How To Tell If Your Crazy Idea Is Going to Work

If you’ve seen this 90’s Apple ad, you’ll be familiar with the saying that “people who think they’re crazy enough to change the world are the ones that do.”

As investors, we hear a lot of crazy ideas. While some crazy ideas are quite brilliant, some are just… crazy. *Cue the Bacon Alarm Clock*

I was hoping to share an investor’s perspective on crazy, disruptive ideas and how we try to apply some logic to them. This is some general, high-level thinking. We’re not getting into the nitty-gritty of how companies necessarily work today.

Value and Other Incentives

What’s the value proposition for the product you’re offering your customers? Is it genuinely impactful? There are two common sayings I use for a gut-check on the value offered by a new product.

  • Is it better, faster, cheaper?
  • Is it oxygen, aspirin, or jewelry?

The second one is likely the only one that needs explanation — you’ve probably heard the first before.  This saying gets entrepreneurs or investors to think deeply about the true level of need customers have for a product. For jewelry, the product may be something you like or enjoy, but could certainly do without. For aspirin, the product genuinely alleviates a pain point, but again isn’t 100% necessary for your day-to-day. For oxygen, you quite literally need this product — you couldn’t imagine your life without this product. I like to think of this as if it’s more of a spectrum rather than a sheer categorization; if you ever figure out how to make a business out of selling oxygen, call me. 

There are many blog posts out there about how to think about value, but not enough to think about the other part of the equation: the resistors.

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The value offered by a product must be great enough to overcome the opportunity cost of the customers timemoney, and, if they’re switching from a previous product, the entire value of that previous product. When you dig into the neuroeconomics of how a customer makes this decision, it’s quite obvious that people don’t really like change — as nice as that would be. Brand loyalty is a very powerful thing, all thanks to the croc brain.

Market Readiness

Bill Gross has quite a popular Ted Talk on how timing is likely the most important factor for startups — and it’s true! However, doesn’t that sound a little vague? What does that really mean? Well, it means a lot of things, and frankly, it’s pretty complicated. I’ll try and explain it in a simple way. Let’s consider these factors, also known as PESTLE analysis:

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This analysis is meant to be up for interpretation, so I’m not going to break every factor down in great detail. I’m just going to really focus on two: Social and Technological. 

Social speaks to people’s behavior. If your product requires people to drastically change their daily lives, and that change is unwanted, it might be a bad call. Take traffic, for example. There are a lot of solutions out there today to “solve traffic” (e.g., MagLev, the Boring Company, Autonomous Vehicles, Scooters, etc.). If your solution is to have people work remotely, perhaps they don’t want that. Perhaps they like going to work and being with their coworkers. Perhaps they get more work done there. Your product has to fit with the customer’s life, not cause an unwanted dramatic change in it.

Technology is a bit of an easier subject. I mean, ask yourself, is this idea technologically feasible? Can we even build it?

However, sometimes it can get a bit more complicated or indirect. A great example I like to use here is Instagram. Instagram is likely one of the best timing stories. Instagram would have never worked if it were not for the smartphone. As a website, it would have been a total, painful failure, which is likely why the website has limited features. The ability to quickly take a high-quality photo and upload it to social media was a really powerful thing. It was something that was wanted, people already owned smartphones and were taking pictures, Instagram simply provided a place to share them. The supporting technology was already in the palms of all the users, and folks were starting to take more pictures already because of their always handy camera.

So, now that we’ve gotten here ask yourself: is my product really valuable? Is the market ready?

If you answered yes to both those questions, go build the damn thing. 

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The Hunt

As a few of you know, we recently wrapped up the Venture University program for Cohort one! I’ve been a bit underwater as of late being what my girlfriend likes to call “fulltime unemployed.” Jokes aside, the VC job search process is an arduous one — which I’m sure many of you know. I’ve been quite busy as of late, but I have a lot of really fantastic updates I hope to share in the coming days.

I thought about writing a post on the two traditional routes into VC: PE/Banking and Startups. However, I don’t want this blog to be what many VC blogs are, which is a regurgitation of the same content. I thought I’d instead share what I’m doing that may be a little “outside the box” thinking. If you’re not a banker or a startup guru, you’ll need to be a bit creative when it comes to breaking into the industry. Associates tasked with hiring new analysts neither want or need to take a bet on people that don’t meet the criteria they typically look for.

