20VC: Index's Shardul Shah on Why Market Size is a Trap | Biggest Lessons on Pricing from Leading Rounds in Wiz & Datadog | Why Benchmarks & Averages in VC are BS | How Index Makes Decisions and Why Growth & Early are the Same Investing Style

0:00The lessons to learn are don't be cute on price, don't underestimate fantastic founders, and don't overthink it. Tam is a trap. Go back and look at the S1s of some of the biggest public companies today. Their market caps are bigger than what they thought the Tam would be. The best founders find and expand market opportunities. We are in the business of finding fund returners. The power law dominates our business. not being in a $10 ,000 ,000 ,000 company is actually painful. This is 20VC with me Harry Sturbing's and I'm so excited to welcome to stay one of the best investors of the last 20 years.

0:39Few VCs have not won but two 20 billion dollar plus companies to their name. Shaddle Shaw, partnered index ventures and one of the best cyber investors in the business. Shaddle has led rounds in data dog, whiz, coalition, duo security and many more incredible names. This is an incredible discussion on investing lessons from the last 16 years at index. But before we dive in, when a promising startup files for an IPO or a venture capital firm loses its marquee partner, being the first to know gives you an advantage and time to plan your strategic response. Chances are, the information reported it first.

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3:22So to learn more about the number one most active law firm representing VCs backed companies going public. Head over to coulee .com and also coulee .com. Coulee's award -winning free legal resource for entrepreneurs. You have now arrived at your destination. Shadult, dude, it has been so long since we did our last chat. I have aged incessantly, but thank you so much for joining me, stay, my friend. Thanks for having me back. Tell me, in all of the time you've spent interviewing so many people, what's the number one lesson you've There's no right way to do venture. After 2 ,700 shows, I've learned that one of the biggest mistakes people make is they try and copy someone's style totally that's not authentically theirs and think that's the right one.

4:11And actually it's about finding where you are uniquely great in the three pillars of venture, sourcing, selecting and servicing and really leaning into one over others actually. That's been my biggest lesson. Yeah, it took me a long time to figure that out. Like growing up, I grew up outside of Chicago and so my childhood hero was Michael Jordan. And all of the advertisements are B like Mike. And B yourself is actually the message in life as an ambassador. Do you think that's possible though, Inventure Phums? If you are a young person trying to scale the greasy land of a venture firm as much as on my hate set, with internal politics like many have, you have to adjust yourself to the firm to be promoted.

4:57It's a game of strategic promotion. No way. I think, you know, I learned this from Josh Madhah, who's the founder of Coalition, sent me the annual reports from Stone Ridge, which is a hedge fund. And everywhere, kind of a Warren Buffett style, kind of annual report comes out. And one of the reports found are alluded to a culture of belonging. And the spirit of belonging is for people to be themselves and not to assimilate. Like if your goal is to be the best version of yourself and your firm's goal is to be the best firm on the planet, there's no room for assimilation and confirmation, conforming to other norms.

5:39So I think it's absolutely wrong. I think if you try to assimilate to be someone who you're not, You're setting yourself up for failure. So you do not think that actually individuals and people who want to scale an adventure firm should kind of play the game on the field. No where they can get angles to get promoted and focus on that. And they said like, you have to fix problems in firms. If you were in the fund, don't worry about it. Sure, but it takes eight to ten years for them to know. Often there's a messy middle, you were in Figma. For years Figma did not look like a winner. It is not always apparent and actually often in the early years you have managing partners with great deal flow Well partners with great flow who need assistance?

6:21It's about being a plate remover and so doing the diligence doing the grump work in some cases is the strategic move to get promoted I don't know like what can I tell you like I've been with index for like 20 years So I don't have actually a lot of experience with other venture cultures at index there's this deep acknowledgement of the importance of mentorship and apprenticeship, right? That's how you evolve in your career. And I've been super lucky to have seven mentors in my career. Not once was I coached or not once did I play a game around doing X to climb up a corporate ladder. Like every time I was promoted I was surprised.

7:06So maybe you're right. Like if you're in a institution of 200, 300 people. Perhaps there's like machinery that you need to navigate. But in my home at index, it's about finding funder jobs. Danny's been a big shaper on me. How did Danny shape you? How did Danny shape you? Oh, so many ways, but how I think about building great partnerships, how I think about incentivizing partnerships, how I think about LP management, those would be the biggest. Also, I would really say with Danny actually for me focus. There is a lot of things that I could do. He always reiterates to me about the importance of keeping the main thing the main thing.

7:47I think if I had to distill it to the essence, it's intentionality. I've become much more intentional with my time. I've become much more intentional with my communication. Where did you spend time that you now with more focus don't? When I started my career, every meeting default was an hour. Danny reminded me that I probably know the answer in 15 minutes. And so now the default first meeting I have is 30 minutes. That's huge time savings across the number of meetings I have. What's your initial filtering on a do I meet? The more do I give to another team member? I know it sounds blunt and harsh, but like you have a certain number of hours in the day.

