Elizabeth Yin on early-stage valuations in a frothy market
Each week on The Cap Table (TCT) we highlight investors, operators, founders, and industry leaders in the private markets to share their tribal knowledge of how to get onto “the cap table.” Know someone we should feature? Let us know here!
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We’re thrilled to announce this week’s exclusive with Elizabeth Yin, co-founder and General Partner at Hustle Fund! A prolific writer who was previously a Partner at 500 Startups and a 2x founder, her superpowers are focused on investing in great companies at the Pre-Seed funding stage. Aside from running a venture firm, her mission for the next 30-40 years is to democratize wealth through entrepreneurship. We had to pleasure of sitting down to talk all things cap table related, including:
Why speed matters at the seed stage
Optimizing deal flow: how the Hustle Fund built their own marketing funnel 📥
The most memorable lesson from her late mentor, Tony Hsieh 🙏
Cap table tips and tricks ⼏
The state of Pre-Seed funding in 2030 🔮
TCT: You’re co-founder and GP at Hustle Fund, which invests in Pre-Seed software startups, noting that you prioritize founders’ speed of execution above all else when it comes to making investment decisions. Why does speed matter at the pre-seed stage?
As a VC who invests in Pre-Seed startups, often the data that we get from startups has pretty much nothing. Companies at this stage usually don't have any revenue, products are barely even built or half-built, so there's not a whole lot to look at.
One of the things that I do look at is speed or velocity. I want to know things like how quickly a team is iterating and moving. In the early stages when you don't have a whole lot you don't have a lot of information to make decisions to know whether you're on the right track, you don't have a lot of resources to work with, you don’t have a lot of people, you don't have a lot of cash, and so forth. So at this stage, speed really matters. At this stage, it's a matter of doing your customer development quickly, which is learning about the problem set at hand and moving as fast as possible and then iterating on your solution to make sure that you are addressing the problem head-on. The more iterations you can get in, the greater the probability of success, so that's why speed matters.
The caveat is that this speed has to be done on the important things. Focus on figuring out what the problem is and trying to attack the solution
You were quoted in a recent Business Insider article stating that investors are driven by a ‘hype market’, implying that it’s a good time for entrepreneurs to take advantage of this to raise more money at higher valuations. As an investor, how do you balance not getting lost in the hype cycle when you find a company you like and want to invest in? At what point does valuation become a deal breaker?
It's interesting that we’re in a hype market these days and what I'm seeing is that pretty much every deal that we're doing, two weeks later the valuation could go sky-high (it could double or triple within a matter of days or a couple of weeks). For me, this is just mind-blowing.
I've never been in a frothy market like this. It's important to realize that you need to go back to fundamentals and not get caught in the hype. And for me, the question that is at hand is: are these evaluations that are going sky-high justified? Are they going sky high because people are discovering that internet businesses are actually much bigger opportunities than they thought? Maybe. We're certainly seeing, at least in the public markets, that you can build a company that is worth tens of billions of dollars (or even a hundred billion dollars), and I think that that is part of the reason valuations are going up because investors realize they can afford to pay up on valuation if those exits are true. However, the reality is, for most businesses, those exits are still not there. We've certainly seen an increase in the number of unicorns, but you also see many many more hundred million dollar businesses.
Probability-wise, it’s not like you have a higher probability of becoming a unicorn or a decacorn. For us, valuation does matter. We look at things from the perspective of: for this particular business at hand, if everything went well, do we think this can be a 100x company from the entry point (the valuation when we're getting in) and our exit point, which we have no control over. It's hard to really say whether we can get a 100x multiple, but we do our best and that's really what it's all about.
In summary, we will pass on companies based on valuations if we think that it's too high and even in a frothy market like this, you can still feel you can still find good companies in the valuation ranges that were used to with no sacrifice on quality. It's just a matter of being patient and finding the right deals. Frankly speaking, I think we probably are on the side of doing too many deals anyways :)
You’re a prolific content creator, constantly publishing startup & venture educational threads on Twitter and on behalf of Hustle Fund portfolio companies. What do you see as the power of content when it comes to running a fund?
These days, there are thousands of VC firms, and when you think about it, money is now a commodity. Why should someone take my money over somebody else's? I think VC’s need to provide more than money, and for us, part of that is content.