If you’re an avid reader of the blog (thank you!), you’ll recall that I often promote the idea that it’s never too early to work on your VC network or deal flow. These are two ways you can really add value to a firm. So, I thought I’d shed some light on how I’m working on that now.

I hope that this insight will be a little more valuable than the conversation I had with my colleague and friend, Michael, the other night on creative ways to get folks to read your resume. I’m not sure I’m quite brave enough yet to be a Sand Hill Road Uber driver who passes out his resume or to duct tape my resume inside bathroom stalls at investor summits.

Attending Summits, Demo Days, and More

I’m lucky enough to where I can now use either Skyler (VU boss) or my status as a VC investor to get into events — sometimes for free! However, some of you will have to get a little more creative. One thing you can do is sign up to be a volunteer at the event and just network while you’re there.

While you’re there, you can meet a ton of awesome people and see a lot of cool deals and industry trends. Attending these things supports the narrative that you’re an involved member of the startup community, and will help you keep an open conversation with the people in your network. Also, sharing a deal with a VC that ends up investing in said deal is likely the best way to get a job at a firm. This is coming to mind as I just wrapped up an awesome event put on by Primary Venture Partners in NYC.

Don’t Be Shy

If you subscribe to enough mailing lists, you’ll hear about every new fund being raised under the sun. When a fund is raised, often hiring follows. Reach out to the managing director or a general partner and ask about if there is an opportunity. The worst possible outcome is just a no. Get comfortable with a no, because if you’re going down this path, you’ll be hearing a lot of them. So, if you see a posting for a VP position and you only feel qualified enough to be an analyst or associate, still shoot out a note and see if they’d be open to hiring an analyst as well.

Leverage Your Alma Mater

Conveniently, USC just launched the Marshall Venture Fund, where they’ll be investing in startups founded by Trojan alumni, students, or faculty. Hopefully, I’ll be able to get involved any way I can. However, the point here is that colleges are often up to really incredible things that can help you with your career. Make sure to check back with your university and see if there is anything you can get involved with, people you can connect with, or even a way to give back. An open, healthy relationship with your college is always a great thing.

Other?

I’m hoping to transition this blog into more of a conversational medium. What do/did you guys do to find that coveted VC job? I’ve heard a few creative stories, and I’d love to hear some more.

Sanity Tests

Building models for really young companies is distinctly different from what you may be doing in investment banking or similar financial jobs — especially if the company is pre-revenue and has no historical financial data. The purpose of building models at this stage is to run a simple sanity check.

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You really just want to see if what the entrepreneur is proposing makes financial sense. Here are a few examples of what might be considered insane:

  1. Projecting sales volumes that exceed total market size (even, say, 10% market penetration is often a bit too hopeful)
  2. Assuming incredibly low churn/ incredibly high conversion
  3. Not including R&D expenses
  4. Growing revenues rapidly without hiring a proportionate amount of talent

Most startups are burning cash at the beginning. The sales volumes aren’t supporting the expenses, and sometimes they haven’t been able to get their variable costs low enough to even make money at the unit level. This is normal. In fact, many VCs use a popular

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metaphor to explain the financial life cycle of successful startups: the hockey stick. When you get into venture, this J-curve will become all too familiar. Every entrepreneur wants to say, “well we’re burning cash now, but eventually we’re going to take off like a rocket ship.” That’s a nice story, however often it’s not much more than just that.

 

So, when you’re constructing a model, you’re really trying to just tell a story, and ask a few critical questions. What does the company need to do to become cashflow positive? What expenses are associated with meeting those objectives? Are these assumptions reasonable? What should their financing strategy be? What’s a reasonable return multiple I can expect from my investment in 5-7 years? What’s the IRR for that? How much will my equity be diluted down the line if I don’t do my pro-rata?

Once you’ve passed this sanity check, you’ll need to evaluate some of their metrics from what you’ve built.

Maximum Negative Cumulative EBITDA

Calculating how much negative cash flow a startup accumulates from their projections can help you create a financing strategy. The timing of this is also critical. It is actually quite normal for this number to get quite high for early companies. They should expect multiple rounds of financing. However, it’s important to make sure they have an appropriate amount of runway to grow their revenues, say 18-24 months. Failure to meet milestones and grow revenues when raising a premature round could lead to excessive dilution, which isn’t good for the entrepreneur or the investor. You need to be able to anticipate this so that the entrepreneur raises the appropriate amount of capital, not too much or too little.