8:26You have to have leverage with more team members, more junior team members. All the filtering process between I will meet them versus, you know, what interesting, but I didn't have time for it. Every meeting ideally would have two people in it. So that's a super high bar for taking any meeting. I'm asking to prioritize someone else's time in addition to mine, which means the threshold for meeting is super high. Now in terms of handing off a meeting to someone else, I only do that if I believe one of my like colleagues will have more chemistry or is more relevant. Like we were talking about vertical SaaS.

9:03Like if you're starting a vertical SaaS company, you ought to talk to Nina or Paris, they're geniuses. I don't know anything about vertical SaaS. We go for two people in a meeting. Why do you like majors? You specialize in cyber and you said that you don't particularly specialize in vertical SaaS. Can you just unpack your thinking to me around why it's important to have a major adventure? And does that mean the future of venture is specialization? Little nuance, I'm a liberal arts graduate from University of Chicago, so I believe in concentrations, not majors. That being said, yeah, I kind of fell into cyber.

9:39One of the areas actually started in at index was biotech. So I think there's a lot of utility in each of the three competencies that you think about like selection, you know, winning and supporting by having some amount of focus, especially for me, but similarly at index, I wouldn't recommend this to the vast majority of investors. Each of us is stage -ignaster, right? We're investing at seed, venture, and growth stages. The vast majority of investors on the planet specialize by stage. Do you not find it difficult to adjust your mental plasticity with stage? You know, at preceding seed, you have to get very comfortable at making decisions without much data or any data at all.

10:20And then in series B, you have a lot more data. How do you think about that mental plasticity with stage. Starting point is actually the same across stages. It's all about the founders. There's this canonical question I think in our industry. Is it the market or is it the team? Many great firms would argue that it's market. In my view, it's very clearly the team. As a consequence, when you're trying to think about even paying high prices at late -stage businesses, you're still fundamentally taking a view that that team will find adjacent market opportunities over time. And so the in some sense the plasticity required to evaluate a team at stage is not a requirement.

11:01How is what you'd love to see in founders changed over time? And so an example for me would be I place a lot more emphasis now on finding entrepreneurial talent early in one's career. One of the biggest determinants I found of success from interviewing 500 founders is actually that the best always start early. So I spend a lot of time on childhood and not much time on the business. Oh, interesting. I'll try to think more about that. I mean, if I step back, in our industry, there's clearly a power law. Bill Gurley has talked about this at early stages. LaFont did a good job at East meets Wets, bringing real attention to how seven companies are driving the returns in public market indexes.

11:44So the power law exists, I think, at every stage. That's a pattern. When it comes to patterns of selection and patterns within people, the only pattern is there is no pattern. Now, to your question of like what has evolved, I think I've become much more conscious of two components of my decision making. One is intuition and the second is like an analytical framework and venture is a craft and so you're constantly kind of refining it. Intuition, like a harder time kind of putting to words, you know, it's of feeling, I know it when I see it, my partners definitely know it when they see it in me, but that intuition and conviction has definitely evolved and grown.

12:27Can you take me to a time when you've had the strongest intuition and it was wrong? Why do you think it was wrong? At index, we, I was once asked to run like a tech off site. So I kind of threw the old approach out of the window and I told all my partners to do homework and I asked them each to write a post mortem on a company we could have created a billion of gain or more and then we distilled kind of the lessons learned and ultimately the sins of omission are much greater than the sins of commission. The sins of omission for us distilled into three lessons. One, don't be cute on price. Two, don't overthink it and three, don't pass on generational founders and so intuition around like I'm so smart like one of the challenges with being a major concentrator in a domain is you get so smart that you actually think you know what you're doing and then you might instinctually be dismissive of actually a disruptive idea.

13:26Don't be cute on price. I get it. I completely agree with you. But we're seeing the pains of that now with so many companies looking at valuations going, I don't know how we're going to grow into that. Is there a line between high and a step too high? and how do you think about that and across different stages? Not when you have conviction, right? So intuition is one part of it. The other part of it for me is an analytical framework. And founders, I look for folks that have imagination, operational excellence, and high quality decision making. And I find that like combination to be rare in one individual.

14:01Some of that may come out in kind of a childhood trauma like that shapes who someone is and ultimately gets manifested in the types of decisions and the style of decisions that they make. But when I think about conviction in people at the earliest stages, I think you can be really elastic on price. Late stage, if you have conviction, price is just a representation of future expected for cash flow. So you're probably not wrong on price. You're wrong on the investment. When did you do a deal at a really high price? Actually, it turned out to be a great decision. The supposedly very high price at the time was not actually high given the outcome.

