E7: How Floodgate Differentiated Again From Thousands of Seed Firms

0:09Welcome back to Turpentine VC, a podcast where we discuss the art and science of building successful venture firms, VC to VC. This is a fantastic conversation with Mike Maples and builds upon the narrative of SeedVenture that we've been sowing for the past few episodes, including episode four with Sam Lesson of Slow Ventures and episode six with Chad Byers of Sousa. Mike is, of course, a co-founder of Floodgate, a storied seed firm that's invested in Lyft, Twitch and Twitter. In this episode, Mike and I dive into why it's so important to force a choice and not a comparison when differentiating, why discipline and patience are a form of arbitrage, and ultimately why they've shifted their strategy to predicting who the next great founders will be.

0:50If you like what you hear, please do subscribe and leave us a review. Now on to the interview. Mike, welcome to the podcast. Great to chat with you again. Yeah, thanks for having me. Mike, so you at Floodgate have done phenomenally well. Uh, you guys have done Lyft and, and Okta and, uh, Twitch and Twitter and a number of other winners where we're lucky to be both applied intuition and, and, and rappy together. Um, I want you to trace the history of floodgate a little bit, kind of fun to fund, maybe to talk about kind of the biggest inflection points in floodgates history. Yeah. So, um, you know, a couple of these things, uh, I was doing right only in hindsight, not really understanding at the time.

1:35And so I like to say that one of the tricks to startups is living in the future and seeing what's missing. And so I'm a big believer in that saying by William Gibson, the future is already here. It's not evenly distributed. And so I was out here. I just moved here from Austin to Silicon Valley. And I was hanging out at two firms, Foundation Capital and August Capital. And I just saw time and again, founders were trying to start their companies for much less money than they had in the past. The way companies were being built was changing with the LAMP stack and open source software and soon to be Amazon Web Services.

2:12And so, you know, it was just, I was noticing that founders couldn't raise a million dollars in Silicon Valley. They had to raise 250 ,000 from angels or they had to go straight to a $5 million series A. That seems impossible to believe in today's world where you have like more, you know, if you type in angel investor and LinkedIn, there's more angel investors and seed investors than there are founders, I think. But like, you know, in 2000 seed firms and all that stuff, but that wasn't true in 2005. And so, you know, it was, it was, um, trying to solve a problem that the entrepreneurs kept saying they were having, which was, you know, I can't raise just a million dollars and that's what I want to do.

2:52And so that's how we got started. just, you know, I like to say at the time 500 ,000 is the new 5 million. And that was the, that was kind of the founding premise. Well, one of your principles is, you know, don't be the best, be the only, and, you know, force a choice, not a comparison. And so what happens is you had this early insight, but then a ton of other firms came behind you and also, you know, followed that. So, so trace what then happened from there in terms of how you thinking about evolving the firm. Sure. And I guess the first thing that's probably useful to do is just to clarify what I mean by forcing a choice and not a comparison.

3:28So in life, I think, so business is never a fair fight. The only question is who gets to fight unfair. And when you're an upstart, the default option is the incumbent gets to fight unfair. The incumbent has the advantages of incumbency. And so the only way that an upstart can behave unfairly is to change the subject, you know, is to deny the premise of the current rules. And so when I talk to founders, that's why I say force of choice and not a comparison. Like when people took a Lyft ride, they didn't say, oh yeah, but how does that compare to taxis? And, uh, and so you want, that's what you really want, Right.

4:12Um, you know, Blake Scholl's now doing boom supersonic. Nobody's going to say, oh, well, how does that compare with like normal jet travel? You know, it's like, you can't compare the two. And so when you're a startup, you want to offer something that is so radically different that it literally breaks the pattern of how people are currently doing things. And you want to have something that can't be reconciled with what's come before it. Right. So like when we were in the early days of floodgate. Nobody said, oh, well, how does that compare to Sand Hill Road? It was like, we're writing$500 ,000 checks.

4:48The other guy's writing$5 million checks. There was us and just a few other guys, right? Maybe Steve Anderson and a few other people, Josh Koppelman. But none of us had enough money to do all the deals we wanted to do. And so more often than not, we decided to collaborate out of necessity rather than the other way around. If I saw something I wanted to do, the first thing I did is I called Josh or Steve, sometimes both. Uh, and so the next thing, you know, to your point, Eric, there's like thousands of seed firms. And so I found myself in this funny position of, am I a hypocrite now? Because I am playing the comparison game and, uh, why, why, you know, under what basis am I, am I able to say to a founder, don't play the comparison game.