However, this metric can also be a bit excessive. If the projections here amass to a huge number that isn’t typical of the industry the startup is in, their raise for a bridge to A round could look a little more like a pier.

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Gross Profit Margin

Many tech companies are often losing money quarter over quarter, but you want to make sure that there are significant cash flows. The free cash flow a startup create gives the company independence from outside financing. Significant expenses in R&D or marketing can be supported by their own sales volume, rather than raising large rounds over and over. Considerable margins may also give a startup the ability to quickly generate cash, or even rebound from non-dilutive debt.

Seasonality

Is there any degree of seasonality to sales? For example, we all know that pumpkin spice latte’s sell more in the fall/winter. If there is a serious amount of seasonality to your sales, how are you accommodating that? Do you use short-term contracts for some of your employees? Are you oversubscribed on fixed costs that could cause a serious issue when sales fall?

Capital Efficiency 

How much revenue is generated from capital spent? In other words, if I put in $3M into a deal, how much revenue will the entrepreneur be able to generate with that? Low capital efficiency could also cause an unnecessary amount of financing rounds, which will dilute your equity share.

 

These are all boxes that need to be checked. Often, first-time entrepreneurs don’t look too far into the future and can be a bit heads-down focused on product. It’s your duty as a potential investor and equity partner to not necessarily dock an entrepreneur for not thinking of some of these things, but to advise and create a strategy that passes the sanity test.

Often, entrepreneurs have a great team and product, but not the best strategy — and that’s ok! A plan can be changed, but a team cannot.

Getting Certified in Data Science/ ML

If you’ve read my posts, you know that I’m a firm believer that good tech investors know product. It’s absolutely essential.

Bill gross gives an excellent Ted talk covering some of the top reasons that startups succeed.

The talk goes into detail discussing which factor may be most important, but I believe that they are all essential. Investors need to know why a product is unique and ultimately defensible.

I’m also a huge proponent of pursing education online for free or at least for a low cost. Today, I’m simply sharing an episode from one of my favorite podcasts, the Machine Learning Guide by OCDevel, which covers what degrees/certifications are available to you and how they are perceived by employers.

https://itunes.apple.com/us/podcast/machine-learning-guide/id1204521130?mt=2&i=1000381369979

I’m Learning to Code, and You Should Too

When you start a career in venture capital, you’re not just beginning a career in investing, you’re beginning a career in entrepreneurship.

As an investor, it is your responsibility to understand startups and founders. How do you expect to do that without any basic knowledge of one of the primary skills in new companies? There’s a bit of debate on the accuracy of this statement, but many claim that the ability to code is the new literacy. Let’s make a compromise — that’s at least true for the startup community. Knowing technical skills will make you a better investor. You’ll be able to understand complex products, hold a conversation about them, and identify when a product is unique. Whatsmore is that it opens up the opportunity to be a founder yourself — something that I hope to be a part of my personal career.

If you didn’t major in CS in college, it is not too late. Codeacademy has online fundamental courses in a bunch of languages. It’s extremely intuitive and, most importantly, completely free.

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Too often, I hear excuses from people claiming that it’s not completely necessary to have a successful career in venture. Well, that’s totally true, but you’d be better off if you did it anyway. It’ll only add another tool to your professional war chest. As a VC, you should always be looking for a competitive edge, as it’s a competitive business. The majority of VCs don’t make crazy returns. It’s just really hard to find the winners. You don’t need to get a Ph.D. in ML or anything like that, but you’d be doing yourself a great service if you cover the fundamentals.

Revolutions

You may have heard the adage that it takes 10,000 hours to master a skill. When it comes to the business of venture capital, it’s no exception.

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However, there’s one caveat to this theory that is often overlooked: deliberateness. If you’re a firm believer that practice does, in fact, make perfect, yet your definition of practice is just mindlessly going through the motions, you’re wasting your time. To truly master a skill, you need not only significant training volume but also excellent quality. Quality training, in its essence, is more efficient training. Meaning there is less time needed to achieve the result desired. One surefire way to ensure that your training efforts are of high quality is to incorporate a serious amount of variety.

