E545 | Mike Maples Jr. on Inflection Theory and Breaking Patterns in European Venture

0:00Most startups play by the old rules and lose. But the biggest winners? They rewrite the game entirely. A startup doesn't win by doing any of those things. A startup wins by changing the subject. Even the smartest founders with perfect business plans hit the wall. I saw this happen all the time. I saw most likely to succeed startups fail miserably or just go nowhere. While others with broken servers and no clear leadership somehow won. The difference isn't execution. It's not timing. It's this. Better doesn't matter with startups. You have to be radically different to make a difference. Mike Maples Jr.

0:33learned this the hard way after missing billion-dollar opportunities hiding in plain sight. The only way I'm going to succeed is if I offer a radical new form of empowerment that forces a choice and not a comparison. The next inflection is already here. The question is, will you see it? I think that great startup ideas come from living in the future before others do. Stop competing. Start dominating. Specificity is a superpower. Discover the pattern breakers framework that's reshaping how the smartest VCs spot the next unicorn. Full episode, now on EUVC Podcast.

1:26This show is not investment advice and the hosts of this episode may be invested in the funds and companies featured. Welcome back, my friends, to another episode of the EUVC podcast. I hope by now this is your home for connecting and championing the builders of European tech. Today's episode is one that I have been counting down the days for. We're joined by none other than Mike Mables Jr. voice who has truly shaped how an entire generation of VCs think about inflections, movements, and the power of convictions. There's no one that has probably formed my thinking as much as Mike has. So I'm looking very much forward to diving in today.

2:02We'll explore the frameworks behind Patent Breakers, Mike's recent book, but work you've been working on, I think, almost as long as Floodgate has existed. We'll, of course, dive into how it informs your strategy and also how it informs Europe and how you think about Europe and what Europe looks like when viewed through this lens. We're talking everything from capital formation to LP psychology, policy, and geopolitics. Mike, let's get right into it. I've long admired your thinking, as I just said. Now, tell me about yourself and Patent Breakers, how it came to be. Well, hey, thanks for all the kind words, and hopefully I'll have something to offer.

2:40I know it's a very European sort of audience here. Where did Patent Breakers come from? It kind of came from an unsettling realization. So I was 10 years into doing seed investing. And one day I noticed that something like 80 to 85 % of my exit profits had come from pivots. You know, I talk about this a little bit in the book, Pattern Breakers, but it's even worse than the book describes. So with Twitch, I had invested in Justin TV and about five years in, they say, great news. We pivoted. We're two companies now. We're SocialCam and we're Twitch. And I thought, okay, the reason they did that is nobody's going to want to watch people play video games.

3:23So SocialCam is the real company. And at the time, Viddy was a hot startup. So then SocialCam gets bought for$65 million. And I just forgot about Twitch. You know, I wasn't a user. And so one day, I noticed that Amazon is thinking about buying Twitch for close to a billion dollars. And I'm like, man, you know, is that just in TV? And I reached out to Emmett Shearer and said, hey, just doing some clerical accounting work, you know, just want to verify how many shares I've got. What do you think? What does your number say? And so I didn't even have Twitch on my books. So you can imagine I'm talking to my LPs.

4:07I'm like, okay, I got some good news, bad news. One, the good news is we'll start with that. We just made 90 times our money on this investment in Twitch. The bad news is I haven't, I haven't put it in any of my financial reports and I'm embarrassed and that's not how I like to do things. So, you know, if you need me to restate my financials, I can, we'll work something out. And every single LP was like, nope, we're good. just send us the money. This is awesome. You know, people send me champagne and stuff, but, but like, I, I came away from that thinking just what business am I even in? Because like that, that same week I'm helping a founder shut down a company that had done all the right stuff.

4:46You know, they'd define their culture. They had, uh, use the business model canvas. They'd, you know, they would have been a Harvard business school case study, except for the fact that they'd failed. Right. And, and, and I don't know, this may resonate with you and some of the, some of your listeners, right, who invest in seed rounds. But this wasn't a one off for me. I saw this happen all the time. I saw most likely to succeed startups fail miserably or just go nowhere. And I saw, you know, like the Twitter guys couldn't decide who the CEO was, couldn't keep the servers working. But it didn't matter because people wanted to tweet.