We think that there's a lot of opportunity to help out founders by making the world a bit more transparent. It could be helping people understand how to tactically fundraise better, or how to think about their customer acquisition costs. I don't think there's a lot of information out there that's very tactical and helpful. We try to put content out there to help not only our founders but also other founders. This is a way for us to brand ourselves to help demonstrate that we know something about startups and that we have some level of value beyond our money.
What’s your most memorable moment of winning over a founder(s)?
Funny enough, my most memorable moment of winning over a founder hasn't happened yet at Hustle Fund. Since we play so early on in the funding process, most of the time it’s not an issue. There’s certainly been a number of deals that we scramble to get into at times, though.
However, when I was a partner at 500 Startups running the accelerator there, we had two things we were combating at the time. First, we had our standard accelerator offer, which was somewhere between 2 and 2.5 million (post-money) valuation, which, even back then, was fairly low. Secondly, we were also going after companies that I would call “seed stage” companies that did have solid traction, sometimes 10k/per month in revenue or higher. So, how do you win companies that have traction and are great companies when you have this offer that is quite low in the market? That was when I really had to test my sales skills.
One of the companies that I was trying hard to recruit for one of the batches is this company called The Pill Club, who has gone on to do incredibly well and I’m glad I won that deal. But, there were many times when I felt like giving up but found ways to win over the deal. Since they were renting a house in downtown Mountain View at the time (the 500 startups office was also in downtown Mountain View), so I would literally just go over to their house (which was also their office) and just swing by to say hello. I was like that car salesperson, the one trying to sell them on what we could offer and why they should go with us. Eventually, after many conversations, and talking about our value proposition, we were able to work with the team and I am so grateful to have found them. That was probably the most hustling that I did to win over a deal.
When raising Hustle Fund I in 2019 (How I Raised $11.5 Million Venture Capital fund) one unique tactic you used was creating a video explaining who you (Hustle Fund) were. This was a bit of a gamble because you spent $13k producing the video, but it paid off as you were able to stand out. If you had to go out and raise Fund I all over again in 2021, what unique tactic or gamble would you use to stick out and differentiate yourself?
I did talk a bit about how we raised Hustle Fund I in that article, but one of the unique things we did was spending thirteen thousand dollars producing a video about us. By all means, this was a ton of money for us to spend on branding, but we really wanted to take that bet on ourselves.
One of the things we did know was that in this day and age, we often talk about marketing yourself as a VC and why this is so important, because money is a really a commodity now and we wanted to create a video that would be the best way to illustrate who we were and what we're all about. And I think that bet paid off. We’ve had so many people cite the video and say things like “I understand your ethos, what your mission is, and what it’s like to work with you, and how you think about the world”. I think that it’s helped us tremendously. Branding activities and marketing can be hard to quantify, but it’s certainly something that I would use again for sure.
Per SEC rules, you can only accept 99 accredited investors into a fund, meaning, if you want to raise a $10m fund, you need the average check size to be above $100k. What are some creative ways of overcoming this if you’re raising a new fund without a track record and looking to bring in as many investors (and small checks) as possible?
This is a real challenge for a lot of funds because you have to manage your checks from start to finish with this rule in mind. You’re constantly running scenarios like “if I bring this person at the small check, then my average check like that to go up X”, so it's harder to raise higher level checks. So, at what point do I stop the smaller checks and only focus on the bigger checks? This game is a terrible dance that emerging managers have to play now-a-days.
What we ended up doing was using this rule as a forcing function. This rule, frankly speaking, is not optimal, and I think it should go away. However, we did use it as a forcing function in our own fundraise. In the beginning, we did have low minimums (for Fund I), bringing people in for $10,000 or $25,000. But, after a while, we started approaching people and told them that we have to raise the minimum due to this rule and could only accept a handful of smaller checks, otherwise we’d have to sacrifice the fund size and this is the only way we can raise our target amount. That really helped incentivize the smaller investors who knew they couldn’t meet the higher minimums. So, the smaller checks came in quicker because they knew there was limited space and then they helped create momentum for larger checks.
That was a tactic that we used over and over and that works quite well.
Hustle fund does ~50 investments per year. What tools do you use for managing pipeline, dealflow, fund performance, etc?
These days, it's looking closer to 80, sometimes on pace to closer to a hundred checks per year now which equates to around one to two companies per week.