If you’re still with me, I’m going to show you how this can all tie into venture capital with two examples.

Running Pitch Meetings 

There are a few things that go into running a good pitch meeting; the main one is asking good questions. When a general partner asks you how a meeting went, and you can’t answer some of her basic questions, it is utterly mortifying. I’d know, I’ve seen me do it.

The advice I’ll give here is twofold. You can’t learn how to run a pitch meeting well if you don’t try your hand at running them yourself. Also, you won’t learn how to run better meetings if you don’t observe how others do it. At Venture University, I make a point to not only hold meetings with our general partners there, Sky and Andrew, but also with many of my coworkers. I’ll often bring in people from other teams or sit in others’ meetings to observe the types of questions they ask and learn from that. Otherwise, I’m just sitting in the conference room day after day asking the same questions, not getting any better, and not learning anything.

Building and Analyzing Financial Models

This is a great example where volume training has a significant effect on your ability to master this technical skill. Yet, your ability to compare one company’s business model to another drastically enhances your ability to understand and ultimately create a model. If you’ve built a model for 50 restaurant companies, you’ll inherently know what standard metrics to expect and can see when something is out of whack. You’ve got to get your revolutions in.

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The key takeaway here is to get comfortable with being uncomfortable. My old high school rowing coach used to tell our team that “every day you have the option of getting better or worse.” Maybe that statement was profound, or maybe it just stuck with me because he was a 6’5″ German dude that scared the living daylights out of me.

Doing something familiar every day won’t help you grow as quickly as trying new approaches, and entertaining new ideas.

The DIY VC

At the end of the day, the Venture Capital business is a knowledge race. The more you know, the more intelligently you will invest. This is one of the primary reasons VCs will expect analysts and associates to have some operational experience before joining a fund. If you’re trying to break into VC, one of the best tactics is to show that you add value to a firm. A few ways to do that are:  having unique technical skills, having proprietary deal flow, having a valuable VC & LP network, and having profound market expertise.

The last one I’ve mentioned is probably the easiest to attain as a young person. There are a ton of resources you can use to your advantage to self-educate on markets and the business of venture capital. This approach reminds me of this scene from Goodwill Hunting, but instead of wasting money you are wasting time.

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I’ll quickly go over a few different types of resources I use to get a competitive edge and share the ways I make time to read/listen to it all.

Podcasts

This one is an easy one, but an often overlooked one. You can listen to podcasts while you’re in the gym, during your commute, and as you’re winding down for bed. So, if I spend an hour in the gym, an hour total going to and from work, and carve out 30 minutes before bed, I can absorb two and a half hours of content every single day — that really adds up over time. Here’s a list of my favorites, which are all available for free on Apple’s podcast app:

  • The a16z podcast by Andreessen Horowitz: great for learning about evolving markets through the lens of intelligent VCs.
  • Machine Learning Guide by OCDevel: Great overview and starting place of machine learning as a subdivision of artificial intelligence. There are other resources that get much more technical. If you don’t come from a technical background, start here.
  • FringeFM by Matt Ward: This one is a fun one. It covers theories and conspiracies about the future and technology.
  • StartUp by Gimlet Media: A great podcast that is an in-depth, intimate, story of startups going from concept to successful business.
  • The Twenty Minute VC by Harry Stebbings: Harry covers many great topics in the VC business and frequently brings on great guest speakers.
  • How to Start a Startup by Y Combinator and Stanford University: This is an actual course covering startups with some really B.A. lecturers: Sam Altman, Dustin Moskovitz, Paul Graham, Adora Cheung, Peter Thiel, Alex Schultz, Kevin Hale, Marc Andreessen, Ron Conway, Ben Silbermann, Alfred Lin, Patrick and John Collison, Aaron Levie, Reid Hoffman, Keith Rabois, Ben Horowitz, Marissa Mayer, Hosian Rahman, Kirsty Nathoo, Carolynn Levy, and more.

Books

Books are something I’ll usually save for travel, vacation, or as an alternative way to wind down before bed. Unfortunately, you can’t read books on the go as you do by listening to podcasts. If you’re especially busy, try to find an audiobook to make it work.