5:19And it just like, but there weren't any best practices that I could discern, you know, in the early days. So that was the the genesis of the pattern breakers thinking was okay what's going on here should i just retire because it's random and i'm going to get exposed or uh is there is there something happening below the surface that yes there's some chance for sure but it's not all an accident that led me on this kind of rabbit hole multiple year quest to kind of figure out what's going on here and the ideas of pattern breakers are my attempt to answer those questions and maybe let's lay out that framework.

5:55So if I just put my context in there, I started in venture on the investment side, direct investment side, and then I helped build a fund. And then I realized there's a lot of, in this framework, thinking that can also be applied as an LP when I was later involved in LP investing and still am. And I thought there's so much here that can be used to understand how any VC should be or is thinking about and whether they're truly thinking about breakout companies or they're betting on the next iteration of something that's already out there. Maybe you can talk a bit about that. And I don't know if you think that's a good setup, but at least that's how I think about it.

6:34I think so. So here's how I would internalize it, Andreas, is that startup capitalism is a fundamentally different kind of capitalism. So most people, when they talk about capitalism, they talk about defensible moats and compounding advantages and Michael Porter's five forces, Hamilton Helmer's seven powers. And you realize that a startup has none of that stuff. They only have the founders and their ideas. And so a startup doesn't win by doing any of those things. A startup wins by changing the subject. So a startup capitalist wins when they refuse the premise of the rules and impose a new heretical set of different rules and then get the world to agree with their idea, their heresy, and then move the future into a different direction.

7:25And so that's what it reminds me of an evolution. You know, you look at the fossil record, the fossils look the same for a long time, then you have punctuated equilibrium, like a flood or an asteroid or something. The startup capitalist job is to create punctuated equilibrium. It's to challenge the current frame and propose a new frame. So the ideas in pattern breakers then are, how do you do that? How do you change the subject? How do you deny the premise of the rules? You start with inflections. And an inflection is a change event that creates a new form of empowerment. The startup needs the inflection because we want to wage asymmetric warfare on the present.

8:03We're not interested in having a fair fight. We want to have an unfair fight that's to our advantage. And then the insight is, okay, so what? How does this inflection let me do something that's non-consensus and right? One company we invested in was Lyft back in the day. The inflection was the iPhone 4S had a GPS chip in it. And you could have had the idea for ride sharing before that. It wouldn't have mattered because you could have implemented ride sharing. But now all of a sudden, there was a window of opportunity where for the first time, you could implement ride sharing, but you had to have an insight, right?

8:39You couldn't just be aware of the fact that that chip was in the phone. You had to say, hey, this thing in my pocket, there's a new form of empowerment that could be unlocked in special ways. And so ride sharing would be an embodiment of how to unlock that empowerment. DoorDash was another type. Instacart was another type. But like none of those things could have existed before you had smart chips that could locate people in real time. So like the inflection is the thing that happens outside of the startup. And the insight is the thing that happens in the mind of the founder. You know, it's the creative source of inspirational breakthrough that causes them to propose a heretical different future.

9:20What I started to realize is that better doesn't matter with startups. You have to be radically different to make a difference. And what was happening and the reason that some of the people who did all the right things didn't succeed is they bought into a context. They bought into the rules as they were defined by the incumbents. And so they were limited to playing in the incumbent sandbox. And so when you play in the incumbent sandbox, there's only a small part of the territory of that sandbox that's going to be offered to you. You're going to always have an incrementally upsided opportunity.

9:55What you want to do is escape competition entirely by harnessing these inflections and having a non-consensus and right insight. You want to force, like maybe we can drill down on this, but I say you want a product that forces a choice and not a comparison. You want to escape the comparison trap entirely because comparison is death for a startup, right? Like you want to be something that can't be reconciled with anything that's come before. Let me then ask you, because you have different forms of inflections. You have the adoption inflection, technological inflections, the societal inflections.