5:34And now I'm being compared in every deal I do. So I decided to shift the strategy. And I mean, we're, we're involved with a company together. Applied Intuition is a good example of the strategy. So I decided I was going to try to predict who's going to be a great founder someday and get to know that person before they have a startup. So with, uh, Applied Intuition, I spent 14 months on and off with Caster Yunus before we wrote a check. And why am I doing that? Well, by the time they decide they want to start a startup, I want to say, Hey, look, we know each other. We know what it's like to work together.

6:09We know whether we want to get trouble together or not. So here's my question to you. Do you want to do something? Yes or no? And if we want to do something, if we want to work together, let's find a deal that's fair. It'll be higher price than I want, lower price than you want. But like life is too short. And if you go pitch 10 other firms, you might get a better deal. But like you're not going to know these people for more than two hours and you just can't reconcile that. You can't reconcile the choice between us working together and you taking the best deal from somebody you meet for two hours.

6:41And so like that's that's how I decided to do it. But like I believe fundamentally that particularly since we've decided to be small and not raise giant funds, you must force a choice. You must. And if you don't force a choice and if you play the comparison game, you can do well, but you'll only do well relative to the average. you know it's only a question of how much better than the average slightly do you do it's kind of like index investing right if you do what other people do you're gonna you're never gonna seriously outperform you'll only slightly outperform at best and and so the way you force a choice is is going earlier which which we'll go deeper on but just to also talk about the counterfactual you guys you know have done very well so you could have raised any any kind of amount you wanted, you could have also forced a choice in the way that some others did perhaps by going much bigger, um, and, and becoming multi-stage and, you know, really investing in, in sort of all these services, the way a 16 Z had, we had Ben Horowitz on the show, um, talk about what are the, like, why didn't you take that path or what are other ways in which you considered, you know, potentially forcing a choice besides going earlier?

7:52Um, you know, that was the only way I ever figured out that I thought I could actually succeed at. And so I think part of, part of forcing a choice and not a comparison and part of entrepreneurship is knowing how to show up in the world as your best self. And it's very tempting to try to define yourself relative to the others. And what I find is that there's only one you. And so if you're your best self, you become hard to compete against. And so, um, you know, that means that floodgates never going to have a big team. we're gonna always have a really small team and that means that we're going to take it really seriously when we add a partner right so like um and and i've been working together 15 years iris joined over 10 years ago arjun is like our new new early timer partner and he he's been here for eight years and so like um we you our model only works if you keep your funds small and if you have a team that really trusts each other.

8:51And, uh, you know, to me, once you get big, you have to scale and you have to start having processes and you can succeed, but you're going to succeed more in the way that, uh, an index fund succeeds, right? You're going to, you know, if I'm a sovereign wealth fund and I've got tons of money to invest, I'm okay. If you're slightly better than average, because I need to put money to work in these big investment vehicles. Um, But that's not what we're really interested in. We're, you know, and sometimes we take risks that fail and will underperform. But like we believe fundamentally that we want to be a very small team of a highly differentiated set of people pursuing a highly differentiated strategy.

9:32And one that reflects who we are as people rather than, you know, oh, Sequoia is doing this. We should do this. Oh, A16Z is doing that. YC is doing that. To me, the answer has to be no matter what, don't do what they do, right? Like doing what they do is, is going to be wrong almost no matter how good they are. Uh, you know, being different and worse sometimes is better than being the same and trying to be better at being the same. competition is for losers as uh you know as peter teal says well to that point you know yes when firms raise you know billions or tens of billions their their return profile doesn't have to be as high if they're raising from sovereign wealth funds etc or isn't expected to be and won't be i'm curious what you think about firms kind of in the uncanny valley you know between like 500 million and a billion dollar funds you know they're not they're not a succeed they're not these massive funds but but they are really big i don't want to name name names but i'm curious if you think, man, they're in a tough spot or it's unclear what the LP product is necessarily because they probably do have higher expectations and it's going to be hard to return that amount of capital.