Over the years, we have built out a system to manage all of this. Our system, put very simply, flows through type form and Zapier, which then connects everything to Airtable, Pipedrive, etc. We see our business very similar to a marketing funnel where we do our marketing.
To start, we drive people to a form where they submit their business (type form). These inquiries are a combination of both cold and warm intros, but we still drive everyone through our funnel which makes it very structured and organized. This now allows us to do rule-based triaging.
So for example, if somebody is in a geography that we do not invest in, they will get an automatic email saying that unfortunately, we cannot get involved because they're in a geography we don't invest in. For the companies that do fit our criteria, we end up looking at them through Pipedrive. If it’s a pass, we use a number of templated emails that cover all the reasons we might pass. If it fits our criteria, we will advance them in our funnel and offer a meeting schedule link to get a call scheduled.
With just two clicks, we can make a decision on every company in Pipedrive and get the meeting scheduled fairly automatically or we can send out the rejection email with concrete feedback through these email templates on why it’s not a fit. As you can imagine, there are many reasons why you might pass, but many companies fit into various ‘pass’ buckets such as your concerns about the long sales cycle or unit economics that applies to many companies. We also have a Zapier connection between the type form that feeds into our Airtable that allows us to do more analysis later on our existing portfolio companies.
How often do you evaluate fund performance and how do you benchmark this compared to other pre-seed investment firms?
This is a great question.
I think the honest answer is we won’t know for quite a while because we are only three years into our Fund I, and didn't even do all those Investments on the first day.
We only have about two years of data and when you go from Pre-Seed to Seed or even Series A, it can certainly take more than a couple of years to go beyond that and really demonstrate that you're a big company and that's really where you see performance in the couple or handful of really big winners. That's what makes all the difference, so we’ll have to wait and see on that.
Can you tell us about your connection to Andrew Yang? We noticed in his presidential campaign disclosures that he’s an LP in Hustle Fund.
The press has spilled the beans on this through his presidential campaign disclosures. I cannot confirm or deny since we don't offer private information about our LPs, but I wouldn't say that the Press is wrong about it. What I would also say is that Andrew and Eric go way back to their start of days when Andrew was running Manhattan GMAT and Eric was running Beat the GMAT, so they do know each other quite well.
What was your first 100x/10x and how did you get into that deal?
I think the honest answer is that at Pre-Seed level when you're coming in super early and there's not a whole lot there, it’s a lot easier to get to 10x or 100x just because you’re getting in so early. When I worked at 500 Startups and I was running that accelerator, one of the companies I mentioned earlier was The Pill Club, and they're doing super well now. I can't disclose what their valuation is, but I can tell you the standard offer for 500 Startups is around $2.5 million (post-money) valuation at that time. So, a 100x on that would be, hypothetically, a $250 million post-money valuation. Obviously, this is a really changing milestone. But, if you’re getting in at, call it, $20m post-money, that company has to get to closer to $1b or $2b+ to get a similar return.
I have a couple of companies in that sort of 10x/100x range. But, I have a lot of companies there just by getting in early. If they get to a Series A (Series A’s these days are anywhere between $30-$100m post money valuation), you’re in a good position to that 10x/100x range. A lot of investors who go in that early pre-revenue have that advantage of the larger upside (as well as higher risk).
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What’s your secret for getting on the cap table?
I think this is very similar to an earlier question of getting into deals.
The first part is just letting people know about yourself and what kind of deals you do. We do a lot of our own marketing and have our own marketing funnel. We don't have to try really hard in most cases to win deals at the stage since we’re so early. If we were looking for companies with traction, it'd be very different. Seed stage is quite competitive but at the Pre-Seed stage there's barely anything there and a lot of people who will take their time or will pass. As investors, we just go in and make a quick decision and this is a huge advantage for us.
What’s your biggest cap table “mistake”? (alternative: What's your biggest miss (a company you saw but passed on)?)
I've had a number of misses.
I think we'll see where they pan out, but one of the more notable names that you may have heard of one is a company called Tandem, which provides a virtual office for remote teams, and was one of the most sought after companies to graduate from Y Combinator Summer 2019 Batch. They were backed by Andreessen Horowitz in a very competitive round so it will be interesting to see them grow and where they land.
Another one was when I was at 500 Startups. We were weighing the decision on Instacart, and the price at the time seemed quite high. We were not pitching them for the accelerator, they were pitching us for the Seed round and I think the valuation was around $10 million (post-money) valuation at the time, and obviously Instacart is well over a 100x that now, so that was obviously a miss.