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  • Venture Deals by Brad Feld: This one is great for getting an understanding of term sheets. Brad Feld and Jason Mendelson also offer a free online class for this, from which you can get a certificate.

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Online Classes

Repeat after me: Coursera is your friend. Coursera offers an awesome array of online classes to take in advanced topics. This is great for more technical stuff, or, if you have a technical background, business topics. This is just something you need to make time for. If you want to take the fast lane to a career in something like VC, you have to put in the hours. For the moment, I only have one recommendation here, but Corsera, again, offers a wealth of knowledge for free. For a small fee, you can also get a certificate which would be a great line item for your resume.

Blogs/ Newsletters/ Articles/ Magazines 

There are so many resources out there for gaining new perspectives and staying current. Staying current in market activity is especially valuable if you plan on holding an interesting conversation with a VC who is interviewing you. I usually start my mornings with this stuff when I show up to work to prepare for the day.

I usually am able to get in 3+ hours of self-education each day with relative ease. It’s an absolute must if you are trying to get into venture at a young age. These resources just scratch the surface of what’s out there, but it’s a great starting point. The most surefire way to get a job in VC is to be extremely well informed and have a strong, opinionated investment thesis that is enticing to potential employers. Plus, this will help you actually become a better investor once you do break into the space.

Why Do You Want To Be An Entrepreneur?

I ask the same question at the end of every interview I do with a founder: “Why do you want to be an entrepreneur?” You might have guessed that based on the title of this post.

When you invest in early-stage companies you need to collect a lot of intangible data — I kind of touched on that in my last post. I like asking this question in particular because it says a lot about the founder as a person. The founder is what you are ultimately investing in — not the product.

To be an entrepreneur you need to be a bit of a psychopath. If you’re 90% of founders, you’re looking at spending 3-10 years of your life working your ass off, working after hours, and working weekends just to end up broke, back at square one. Yet, great entrepreneurs don’t bat an eye at that statistic because they simply don’t care. To them, their work is vastly more important than the risk. Most entrepreneurs have the world’s biggest grin on their face when you ask them this question — and they should. The entrepreneur is a brave, passionate creature. These are perhaps two of their most defining, essential characteristics. If an entrepreneur isn’t overwhelmingly curious and driven, that’s a big red flag.

I’m not really looking for a specific answer when I ask this question. I’m looking for any response that is believable and authentic, and, of course, I’m also looking at how the founder reacts, not just what she says.

Churn: The Crystal Ball Metric

One of the responsibilities of a good venture capitalist is to have a good understanding of what the future holds. Between shifting markets, developing technologies, and disruptive entrepreneurs, the details of the future prove to be a bit of a moving target. Venture capitalists do their best to understand what may happen in the future but have to admit that no one truly has a crystal ball.

When evaluating a company, you must do your best to create potential answers for the elements that are unknown. Ask yourself: What are the narratives that convey the value the startup offers and why it will ultimately be successful? This is especially difficult for early-stage companies with limited data and performance metrics. However, there’s one metric that may provide you with a snapshot of a startup’s customer experience: churn.

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Churn, which is essentially the inverse of retention rate, displays the rate at which a startup is losing customers. High churn rates indicate that there may be something wrong with the physical product or service and that user growth may merely be a result of an effective marketing strategy. Plus, high churn adversely affects the growth that you’ve worked so hard for. Running a startup with high churn is like trying to ice skate uphill.  Low churn rates often translate to a long customer lifespan, a wonderful customer experience, and most importantly a high likelihood for gaining cheerleader customers.

download-2.jpg You may be wondering what I mean by cheerleaders — allow me to explain. Folks in marketing will often categorize different types of customers in a multitude of ways, but there is one type that is typically the most coveted: cheerleaders. These customers will be active advocates of your company to all of the people in their own network without any incentives from the company like a referral system. These cheerleaders create somewhat of a network effect where they strongly encourage their friends to use the product too. They create an infrastructure for the most powerful type of advertising: word of mouth.

Here’s a great example of a cheerleader I think we can all relate to.

Low churn rates and a high number of cheerleaders are two excellent metrics that create a narrative of a valuable customer experience, which typically equates to an extended customer lifecycle and high lifetime value.