10:38To your point, the strategy only works if your funds are small. What do you think about that? I'm a little embarrassed to say, to be honest, I don't really think about it that much. And so to me, the only thing that matters about thinking about other firms is how it affects the perception of the founder. And so like, like what I've learned is that the best way to succeed in doing something different is to provide differential value to the founder. And so the, the, the path to the light is always what are founders not getting that they would find valuable. And, and, and usually I find that if I spin my wheels, it's because I'm overly focused on what, what my peers and competitors and other folks are different, right?

11:22Finding a differential valuable thing that entrepreneurs care about always ends up being a good answer. Hey, we'll continue our interview in a moment after a word from our sponsors. Yours was, you went pre-company and having started on deck, I definitely resonated or inspired by a similar idea. And so when it comes to pre-company, you think about the people and you think about idea. And I know you've studied and written about both. let's maybe first talk about the people. Kasser, you know, an incredible entrepreneur, you know, a bit more seasoned, but you're also working with people perhaps less seasoned.

11:57I know you've read about different basketball coaches or other sort of amazing identifiers of talent. What have you learned or what have you taken as you've considered, you know, how to bet on people or evaluate people before they have a company? Yeah. So, so it's interesting. There's this term that I like, uh, recently I call it a pattern breakers and, and, um, you know, people say that VCs are about pattern matching and I actually kind of reject that. Right. So like, actually I think good venture capital is about understanding where the pattern is about to be broken. So humans, right. We're pattern seeking creatures.

12:36You know, we brush our teeth every day. drive to work the same way. And for the most part, behaving according to a pattern enhances our survival. It helps us fit in the social hierarchy. It helps us, you know, it helped us run away from saber tooth tigers when they, you know, were coming after us, stuff like that. But like in startups, you know, back to this premise that it's never a fair fight, a startup has to engage in activities that break patterns. They have to do two things. They have to have an idea that's pattern breaking, that defies the norms, that changes the rules. But then the founders themselves have to engage in pattern breaking behaviors, which kind of gets to your question.

13:14So, um, for example, Justin Kahn, when he pitched me on, uh, Justin TV at the time, which was a terrible idea. Um, I remember thinking this is a terrible idea, but I liked this guy and I liked the technology they're building. And then that night when I was studying it some more, they had sold their prior company Kiko, which was a calendar company, they'd sold it on eBay. And I was like, who does that? And I was like, you know, these are the kinds of guys that win because they're, you know, pattern breakers engage in behaviors and activities that conventional people wouldn't normally engage in.

13:49You know, in hindsight, one of the foolish things that I did was passing on a startup called Airbed and Breakfast before it applied to YC. And, and, you know, Brian Chesky, when he pitched me, there's a box or room full of cereal boxes, Obama owes and Captain McCain. And like looking back on it, that was much more of a feature than a bug because it showed that he was willing to do unconventional things to get unconventional results. And so that's a lot of what I look for. And when I'm talking to founders or prospective founders, I'm trying to understand what are the, what are the types of things that they're wildly interested just for their own sake?

14:27What are projects they've done in their lifetime that they did just because? What are things that they've done that didn't improve their status or the dominance hierarchy, but rather were just things that they did for their own sake, for their own independent reasons? And so that's been an important indicator for me a lot of times. Fascinating. One challenge with pattern breakers is they don't always reference amazingly, right? because sometimes they're troublemakers at their previous employee, or maybe they're just not good employees. And so I'm curious when you're doing founder references and you're trying to determine, is this the good kind of bad reference or the bad kind of, you know, not great reference?

15:05How do you disentangle? Yeah. Well, the first thing I would say is I think I've learned a lot about reference checking from Matt Mashari, who's kind of this famous coach. And I was lucky enough have to work with them a little bit. And one of the things that Matt recommends is, let's say you're looking at somebody's resume. You ask them while you're interviewing them, okay, who was your manager in that situation? What was their name? What did you learn from them? And then at the end of the interview, rather than say, hey, can I have some references? You say, that list of names right there. Can I talk to those people?

15:43And so like a lot of people make the mistake of thinking, well, I'm going to get an indirect reference. And that's going to be good because now I'm going to find the scuttlebutt about who they really are. But the problem with that is that indirect reference may not have actually worked with that person, or they may not really know what that person's assets and liabilities are. Whereas if somebody worked directly for you, you're in a pretty good position to objectively say what their assets and liabilities are. And so, you know, So now they may still get a bad reference, but I'm not as interested.