14:43Every investment in data dog was at a high price. It's not an outcome yet. Of course, but every investment in Whiz has been at a very high price. I feel great about each of those decisions. Have you ever had a great investment that's been a good deal as well? I don't know. Do you see what I mean by that? which is like often people say listen the best price time. Yeah, you know, Demir on my team once asked me this question is like, sure, do how did you get comfortable with that price? I was like, wrong question. I don't seek comfort. You have to be comfortable with being uncomfortable. We're in the business of taking risks.

15:22I'm not a value investor, right? I believe in the power law. I think very few investments and decisions we make will create disproportionate returns. So I'm not seeking average returns. I'm not seeking good deals. I'm looking for outliers. I completely agree with you on like, hey, you shouldn't be comfortable. When you think about risks that you're willing to take versus risk that you're not willing to take, you've got execution risk, you've got market timing risk, you've got market sizing risk. How do you think about those different risks and your willingness to take them or not take them? Are you Star Wars fan?

15:56There's a scene. I see the hesitation. I've never seen a star. I'm the nerd here. There's this guy, General Akbar, who's like, is alien. And at one point, he screams, it's a trap. That is the voice I hear in my head anytime someone talks about tam sizing. Tam is a trap. Like, go back and look at the S1s of some of the biggest public companies today. Their market caps are bigger than what they thought the tam would be. the best founders find and expand market opportunities. So I think at index, we've been really good at overthinking TAM and systematically underestimating the magnitude of our best companies.

16:34So no, I never run into market sizing because I don't put effort into it. In terms of market dynamics, I get that wrong all the time. What do you get wrong in market dynamics? Misunderstanding competition, misunderstanding timing, what elements there? Here's an example. I thought that the end -point security market would be totally commoditized by platforms. I thought I use a Chromebook. I thought MacBooks have pretty good security and as a consequence the EDR market, which the first generation was Macafee's and Antick, etc., would cease to exist. At least $65 billion that explains I was wrong on CrowdStrike, like cyberies and Sentinel one, like this entire category.

17:18If you unpack that, what do you take away from that? Like what's the subsequent lesson for you there? Don't come to such quick conclusions. How do you change your mindset as a result of that realization? It was not a quick conclusion. Uh, it was a consequence of overthinking it, like rule number two, and not recognizing George Kurtz for the phenom that he is. Like those are the lessons from CrowdStrike. like a terrible mistake. Did you have the chance to invest? I mean, even if you had anyone had the opportunity to invest as a public company and still make a tremendous return. When you think about, you mentioned that kind of one, so you missed, are there any that you believed in that you were wrong about?

17:59You don't need to name them obviously because that's very harsh to say. But what did you get wrong when you saw something that later turned out to not be true? You know, there are business models that have of real capital needs, they can encounter two challenges. Either the founders are unable to raise significant amounts of capital or their distribution model gets in the way of allowing there to be sufficient growth to overcome the capital needs. And so I overestimated like uncapped market upside, underestimated the capital intensity of a company voted in favor with high conviction on the investment.

18:40And yeah, I think one of my partners doing a great job of finding a path to returning capital on that investment, but that's certainly not desired outcome. Do you think the best found is all the best fundraisers? No, I'm packed out for me. When we invested in Olivier and Alexi's series A, a data dog, he was not a great fundraiser. Thank God he was not, right? If being a great funder, fundraisers defined it as having multiple opportunities, you know, in a short span of time, did he evolve into being a tremendous fundraiser over time? But I don't think the best funders begin as the best fundraisers.

19:18We mentioned this company that I'm looking at doing, you know, whatever the check sizes now, and I'll just leave it there because the other fund will kill me if I mention it, and he'll know. It will be an incredibly dilutive company along the way. It will need a lot of cash and that is a consideration. How do you think about capital requirements over time, capital intensity, potential future dilution when investing? Or do you not think about that? I probably don't think about it as much as you. The luxury of having a seed venture and growth fund as we can build ownership over time with more capital if the company is performing.

19:52That being said, there are definitely business models like in biotech drug discovery. Those are where hugely capital intensive can have binary risk, binary scientific risk on if a drug asset becomes an actual, like a candidate becomes an asset. Those are business models that we won't participate in. So I spoke to 12 people who've either invested, like invest with you today, or have invested with you in the past. And nine of them said I had to talk to you about conviction building. Just nine? Yeah, just nine. What are the other three you're talking about? Yeah, I said you're incredibly difficult to work with generally always struggled to put the microphone in the frame, just challenging all over.