We’ll see what the true big misses are in about 5 years :)
What are you passionate about outside of work?
Unfortunately, like so many founders, work is my life and passion but it's a good thing because I really enjoy this job. I was looking for a problem I was excited to solve for the next 30 to 40 years and I feel so fortunate to be able to do this.
Our VC fund is one component of it and that certainly it's fun, but we’re building a business with Hustle Fund. We’re trying to tackle the problem of “how can we democratize wealth through entrepreneurship?” Meaning, how can we level the playing field with startups. It could be on the funding side, it could be on the knowledge side, education, networking, community, as well as how can we add more angels to the cap table? We’re working on many of these initiatives. I focus on the VC side but we also do actively recruit entrepreneurs to work alongside us to help build this and execute on this mission.
So, I guess that’s nothing outside of work :)
On your personal site you wrote a letter to your mentor, Tony Hsieh, who unfortunately passed late last year. If you had to share the most impactful lesson you learned from him, what would it be?
Tony has taught me so many lessons but I think the most impactful lesson that he's taught me is to always go back to first principles thinking and questioning.
He was constantly questioning why we do things in a certain way and never took anything as the right way of doing things just because it was written down or said earlier by someone else. I think that’s absolutely the right way to live life. The things that we consider to be true all come from the first principle that may have been true but in a world that’s constantly changing, that first principle may no longer be true.
A strong example of this, at least in Tony's life, was moving Zappos from the San Francisco Bay Area to Las Vegas in the mid-2000’s. At the time, it was unusual and not common. But, he did it because it was the best decision for the company, even though others did not likely agree with this at the time.
All said and done, that was absolutely the right choice. The cost of talent here in the Bay Area was too expensive and he needed to bring his costs down and especially if he wanted to provide great customer service, which Zappos was infamously known for before being acquired by Amazon in 2009 for $1.2 billion dollars.
What’s the state of Pre-Seed companies in 2030?
This is going to be a fun one to predict but I think we're already starting to see the trajectory.
I think we'll see the rise of both Micro Angels and Angels, both contributing to more funding besides VC's which is huge. I think that's great for a number of reasons. First off, the number of VC's has ballooned from tens to hundreds to thousands of firms today, so entrepreneurs have more choices when it comes to taking on capital and adding great investors to their cap table. This also means that funders are investing in a greater swath of companies. By having more angels, will help provide a little bit of capital to get most companies off the ground that’s needed at the early stages as well. If we can get more funders at the Pre-Seed stage, that really does help get most companies off the ground to start. At this stage, a few angel investors could help launch a company whereas before it would have only been possible if a VC was willing to commit at such an early stage.
The other thing I think we’ll see happen is how funding is done in the future.
The traditional way of investing is through equity. You buy shares and hopefully those shares become worth something. I think we're going to see other models that are a little bit more akin to “friendly debt”. So for example at Hustle Fund, we have a revenue based financing fund called Hustle Flywheel, and they issue “entrepreneur friendly” debt. For them, they don't need to have belief that you’re going to be worth a 100x multiple on your exit. In fact, they don't have to care about your exit (at this point in time), they just need to believe that you will be able to pay back your loan plus a little bit extra, over a certain short period of time and that's a lot easier to get belief around because that's less around how fast a company is growing, and also less about how much revenue we think the company will do in five years, which is really hard to predict. Along those lines, I think we’ll see other models that people are experimenting with, like Earnest Capital and other models like this.
Lastly, I think Crowdfunding is another model that fits actually both of these things above related to raising outside of tradition venture capital. I think most crowdfunding options are equity-esque, where you are buying equity, but I think we will also see variations on crowdfunding models, including more along the lines of debt and other creative models.
I think we’re going to see a lot more funders and a lot of different methods of funding as well as a lot of different types of funders as well. This is something I'm really excited about because entrepreneurship is not a zero-sum game.
The more great entrepreneurs we can fund, the better. We just don't have enough resources today who are participating in doing that and I’m excited for the future of funding, especially at the Pre-Seed and early stage.
Follow Elizabeth on Twitter (@dunkhippo33) for more insights into Pre-Seed investing, startups and venture capital!
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Sources: Crunchbase, LinkedIn, Twitter
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