16:16I don't say to the person, hey, do you recommend this person? I'm more like, okay, tell me the circumstances where you think they were excellent. Tell me the ones where they're not. What are their superpowers? What are their Achilles heels? You know, that kind of stuff. So you're trying to get their balance sheet rather, you know, what are their assets and liabilities rather than just an absolute answer, I think. And it's up to you to decide, right? Is this the type of person who's going to move the world to a different future? And that's a different job description than were they a good employee at your company.

16:48Yeah, totally. While we're on the topic of references, let's switch the lens to the VC LP world. We're going to talk about sort of advice for emerging managers and they're trying to raise for LPs and LPs do a ton of references, right? More than VCs usually do. what do you think is most important for the emerging managers to take in mind about how they should think about what they want to reference well as, or when you're referencing, let's say you were on the LP side and referencing emerging managers, what are the biggest questions you would be asking? Yeah. Well, I think if I was an LP, uh, I would be asking questions that relate to, uh, whether, whether the person has an original approach to investing that I think is compelling.

17:34Uh, I think that, that, um, sometimes the LPs are looking for people that appear conventionally successful and, um, that doesn't always work out. But, but if I zoom way out, the thing I would recommend at most GPs, because I like, I, I don't know if I would succeed as an LP, right. Um, the, the mistake I see most GPs make is they treat fundraising like it's a sales cycle. So they say, okay, there's a bunch of LPs out there. There's a funnel. I'm going to pitch them and I'm going to try to anticipate their objections and try to, you know, overcome the objections and get them to invest in my firm.

18:14And what I've kind of come to believe is that LPs decide very quickly whether they want to be in business with you. And if you have to persuade them beyond what they've already decided, that it's a fool's errand. And so, and why is that? It's the same reason that, that, that I say to founders, people are animated by belief. And, and the, the, the reason I found it, whatever success we've had with LPs, it's because they believed what we believed. And it wasn't because I looked at it, like, how am I going to pitch this person? I was just like, here's what we are. And like, you either believe it or you don't believe it, but, but I'm not going to change what it is.

18:55Right. And, you know, we're going to make mistakes and we're going to do some things well, but Like we're not going to be a seed fund, this fund and not a seed fund in the next fund. Sometimes I think my tagline should be seed investing dot, dot, dot, really, because I have to re-remind people over and over again that that's still what we do after 15 years. But, but I, but I guess I think that like all you can be is your best self. And, um, I think that there's a certain set of LPs that'll resonate with that. And there's a certain set that won't, but like try to convince the people who don't, I think is a waste of time.

19:28I think what you should do is be clear about what you are. So the people who are prepared to believe what you believe understand clearly what they should believe it. And, you know, so I always like to say that by the time you start fundraising, you should know who's ready to do this. Because if you have to build new relationships to raise money, that's not a strategy I would recommend. I don't think that's a good idea. So you guys are institutional seed firm and you have been for a long time. multi-stage firms have gotten into seed, you know, pushing prices upwards. And so you've had to make a decision, hey, do you play at higher prices or do you find things that other people aren't willing to do and play at lower prices, but it's, you know, much more contrarian bets?

20:13Is that a fair summary of the sort of fork in the road that you've had to deal with as sort of venture has evolved? And what have you chosen? Yeah, I think that's right. So I think that what we find is that the multi-stage firms have been doing a lot of seed investing and they've definitely driven up prices. And for the most part, I think that seed firms can't make money by playing that game. I actually think that the multi-stage firms aren't going to either, but that's a whole other discussion. I think that a lot of this has been very FOMO based and also kind of based on people wanting to have something to talk about other than the high price portfolio companies that aren't working out so well.

20:57So like, why do I think that is? Well, let me take a couple of examples. So Ann invested in a company called Lyft at a five and a half million dollar post money valuation and made 200X on that. We invested in another company, a great company, great CEO, founder, Xamarin. And we invested in that with CRV, a good multi-stage firm. And I think we did a$4 million check at 30 post. They had a good exit. like 450 million, we made, I think, six times our money. I mean, six times ain't bad, but it ain't 200x. You can't live in a world where the occasional home run is 6x, right? Like not as a seed fund, you can't, right?

21:42And so the thing that people don't understand in seed is that price and risk have a one-to-one correlation, right? Like if I can invest at five posts, I can afford to take six times the risk than if I invest 30 posts for the same expected return profile. And so for me to invest at 30 posts, the amount of de-risking that needs to occur and the amount of extra money that I need to put in starts to turn it into asymptotically a series A round, right? And last time I looked, that's not our business. And so I think that's the problem. And so what I'm also seeing with the multistage firms is their junior people are doing the deals.

