Most VCs Are Investing All Wrong

Bruce Gibney Founders Fund

Photo: Founders Fund

San Francisco venture capital firm Founders Fund thinks the rest of the VC community isn’t trying hard enough.Founders was started by ex-PayPal executives Peter Thiel and Ken Howery in 2005, and boasts Napster founder and early Facebook investor Sean Parker as one of its managing partners.

The firm claims to have a different philosophy than most VCs: it invests in companies that are trying to solve hard scientific or engineering problems.

But this isn’t just idealism: Founders believes that these types of companies are best poised to create and capitalise on new multibillion dollar markets and make 10x returns on their investments. Founders compares itself to the classic VC firms from the 1960s who invested in groundbreaking ideas like microprocessors.

We had a chance to talk to partner and COO Bruce Gibney about the firm and what it sees going on in the VC scene in Silicon Valley. Among other insights:

  • Major technological advances have slowed in the last few years, as investors have been much more willing to fund me-too Internet startups than groundbreaking new technologies.
  • Good ideas aren’t necessarily popular because most investors are looking for a “northeast” (up and to the right) growth chart for users, revenue, or some other metric. But it’s very hard to measure progress on a company like SpaceX, which is trying to revolutionise rocket technology. These ideas require long-term investment and risk: they either work or they don’t, but you won’t know until later.
  • A lot of green tech startups are not aiming high enough — they should be trying to invent or discover energy sources that are “as good as gas and as cheap as water.”

Here’s a lightly edited transcript of the conversation:

Business Insider: What’s different about you from other funds in Silicon Valley?

Bruce Gibney: Our investment approach. It’s more akin to the venture industry circa 1963. We’re focused on companies that can capture multi-billion dollar markets, usually through the resolution of a difficult scientific or engineering problem. That’s what distinguishes us.

BI: You’re really interested in engineering challenges. Do you look for technical founders?

BG: Yes, we do look for technical founders although it’s not necessary that they have directly relevant technical experience as long as they’re good engineers. An example of that is Elon Musk, who we knew through PayPal. Elon is a cofounder and a brilliant engineer, but PayPal, Tesla, and SpaceX are all very different. The unifying thing is Elon’s brilliance.

BI: What other things do you look for in investments?

BG: Fundamentally we look for several variables. First, that the opportunity itself has to be extremely large. A more positive impact on the world and along the way they become substantial companies themselves. We’re much less interested in companies solving incremental problems or opportunities measured into the tens of millions of dollars.

The second thing is extraordinary entrepreneurs who we can back to the hilt…Whatever you’re buying when you make your investment in an early stage company is not the first business plan you see, but actually the talent and passion of the entrepreneurs.

The third thing is we are willing to take technological risk. We believe that’s what we’re paid for. We’re particularly interested in technologies that we believe have the seminal technologies in their field. If it were 1850, we’re not looking for the world’s best whale blubber lantern. We’re looking for the light bulb.

The fourth thing – we are looking for companies that are going to transform the world for the better.

BI: So there’s a social element to the companies you invest in? I know some VCs actively avoid that.

BG: It’s not an investment mandate, but we tend to think that companies that have a massive positive effect on the world also tend to be some of the most profitable as well.

BI: What size of investments and what stage of investments are you usually looking for? Are you going after companies with a couple years’ worth of revenue or do you invest in very early seeds sometimes?

BG: We are sector agnostic, but not return agnostic. It’s the second one that drives the first. As long as we believe we can attain a return which is not a 2X or 2.5X but something substantially in excess of that. That naturally pushes us towards earlier stage companies. But as a general matter, we are stage agnostic because our whole process is driven by a demand for a venture multiple. That’s something that distinguishes us from some part of the rest of the industry — we don’t believe that doubling is an adequate return over 10 years.

BI: I think a lot of investors are sort of reluctant to think about the macro climate. What do you think is going on in the broader macro climate and how does that influence your strategy this year?

BG: I talk to Peter Thiel about this quite a lot. The broader macroeconomic climate is not particularly constructive right now because the pace of innovation is lower than it should be. People have concentrated on me-too consumer internet properties and less on revolutionary new technologies. A classic example of this is the surprising level of disinterest early on in some of our portfolio companies. Companies like Palantir and space exploration technologies — SpaceX, Elon’s rocket company. Which are extraordinarily good ideas and directed at potentially vast markets and run by the best entrepreneurs that we’ve ever encountered. At the time, valuations were quite compelling, but there was a certain disinterest by other investors simply because the problems they were seeking to resolve were taking too long or requiring too much effort to understand, even though, of course, they only look at that from the perspective of the past 15 years. If you ask venture capitalists circa 1970 whether or not they should be backing the world’s best rocket company or the world’s greatest software company, the response would have been “Of course.”

BI: Do you find that the current climate makes it harder to raise a fund? First of all, a lot of folks got burned in the first tech boom 10 years ago and then there was the housing market collapse. There’s a lot of uncertainty about the economy now. Do you find that that’s creating a problem?

