By John Artman
Contrary to its name, 500 Startups has invested in over 1800 startups since its inception in 2010. With an investment strategy that emphasizes little bets, the venture capital firm and startup accelerator has made investments in companies in over 60 countries including Credit Karma, Twilio, GrabTaxi, Talkdesk, and Udemy.
Founding Partner Dave McClure was in Beijing for this year’s Global Mobile Internet Conference where he spoke about cross-border investment, creating great companies, and investment trends in Silicon Valley. While there, TechNode got a chance to catch up with him to talk about how he got into angel investing, his unique mix of marketing and engineering, as well as future prospects for 500 Startups in China.
What got you into investing?
I’ve been in Silicon Valley for close to 30 years and got to know some people who were angel investors and VCs in the business. I hung out with Josh Kopelman at First Round and Brad Feld and Fred Wilson and some other folks. When I was at PayPal, from 2001 to 2004, Reed Hoffman was investing in a lot of companies, so I was kind of trying to follow in their footsteps, even though I had a little bit less of a checkbook to work with. I started doing investing around 2004, I had gotten a little bit of money back from the PayPal IPO and started using that to do angel investments. I did that for about 4 years, on the side kind of as a hobby. Even before that, I had been doing some advising and consulting for startups so I was already pretty interested in that topic.
Your education background is mostly engineering, but then for PayPal, you did mostly marketing. Previously you’ve talked a lot about startups not focusing enough on marketing. Could you explain that a little bit?
There are not many people that make that transition. It was kind of out of necessity. I had started out as a programmer; I started doing consulting for database development and client-server development back in the early 90s. Eventually, that grew into a small consulting business and I had to figure how to run the business, how to do sales, and how to stop doing the day-to-day programming as the company got bigger. Turns out I actually enjoyed that process. It was combining those two areas: doing education and marketing for the developer community was how I got the job at PayPal and then that skill set, the combination of engineering, programming, and marketing skill sets was how I got into a lot of deals. Investors would refer me because I knew the marketing for the developer side and software developers had come to trust me because I was a programmer.
So as I started to get know more about startups and investing, it seemed like that those were the two primary skillsets: you have people building stuff and you have people selling stuff. Both were important.
Where does 500 Startups fit in the venture capital ecosystem?
We’re pretty early stage, usually 100k checks, but sometimes as small as 25k or as large as 250k. Usually, we’re one of the first investors in the company. We run accelerator programs in California and that accounts for about half of our investment. We also do seed-stage investment in companies all over the world. We may follow on in A and B rounds, but we’re not generally leading in those rounds.
When do you usually exit?
When a company exits. We have the opportunity to sell secondary sometimes, but that’s usually only companies that get to 200-500 million USD [in valuation]. Most of the time we’re in it until the company dies, gets acquired, or goes public.
Does that mean you give startups more focus?
I think there is a misconception that exits happen because you’re paying attention. Exits happen because companies get acquired. You, as an investor, may or may not have much impact on that equation. We tend to see our smaller exits happen in 2-3 years, medium sized in 4-5 years, larger exits typically take 6-10 years. It is not uncommon to see VC funds extend beyond the 10-year lifecycle. We are only 7 years in now on our first fund and just started to see some of our bigger companies exit last year. There’s still a lot more coming in the next few years.
How do you see unicorns? When you’re looking at companies, is the ultimate goal to become a unicorn?
Well, yes and no. Some of our biggest wins are going to come from those companies, but they happen very infrequently. For us, we’re looking at the 50x-100x outcome 1-2% of the time. Originally, we weren’t really modeling for that but now we’ve seen those outcomes and it does look like it’s happening about 2% of the time, plus or minus. Similarly, we see 100+ million exits 5-10% of the time. On a weighted basis, those two might be equivalent in aggregate value. We see a lot of small exits that might be 1-5x, but we see 10, 15, maybe even 20% of our portfolio with those. In a perfect world, we might get a 1x return on each of those 3 categories, 2% that do 50x, 5% that do 20x, and then 20% that do 5x. We certainly like the unicorn stuff when it happens, but we do make money from medium- and small-sized wins at scale.
That’s a pretty important part of the equation: figuring out how we get better at making the small exits happen and hopefully getting larger than small exits. We’ve started looking at building supporting practices in M&A and working with founders to find exits for them. Right now, the activity is kind of centered around US$ 50 million exits, but that could go up to US$ 100 million.
Are there specific verticals or industries that you look at?
We do a lot of everything, but we end up focusing more on e-commerce, SaaS, and fintech. In general, we do a lot of consumer and business-facing services because we get to use online marketing techniques to get to those folks. That’s not saying we don’t do larger enterprise software and SaaS. Our first fund is going to do very well mostly due to the SaaS companies in that portfolio. The unifying thing across our investments is that we usually do something with software.
What about China? What are you paying attention to here?
China is a little complicated for us. We’re not as active in China as we are in other markets. This is a very competitive market and it has a lot of potential. It has big, big companies that can get started here. I think that’s why you see higher valuation prices here. It’s a high-risk, high-payoff environment, so if you pick that math right, you can make a lot of money. But it is sometimes challenging when you’re coming in at valuations that are substantially higher than we’re used to seeing in other companies.
I think gradually, over time we’ll be able to attract some more deal flow and be able to manage valuations and prices. We tend to take a long view on China. That doesn’t happen overnight, so 3-5 years to figure out what we want.
We’ve been in China for 5 years but only done 10-15 investments in mainland China and another 10 investments in areas like Hong Kong and Taipei. We’ve actually raised a fair amount of capital from China. One of the reasons we’re here is to bring investor dollars to the US. But, we’re always trying to figure out the strategy and get better at investing in Chinese companies.
Which industries are most interesting you in China right now?
I think education and healthcare are two of the areas we think will have a lot of growth over the next 10 years and maybe there are cross-border opportunities that we can take advantage of. Fintech, payments infrastructure, credit scoring infrastructure, and lending infrastructure, but that’s already dominated by players in the sector. Alibaba and Ant Financial are definitely formidable.
You mentioned raising money from China. Are there specific areas that these investors want to see their money go into?
I think China is very curious about a lot of things going on in the US as well as Israel, India, and a few other places. In the US, we’re trying to give our LPs a broad sense of what’s going on in the market and then introduce them to specific verticals that might be relevant to their business. For some of our LPs that are corporate, there are very specific industry sectors and categories that they’re interested in. We have a lot of businesses looking at fintech and lending. That’s an area where we have a good amount of expertise.
Is there anything in China that you wish was back in Valley?
WeChat integration in payments is a big success story here. I think you’re seeing Facebook trying to copy that with Messenger. Apple is supposedly launching payments again. They’re rumored to be looking at a company like Venmo to handle cash payments.
I think the manufacturing base here is pretty exciting. If we had that back in the US, that would be great. I guess the closest thing would be Mexico and we do have investments there.
The ability to point in a direction and have things happen quickly is one the advantages of having a very engaged government here. We don’t have the same ability for the government to take action in the US. When the Chinese government thinks something positive, they really go after it, whether that be the stock market, real estate, or innovation.
Source:: Unicorns, the importance of marketing, and the power of payments: A conversation with Dave McClure