So, does low churn singlehandedly give a VC the green light to invest in an early stage startup? Absolutely not! It’s like getting the corners done in a 1000 piece puzzle. However, it’s a great way to get a read on how the product is being received by the customers when there is limited information available.

When facing a significant amount of uncertainty, I often think back to some advice from my high school physics teacher: Use everything you know to figure out what you don’t know.

In VC, we can equate this to finding these crystal ball metrics for early-stage startups that will give us hints about what the future of the startup may look like.

The Art of Developing Deal Flow

Famous venture capital firms have a lot of what I like to call “passive deal flow.”
download.jpgEvery single day reputable VCs will get their inbox blown up with pitch decks from entrepreneurs. Often times, a good bit of their job — or the analysts’ job — when it comes to deal sourcing is to merely filter this massive influx of pitches.

 

But what about us new kids on the block? When you’re just starting out at a new fund with a limited industry network, a much more substantial portion of your deal sourcing comes from “active deal flow.” This can mean a whole laundry list of things, which is at times overwhelming for new associates. In this blog post, I’m hoping to shed some light on the situation.

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Simply put, the only goal of working on one’s deal flow is to find the winners — the ones that are going to return that 10x, 20x, or even 100x for your fund. Above all else, you don’t want to miss the big one — the Uber, Snap, Facebook, etc. You can’t make the best deals in the industry if you never see them, right? However, in an ideal situation, you are spending less time sifting through deals that aren’t interesting to you so you can spend more time evaluating the great ones. So, there are two sought-after elements here that you must optimize for: quality and volume.

Some bad examples of hijacking your deal flow for high volume while ignoring quality would be to manually scrub all startups on crowdfunding sites or blast out an ad campaign for your fund. Quantity does not necessarily equate to quality. While you may be able to find that winner you’re looking for through a sheer volume play, wouldn’t you rather save the time?

The unfortunate truth here is that most high-quality deal flow is relationship based and takes a while to develop; however, in the meantime, here are some actionable items to improve the quality of your deal flow.

Network, Network, Network: Attend each and every networking event that you can, so long as it is relevant to your investment thesis. A networking event can mean a tech conference, an accelerator’s demo day, or anything really. As long as there are investors and startups there, it’s worth your time. When your at these things it’s important to tumblr_nuc9gavynl1rf6ailo1_250.gifactually meet some folks, otherwise you might as well have stayed home and worked on your computer. Here, you can do a multitude of things to up your game. You may befriend another investor who could share deals with you. You can learn a considerable amount from industry experts speaking on panels. You can even speak on panels — which gets you a lot of attention.

 

Develop an Investment Thesis: Not only is it smart to think hard about what particular types of startups you find attractive but if you become super passionate and opinionated about a specific topic in venture a couple things can happen. First off, you’ll have a much easier time connecting with VCs who may share deals with you. Convincing another investor of a compelling investment thesis will not only get her interest but will also cause her to want to see your thesis in action. If your thesis works and it leads you to a massive exit, you guys are buddies now. Additionally, becoming vocal about this thesis could get you featured on certain online media like blogs, vlogs, podcasts, press releases, etc. In a perfect world, VCs or entrepreneurs who share your vision will reach out to you.

Leverage Your Own Personal Network: Whether you think you have one or not, everyone has a valuable personal network. Your peers are slowly becoming professionals in their various industries. If you went to college, your alma mater has a multitude of resources including, teachers, current students, and possibly entrepreneurial programs — all of which can prove to be a fountain of information and valuable deals. Being active and open on social media about your investor status, also, will let enable online connections to refer you as an investor as any and all of them meet entrepreneurs or see ideas by happenstance.

Follow Other VCs: Examining other VCs portfolios and their investment theses allows you to check the pulse of the startup community, so to speak. For example, you may notice that one VCs most recent fund invested a ton in robotic food prep. Follow up with someone at that firm. Ask why they thought that was so attractive, and how the companies are doing now. There may be an allocation for you and your fund in some of the companies, and your VC contact will have tons of research documents prepared on these investments.

These are the things I’m currently doing to work on my deal flow, but I’m always trying to find more creative and effective ways to source deals. The VC that is more efficient with their time spent on finding deals has a larger opportunity to self-educate, conduct due diligence, and be a better investor in general.

Alright, that’s it, guys. What are you looking at me for? Get out there and find that unicorn.

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