10:32How widely do you go here? Do you think it's even relevant to talk about this nomenclature or is it just an inflection point in whatever axis that is significant enough to create a radical change in time, so to say, for the founder to then be able to take off? Yeah. So what I've what I realized is that the best use of it was sanity checking a current idea. So when I talk to founders, they don't lack for ideas. What they really are interested in is, should I pursue this idea? Does it have enough upside? And my response to that usually has been, how should I know, right? I'm not a customer. I'm not the genius that you are.

11:20I haven't invented the thing that you've invented. But what I realized was that there are some diagnostic questions that you can ask. And one diagnostic question is, what inflection are you harnessing? What is the new type of empowerment that only recently has become available? And how are you harnessing it in a way that creates massive empowerment that people will be desperate for? If somebody says to me, hmm, I can't think of an inflection. I'm like, okay, you still may have one and you just haven't thought of it that way yet. Or maybe you just don't have one. Maybe you have a plausibly good sounding idea that's not that good.

12:00And so, you know, the most dangerous ideas, you know, like back in the day, Sarah Leary, who's a good friend of mine, started a company with Nirav Tolia called Fanbase before they started Nextdoor, Social Network for Sports Fans. That's one of the most dangerous ideas you could do because everybody's going to tell you it makes sense. You know, everybody knows sports. Everybody knows social networks. And so you go talk to 10 people and they'll say, hey, that sounds like a great idea. I think you should do that idea. The problem is there was no desperate people for a social network for sports fans, or at least the way they defined it.

12:38A market that sounds plausibly good with zero desperate people is a failed startup. And so, you know, the inflection allows you to kind of sanity check and say, hmm, the only way I'm going to succeed is if I offer a radical new form of empowerment that forces a choice and not a comparison. And the only way I can offer such empowerment is to harness something powerful, right? And the inflection allows you to ask, what is the empowering thing? What's the empowering thing that's bigger than me or any startup or any company for that matter? Because otherwise you have no weapon, right? You have no weapon to wage an unfair battle against the present.

13:16Yeah. And to bridge from your starting story with Twitch where you didn't even realize that this was actually the company. to today where you're radically successful and have formed this framework, you had a period where you went out and did a bunch of research. Maybe talk a bit about that just for everyone to know the context here. Yeah. So one of the challenging things about researching success is that even the successful people themselves can misremember how it really happened. when something works out, you remember knowing things that weren't so at the time. You have to be very thoughtful about the questions that you ask.

13:59So let's say that you're talking to Mark Pincus at Zynga. You can't say, why do you think Zynga was successful? Because he has a story in his mind about why it was successful. And it may be 100 % true, it might not be true. But what you want to do is you want to say, hey, can you show me the seed pitch deck for Zynga. And I noticed that in this seed pitch deck, Farmville isn't in it. So what's up with that? Like what happened with Farmville? Like what caused you to decide to do that? And so you want to get it out of the realm of value judgment and you want to just get the facts, right? You just want to say, you know, what was the difference between what you thought it was and what it turned out to be and what caused you, you know, what surprises did you notice along the way that caused you to shift in whatever direction you shifted in, or maybe you didn't shift.

14:52But like what you're trying to do is objectively as possible, figure this out. And what I, what I also realized about the inflections is it's the best answer I've ever found for the why now question, because the inflection, you know, it's kind of like a Goldilocks moment. If you try to implement an empowering insight before the inflection happens, you lack sufficient empowerment to deliver that. If you wait for too long, it becomes obvious to people. And now you're going to be playing the comparison game. So there's this window of time where you seize upon the inflection with your insight, because timing is such a critical ephemeral factor in this, to me, the inflection theory was powerful in that regard, right?

15:39It was a powerful heuristic, if you will, to kind of judge a startup idea, either as an investor or a founder. And then let me ask you, Mike, and this is, of course, the secret sauce or whatever, your framework and how you think about things. But I'd love to ask you, how do you, when you're meeting a seat founder now, how do you apply the framework to understand where they are? And here our audience are primarily GPs and LPs that listen to understand how GPs work. I'd love to understand how do you apply it in that first meeting? How do you apply it in the preparational work before even meeting them?