22:24And so the natural thing for a junior person to do is to go look at a bunch of sexy companies, find the chief product officer. They peel out of that company and they automatically won the credentialing game. And they they're raising it 25 to 30 posts. Don't even have a slide deck yet in some cases. And so I just look at that. I'm like, okay, that's where a lot of these multi-stage funds are deploying their seed capital. I just think that's a bad business. And even in the case where it's good, it's already priced to perfection. You're already playing a consensus game. So even if you're right, you're consensus and right rather than non-consensus and right.

23:05And so, you know, at best, you're going to perform slightly better than the average rather than be a super. So we've had to find ways to find opportunities that are not not going to be immediately chased by the multistage firms. And unfortunately, there's plenty of those. yeah i think the one outlier who's been able to been be consensus and still make a bunch of money is is yc because because of the scale that they've been able to um operate at they can take a a lot of bets but they get special economics and so even if they have a very high loss rate um they they will still make uh you know good money and and you know that's uh warren um buffett says a you know, franchise is a business where you can replace everybody with new people and, um, the business is still strong.

23:53And, uh, I think, you know, YC is probably the closest thing to it. What they're doing that's non-consensus is their economics. So, so to me, a lot of people confuse non-consensus with contrarianism and the contrarianism is another form of conformity because you're still defining yourself relative to somebody else. Um, non-consensus means just I'm not the consensus. And like YC is not the consensus because they're getting economics in a deal that nobody else gets. So they're getting something nobody else is getting. They're doing something nobody else is doing. So to me, like super performance always comes from thinking and acting in ways that other people don't think and act, right?

24:33That there's no way to outperform the average unless you do that. And by the way, every time you do that, you risk failing. You risk underperforming the average because you're just wrong. But to me, that's the magic of YC is they're able to act differently than others. And they've established their economics as reasonable to founders. Yeah. Another way of getting special economics is incubation, doing things like what Atomic and others do, where they provide capital and idea support and other kinds of support and get special economics in exchange. And given that you're playing at the pre-company stage in some cases, and you have a curriculum about, you know, a lot of thinking around idea generation and you have the capital, is incubation something that you might do?

25:20Or how do you think about that? I think it's something we might do. The reason we haven't done it so far is that I think most people who do incubations have no idea what they're getting themselves into, right? So you have a VC plotting missile trajectories on a whiteboard thinking that they're a co-founder or something. And they just have no idea how you have to will that sucker into existence. Right. So, you know, guys like Mike Spizer have been incredibly disciplined and focused. So, so like, okay, how can incubation succeed? I think it's not a model or a process. I think it has to flow from the person involved.

26:00You know, Idealab worked when Bill Gross had good ideas. atomic works because Jack Abraham has good ideas. What, what Sutter Hill does works because of Mike Spicer and how he approaches things. But like not anybody can just take the Mike Spicer playbook or the Jack Abraham playbook or the Bill Gross playbook. It's very situational to down. And by the way, other people have done this well too. Founders Fund with Anderil and, uh, Palantir, but like, even in those cases, it was, it flowed from the idiosyncratic differences of what was compelling about the founder, right? Trey Stevens understood the government, he understood defense.

26:38Joe Lonsdale and Peter Thiel had done a bunch of work understanding what was going on in the government with CIA and SSA. I think that the Thrive folks have done a really good job, but like Kareem is like, he came from a medical background, right? That was his life. And so, so I think that, that if we were going to do incubations, we would need to have specific individuals that you could build a strategy around. Uh, and, and, and I think that's the only way we would do it. And I, I wouldn't rule it out, but like, what I'm not going to do is get myself into something that, you know, you don't know what you're getting yourself into.

27:15Totally. And, and when the casters of the world come to you pre, pre company, pre idea, even, and are sort of bad, like, do you have, uh, ideas that you're giving out to people or are you more of an editor using your frameworks to help identify what's a good idea or how do you help there? Yeah, so I have a set of things that I like to call stress tests. So, you know, I would say to somebody, look, it's not my job to have an idea, but what I can do is I can help you do two things. I can help you rule out ideas that sound plausibly good, but that aren't that good. So like a good friend of mine, Sarah Leary, right, before she started Nextdoor with Nirov, they started Fanbase.