had helped us with connections to other startups.

Can you talk a little about the paradigm shift and what is blockchain, do you invest in blockchain, how do you think about that?

There's just been an immense change in the landscape of block chain. In the beginning, like, a lot of things, it seems almost like a toy. I remember in 2012, Brian Armstrong, the founder of Coinbase, which we're now backers of, sent me a Bitcoin. It was $6, and now its over $1000 per Bitcoin. And I was just like this is really cool, I didn’t know where this could go exactly but there's something here. So it started off as this digital money idea. Digital cash. There where some elements out there in academic papers that maybe this could be more than that. But that's really where it started back in 2012. There was a sense back in 2012 and 2013 that Bitcoin would also replace, like, Visa and MasterCard, sort of like the payment slayer.

And then as the industry matured, people talk about Bitcoin as a digital fiat. Fiats like dollars or Euros or whatever. And some people are even saying digital gold. Implying that it’s a store of value.

Yes

It's evolving, but one thing that's clear: in 2012 the entire market of cryptocurrency and blockchain currencies was sub ~100 million dollars. And now it's 20 billion dollars. So in the span of four and half years or so, it went from basically zero to 20 billion or more. So that sort of expresses the amount of financial interest that's at the table. What you've seen more recently, so like in 2014, 15 especially, you started to see the emergence of more and more people building, looking at the block chains, it started with what were called colored coins, and sort of attaching things beyond just like the actual Bitcoin to the block chain.

And I’ll address the idea of the blockchain, as I realize I've been talking without context here, but if you don't know what the blockchain is, its this distributed sort of truth. So that people who don't trust each other or could trust each other could all agree on what reality is. Whether that's about money or about contracts, or insurance, or transactions, or governments. It’s a pretty universal technology, and it had its start in money but it really can effect everything.

So right around 2015, or so, 16, is when Ethereum, another digital currency, really started emerging. And so, Ethereum was one of the first digital currencies that asked the question of: ‘what if you could program money?’ So it's programmable currency. And that has led us to smart contracts. It's amazing what's happening. And building on top of Ethereum are what are called digital distributed applications. Tokens, so new currencies, to the point where you almost think of Ethereum as Apple and these things are like the apps. Not literally but it's sort of figuratively what's going on.

So your seeing almost this new, its distributed internet, it’s a distributed way of doing things so it tends to lend itself well to any models where there's network effects present. And of course VCs love to fund network effects-driven businesses, like Facebook and Uber, Airbnb, and so this is an industry that's really blossomed and was non-existent five years ago and can really disrupt everything. And obviously from hearing me talk you can tell I'm a big fan of the blockchain space. FundersClub was half of Coinbase's seed round, and we were also early investors in ShapeShift. Others IPFS or Protocol Apps, and there's many others who deserve mention.

So you might remember TCPIP in the 90s, I think this is it. And this is recorded forever so we'll see what happens in like 5 or 10 years. [Editor's note: 2.5 months after this interview, the market cap of blockchain had increased by over 5x]

Different area here: do you think having a socially responsible angle will impact the view of VCs regarding a business?

I think ultimately most people want to do good in the world so naturally there is a gravitation toward businesses that can do well. But the overriding force in capitalism is making money.

My view is that if you want to have a positive social impact, you should think of a business model that makes a ton of money, but also has a positive social impact. And sometimes that may not be possible. I'm definitely not saying there's not a need for non-profits and things like that. But I just think from a point of scaling something and having a massive influence on the world, that’s really powerful.

And so it turns out there are companies out there that are doing that, helping, and sometimes this may not be as obvious but for example, there's a company we backed called Wonderschool. On the surface it's an Airbnb for preschools. So it may not sound like a lot but if you're a parent and you can't afford to send your child to daycare, but suddenly you can turn that cost center into a revenue center by just taking on a few more kids.

It's very cool.

It's very powerful, it's socially enriching. Now you're kid also can have other kids to play with and learn from and there's all sorts of positive social benefits there. The flip side of this is those other parents sending their kids there, they can actually afford to do that now, because they're not paying as much for it. So a business like that may not represent itself as a social impact business, but I really think they are. We do very much care about, as I said earlier, moving the world forward, and I do believe that's important.

Stepping aside from myself and my subjective view there, I think that there's definitely a need for the industry as a whole to do more in that area. I don't have any magic answers. For example, how do you solve the social problems where there's not an obvious business model?

What kinds of advice would you give to people trying to enter the space as a new investor?

Well, I think the first thing would probably be stepping back and asking yourself, ‘what are you trying to get out of this?’ It may be about making money, but it could also be about staying current, learning about the future, helping people. But a part of that answer includes making money, so I would definitely encourage you to learn about how startup investing works, how startups work, how startup returns work, how different business models work.

There's education to be had if you do seek that out. Startup investing is really hard. Starting a company is also really hard, so it's not surprising that investing in them is, too. And it's a great way to lose money if you don't know what you’re doing. And even if you do know what you're doing, you're going to lose money in many cases.

In the portfolios of the world's best VCs roughly 60% or so of the investments lose money. So it's fully expected that if you're investing, more that half of the companies you invest with will end up losing you money. So approaching it from that mindset realizing, ‘hey this is hard, it's not easy,’ there's no instant lottery ticket, and so really getting educated is important. I can rep our resources in this area, as we have an education center that’s at funderclub.com/learn.

That’s definitely that's a great starting point. There's a lot of blogs out there now on Medium and elsewhere where you can just learn. Weekly newsletters are good, too, we have one at FC. I know Mattermark has a great newsletter, and there's others that just aggregate these posts from VCs, angels, entrepreneurs. I would say just sit on the sidelines and watch and learn, and then start dipping your toes a little bit but recognize that the learning curve is real.

And for new angel investors that want to start investing online, what are some of the mistakes that you've seen people make and how can people avoid them?

I've actually heard, I forget whom, but somebody in the industry of online start up investing talking about investing as a lottery ticket and I think that's the farthest thing from what it should be. Because when you look at VCs who have been investing for decades, all of these people who have made money have approached it from a portfolio point of view. So you're not spraying and praying, you're not buying lottery tickets, you're being thoughtful and selective. And building out a portfolio. And also thought approaching it knowing that it is totally normal for more than half of these companies to not make it.

One final question, looking back in the last five 5 years, that you've been running FundersClub, what are some of the most surprising things you've learned?

The most surprising. When I started, I came in with the mindset that Silicon Valley, the venture capital world, Sandhill Road—all of it was an old boys club. And that it was about who you know, not what you know.

Yes.

What I'm recognizing now is that's not only true, but it's very true. And so that's actually why I mentioned earlier that some of the things that we do for our entrepreneurs who aren't plugged into that world, is to get them plugged in. And it really was surprising that the ecosystem can be so stilted in this way. So I think we have a lot more work cut out for us in terms of our mission to bring a better way of discovering great founders, deserving founders, helping them, and helping involve more people at the table. This is a lot harder that I thought it was.

And so it's a very humbling experience, it's why I mentioned earlier that we’re not perfect, that we have a lot to improve upon. But it's been a lot of fun. I've greatly enjoyed it, and it's brought me in contact with great people like you.

Thank you, that's a very inspiring way to end this conversation.