16:17How is it enacted inside Floodgate? we're definitely focused on what is the real insight here. Most people, if you ask them, what is their insight? They'll answer in some form of the world needs my product. That's my insight. And so it becomes a tautology. So the question then becomes, how do you know if it is a real insight, if they come by it honestly? And I'd say my favorite cheat code for that is to ask, what future are you living in? And so I don't think that great startup ideas come from trying to think of a startup. I think that great startup ideas come from living in the future before others do.

17:01When you live in the future, you experience the inflections firsthand. So vision is not about your thought process for what the change is. Vision ought to be a verb. Its vision is really more about getting your hands dirty with it. It's about your lived experience with what's new. And by having a lived experience with what's new, you learn what's new about it. You learn how the inflections create new empowering conditions that will change how people think, feel, and act because you yourself are experiencing it. But then you also start to realize what you're bumping up against. What are the limits of how it works?

17:41That's where I think the best insights come from. getting out of the present and living in a valid future and then building what's missing in that future. And so that's what I really look for in a first meeting. And then the other part of it is more, do they have the stuff to convince the world? So you have to not just think different, but you have to act different. Brian Chesky, who I unfortunately did not invest in, was selling cereal boxes to fund the company. And looking back on it, that was much more of a feature than a bug. You know, Justin Kahn was doing a live reality show of his life and the prior company he'd started, he sold on eBay.

18:21And so you look at stuff like that and you say, wow, you know, these people are going to run plays that aren't in anybody's playbook because they have the same type of creativity and generative philosophy in terms of their actions as they do in terms of their ideas. And so, you know, it's hard to get people to move to a different future. It takes great persuasion skills. It takes great resilience and grit. It takes a long-term perspective. And so I'd say that that's the other part of it, right? They can't just have a superior logic about the future. They have to have the ability to emotionally move us to a vision of a different world to get us to want to move somewhere different directionally.

19:04And now, Mike, let me tie us into another point where you are, I don't know if I should call it radically different from many other VCs, but at least where you are very opinionated and you take the consequences, which is you have a strong conviction in first ticket investing. You have typically 30 % follow on and 70 % in the initial check. That's a lot more in the initial check than most VCs do in their models. I know, of course, that this ties into how you're thinking and the importance of understanding the inflection in the beginning. But I'd love to hear you square this. Yeah. So the way I think about it is most venture firms, even the best ones, if you looked at the return on dollars from the first check they write and the return on dollars from their follow-on checks, most firms are scandalously bad.

20:00Like if venture firms were required to report that in their audited financials, some of the LPs would be surrounding firms with pitchforks and demanding change because it's just so outrageous. So I'm like, okay, that's interesting. Most people have terrible follow on returns checks relative to their first checks. Not everybody, but most. So then you say to yourself, should I ever write a follow-on check if that's true? And I think that the answer is yes, occasionally you should because pro rata rights are a right. They're worth something. They're not worth zero. And so the question is, when do you pursue your pro rata rights?

20:46Because the trick in succeeding and investing in anything else is to understand where you have a comparative advantage, is to understand when you have options to make money that other people don't have. and in seed investing, the option to make money that other people don't have is to have better insight, is to see things that other people don't see. And to be a good seed investor, I would assert you have to be good at that. Otherwise you shouldn't even be doing it in the first place. So then on the follow-on side, the question becomes when are pro rata rights an opportunity to play offense with your money.

21:24And so, you know, if benchmark decides to fund Twitter, do you exercise your pro rata rights? Well, over time, I started to realize you probably do. If you think that Peter Fenton is a discerning smart investor and you think Twitter is a good company because nobody else gets to do that, but you and the other early investors. So that's how I look at it. So that's point one. Point two about returns is, and I learned this from Dave Swenson, your allocation model matters a lot. So like if you're an endowment, how much you put in private equity, how much you put in public stocks, how much you put in cash, how much you put in bonds and whatever else your mix is, you know, domestic, international, that defines your return profile as much as any single decision that you make.