20:32But I thought it was really interesting. They said you have to ask about the conviction building process. I did want to discuss that on the theme of, hey, you have multiple different funds, and so you can just concentrate, count it over time. You can, you've got to have some big conviction to continuously double down and double down and double down. How do you approach that conviction building process across stage? I'm not thinking about incrementally increasing my ownership. I'm building a new investment case on, can I create a fund returner? And with that, I do all the work again. So if I think about companies that I've been involved with, I've rotated shadow partners to help me with an objective view on reassessing the management team of redone customer calls, of redone competitive analysis, of rebuilt financial models, I do all the work again because as I've doubled down multiple times within a year.

21:25Does the upside requirements change with each stage? And what I mean by that is, you know, when you are a CTO series, there's like, hey, I need this to be a fun returner. When you get to growth, does it change to be like, we like to see a three to five X pathway? How do you think about that? By upside requirements, is it changes across stage? Yeah, I mean, the observation, when we started our first growth fund, our hypothesis was probably three to five X over three to five years, right? I'd just come out of a private equity firm as had some my colleagues. And so we had like a we had that mentality.

21:57And when we looked at the performance of the fund, it turned out there's a power law. There were companies that were 5 10 x plus. There were very few companies that were actually 3 to 5 x over 3 to 5 years. And so we kind of accepted the fact that we're not value investors. We're invest venture investors at growth stages. We're driven by high conviction. And as a consequence, when we're building our investment cases at growth, we never, it's like, it's super dangerous, I think, to say that there's a safe 2X. There's no such thing. And you alluded to this with the memory of all of the activity from 2021.

22:35There's no such thing as a safe 2X. And so what we're looking for is definitely 5X plus upside, even at growth investments at late stages at high prices. I had some on the show from Greylock, and he said that she, that when you look at series B &C pricing stay combined with the revenue multiple compression that we're seeing with public markets pricing. Actually, Series B &C will just be a terrible performing asset class for this vintage. Do you agree with that or do you have a different perspective? I don't know why we're talking about averages. None of us are in the business of mean reversion.

23:08If we're making a Series B investment, it's by exception, like elastic Series B investment, terrific return, Confluent, Series B investment, terrific return, and the list goes on. But if you were seeing Series B average entry prices go up by 30, 40, 50, 60 % for the best, and then you're seeing compression in terms of public market pricing, even for the best, it is a worse asset cost to be in. Correct? No, that's not. I mean, we're mixing two time horizons, right? Like, when you invest is not when you exit, so the multiples may evolve and change, turns out the best companies get premium multiples and again, above the average multiples that you might be alluding to with multiples coming down.

23:51Second, the best companies that are category -defining are going to be far more significant and so you can afford to pay up. If you look at the averages, I hear you, but from my perspective, there's no reason to look at the averages. What's the hardest thing for you when you think about doubling down on winners? When you look at say like a whiz or a data dog. Can you just talk to me about like, let's break one down. Let's do whiz. What gave you the conviction with whiz to continuously put in more and more money? What's the hardest thing? It's kind of identifying if you're delusional or you have conviction.

24:25And sometimes it can feel like a thin line when you have such deep conviction. In what ways can you be delusional? You can be lazy. If you skip the details, if you don't do the work, if you stop asking questions and are surprised by new information, those are symptoms of being delusional. When you have a culture like an index, we invite agreeable disagreements, right? And it can actually steal your conviction. When I've so much respect for Danny, who we talked about for Jan, for Marton, for Adriana, Nina, Carlos, Vlad, when they disagree, you take it really seriously. You sleep on it and when your conviction is unchanged, it's crystal clear that you need to go deeper.

25:13That said, with whiz, when we were doubling down, we took multiple approaches to it. Top down, look, the cloud market is on a path to a trillion dollar transformation. There's probably 300 billion dollars of spend on cloud service providers. That'll get accelerated by AI compute data demands, right? So we're talking about a potentially a trillion dollar plus market opportunity. In comparable categories, there's 5 to 10 % attached to security spend. So the cloud security market could be really significant. If you think about most software, like functional software areas, the market leader commands north of 25 % market share.

25:56So you do the math on how big could the winner be and you know you can apply various discounts on penetration rates and time and so on and so forth but you get to really significant numbers. Number two, you look at public comps, crowd strike, $50 billion plus business, Palo to Networks, I think now is like a hundred billion dollar plus business. The bottom's up, you know the business in four years the company has grown faster than any company of all time with unbelievable productivity in different segments, in different geographies. From a team perspective, they've gone from strength to strength, adding most recently Dolly as their COO, who's an absolute beast.

26:37And so from every dimension, the story is profound. But I don't think it's obvious, right? Did you get pushed back with each round or not? Yes. On what? Price, progression of company, on every dimension. We beat up investment themes, right? So people, product, technology, competition, traction, market, like every dimension we debate. How do you think about finding the truth together? I know it's kind of a weird tangent, but I think about this a lot now as we build our team and have the same discussions. I want to have vigorous debate and have passionate discussion about these elements, but I also don't ever want to put someone off with the forcefulness of a discussion or with just the kind of vigor of this course.