BG: The pace of fundraising at least in the first quarter seems to be running significantly ahead of where it was last year and for the past couple years. I think in the end that there is in the developed world relatively little hyperactive growth and in the end investors will want access to that. That should be constructive for venture capital so long as it does its job well. Which it hasn’t, based on the return experience of the industry at large for the past 12 years. If venture does what it used to do, which is consistently back revolutionary technologies that can have widescale beneficial effects, then I think the industry will perform well and will attract assets to it.

BI: What’s going on with the IPO market? Are we at the start of a big wave that goes for the next two years? Or do companies stay private longer because they can get the capital they need from private investment?

BG: I think companies will stay private for much longer than before and already have. LinkedIn went out at a multibillion dollar IPO versus Amazon when it went out in the 90s at $450 million. Or Facebook’s IPO, rumoured at $75 to $100 billion dollars. I think the relative scarcity of high growth companies that have come to market in the past means there’s a lot of pent-up demand on the public side. The IPO market can only be as strong as the profit potential of the companies proposing to go public.

BI: Do you think investors are smarter about evaluating profit potential than they were in the late 90s, or will we eventually come back to another mania cycle where you have me-too companies with slideware going public at huge valuations?

BG: I think the human race has gotten neither more nor less intelligent. That’s what it does. From time to time we learn some lessons from the past. Whether those lessons remain planted in the consciousness is unclear.

BI: What should companies look for when they’re getting ready to IPO and how does a company decide when it’s time?

BG: It’s difficult to decide. At some very narrow level, companies should respond to particular market configurations. If the market is willing to pay abnormal premiums for growth, then it can make sense from an immediate monetary point of view to IPO. As a general matter, companies should be billing themselves aa institutions whose profits will support an IPO regardless of market configuration. You know, if you were an investor in your window of opportunity was measured in the fruit fly-like lifespan of the last bubble. But if you were a venture backer of Intel, your opportunity was measured in decades.

I’m aware that a lot of this sounds banal and commonsensical, but in fact actually, I don’t believe that large swaths of the market and investing community believe this. One can see this reflected in occasionally frantic behaviour.

BI: What do they believe? Getting the short term run-up and getting out?

BG: I believe that if you live on a street where at least one person wins the Powerball lottery every so often, you tend to buy more lottery tickets than if everyone was a hardworking engineer at Apple.

BI: What areas of investment and what kinds of companies do you think are overrated or overhyped? And what areas do you think are underappreciated?

BG: As a general matter, we’re most focused on companies that live at the intersection of being inherently good ideas but are unpopular for some reason. A lot of the flashiest investments are taking place in companies that appear to be good ideas and are very popular, so the valuations appear very high.

What constitutes a set of good ideas that aren’t popular? Let me concentrate on not popular first. Companies that are trying to solve difficult scientific or engineering problems — the industry has become habituated after the 1990s to companies where progress can ostensibly be tracked. You need to be able to show a chart on your Monday meeting where there’s hockey stick-like growth. Companies like SpaceX or Halcyon Molecular, which is a genetic sequencing company we backed — there’s no chart you can make about progress, he number of welds SpaceX did on a rocket in a month or how many codes of line someone wrote. After a few years, the product either works or it doesn’t. People are much less interested in those companies because they don’t have the false comfort of metrics. Also they can be difficult to understand and take some time to mature.

Sort of a thought experiment for readers to go through is to walk up and down a road mentally and ask whether the GPs there would prefer to back the latest round of Twitter or any of the sort of great VC companies of the 60s and 70s, your Intels, your Apples, your Microsofts, your Genentechs. I think the resolution of that thought experiment might suggest where there are substantial opportunities for venture capitalists who are willing to do something different. In something like aerospace, with SpaceX, or ambitious software like Palantir. In biotechnology that’s pursued at least in novel ways, and artificial intelligence. It truly does have the potential to be an utterly transformational technology. And robotics, which doesn’t have nearly as much attention as it should have.

BI: What about greentech? That seems like a natural fit given what your interests are. Any interest in that or do you think that’s just a marketing term?

BG: On the efficiency side, there are some interesting companies. On the generation side, we haven’t seen anything that we’re very excited about, and partly because we think that people might be solving the wrong problems.

So, to take an analogy, for example, from the device space, so if I wanted to introduce a new smartphone, if I were a manufacturer, I would not introduce a phone that was like 70% as good as the iPhone and cost twice as much, but there’s like a 20% rebate from the government — depending on which administration was in offfice. That’s not how you introduce a new product. You introduce a new product that’s at least as good as the competitor and substantially cheaper. The serious way we should advance our future is by finding alternatives that are basically as good as gas and as cheap as water. It’s not easy to do — not easy to do at all. But that’s the sort of revolutionary technology that we should be developing. We’ve done it before. We should have faith in ourselves.

BI: And you don’t see any of those kind of companies now?

BG: Well, you know, I would actually be shocked, because I’m an optimist, if there weren’t. It’s just that we haven’t had the opportunity to see them.

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