22:13And I started to realize that your decision about 70-30, 60-40, 50-50 is the VC equivalent of your allocation strategy. And so I'll give you an example. Like in fund one, we were 70 % upfront, 30 % follow-on. Fund two, we were 50-50. Fund one had a lower return on first checks than fund two, but so far fund one has a higher absolute return. So you think about that, you could have made no other different decisions, right? You could have made, you didn't add value differently to any of the companies. You didn't pick the companies any differently. Just that one decision of 70-30 versus 50-50, fund two would have had another 2x multiple on top of what it already did.

22:59So I think right now fund two is something like seven or 8x. It would have gotten probably to 10x had we done 70-30. And that's real money, right? And you didn't have to work harder. You just had to decide better. You just So that to me is the other logic here is there's an amount of follow-on dollars that you want to have to play offense with your money, but you want to have that minimum viable amount, not the maximum viable amount. You don't want to cover up the sins of your bad investments by doubling down on the losing companies. When you said play offense with your follow on money, you did also describe a case where you have Peter Fenton wanting to come in at a radically higher valuation and so on in the next round.

23:45So meaning strong signal from the outside. Is this the only case where you will do it or will you? And let's talk about governance as well, because you have a very different model than others as well, which I've been advocating to so many here saying, why do you not have a single partner running the follow-on investing why do you have it and then they say well we have all the knowledge and blah blah yes but you also have all the bias so let's talk exactly you you know you end up knowing things that aren't so right like so if you buy the premise that follow-on versus up front is an allocation model question then you have to ask yourself, okay, what are the governance implications of that answer?

24:28Our view was that we should have a partner that's dedicated to making follow-on investment decisions. And so we have Iris Choi, who's now been at Floodgate for close 15 years. And Iris is like, okay, I'm going to be held accountable for these returns. And so I need to have absolute decision rights about whether we make this investment or not. That's how it works. So Iris decides our follow-on checks. Now, let's say that I want to put in another 50 to 100K to help the company, bridge the company, do whatever you need to do. I'm free to do that. But that comes out of my first check budget. And there's an opportunity cost for me, right?

25:10If I put$100K into a company that's not working to keep it alive and keep the plate spinning, that's$100K I don't have to invest in the next Applied Intuition or the next whatever great company is coming down the pike. And so what you want is you just want clarity around who decides and under what circumstances. Iris decides to play offense with our money. That's her job. And if she doesn't think that we could play offense with our money, she won't advocate investment. But there are times, by the way, she'll say, like, so applied intuition I just mentioned, after we did the Series A, she said, I think this is a great company.

25:52I think Kasser Yunus is a great CEO. I would own as much of this company as I can any way that I can. And so she started buying up, right? She started buying super pro rata in the early rounds because she's like, my job is to play offense with our money. And so I need to take advantage of the fact that we're in some good companies whenever I can. And there's not that many companies that move the needle in a fund, right? And so whenever there is one that I think has that potential, I got to go unbelievably all in. Tell me just one thing. When you have a single partner that plays offense with follow-on money, why do you not also carve it out to be its own fund?

26:33The reason I think that I wouldn't is you have to, so pro rata rights only exist if you made the upfront investment, right? Okay, so it's to keep the right inside the firm and not have that discussion about it going to the opportunity fund. That's right. So we used to debate this early on. We're like, should we create an opportunity fund? And I realized we already have an opportunity fund. It's called Floodgate Fund 7. and and like what we should be doing is we should be allocating the dollars in fund seven to the best use of those dollars and you know you do an opportunity fund it creates its own its own center of gravity pressure to invest it and so i was like we don't want that right like what we should instead be asking is is fund eight which will probably raise you know next year do we want it to stay 70-30 or should be 80-20 or 50-50 or 60-40 or whatever.

27:30And it should be a function of the circumstances and our belief of the dynamics of the market and the valuations and power law outcomes and that kind of stuff. Mike, I'm in two worlds or two minds here because on the one hand, I really want to get to some policy talk, but I also think that you're one of the strongest thinkers on fund size, especially because you can actually come from a point of integrity and say, stay small. So I do think we need to just touch on that. It's a constant conversation in the GP and LP circles. So of course, do you go large or do you not? So tell me why you think it's so important that you stay small.