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February 23, 2021
Think Seed Like Hustle Fund
This week we’re having tea with Elizabeth Yin, co-founder and general partner at Hustle Fund, where she invests in pre-seed startups in the United States, Canada, and Southeast Asia. Previously, Elizabeth ran an accelerator program at 500 Startups. She has reviewed over 20K pitches in the last few years.
Highlights from Series Tea with Elizabeth Yin
This interview has been lightly edited for length and clarity.
Before I started Mercury, I considered becoming a full-time investor. But there are so many other investors. Do you find that being ridiculously early means there aren't so many actively competing for these companies?
VC is a commodity business. Money is money. My money is the same as anybody else's money. As we start to see more investors enter the fray, you have to compete on things besides money. But there's tons of opportunity in pre-seed; it's not usually competitive to get in. We still have the problem of not enough pre-seed founders. But it's something we think about, and we try to differentiate through services. One of those is a growth school. We're trying to help our companies get customers.
What is pre-seed anyway? These names seem to change over time.
VCs have different definitions of what is pre-seed or seed or post-seed or mango seed. For me, and Hustle Fund, we define pre-seed as you've got a product, but you have no traction. Almost all the companies we invest in have no, or insignificant, revenue. But you have done something beyond just think of an idea yesterday.
As VCs get successful and they raise larger funds, they start writing larger checks. If they write larger checks, then the bar to get a larger check is higher, and that pushes up the traction you may need. So with Series A, instead of getting half a million run rate or a million dollar run rate, now maybe you need to have more traction at a two million run rate. That creates voids earlier.
How do you find these really early companies?
We see ourselves as a B2B business. We need to do our own lead gen. We do events, we take applications on our website. 15% of our portfolio companies come in completely cold. For those that have referrals, the nature of the referrals really range. Sometimes I get referred to companies by other founders we didn't invest in or people I do not even know, but they just found my address off the internet. And we take those.
Marketing is so important for this business. Over half the people initially have a touchpoint with us on Twitter. If you wonder why I waste so much time on Twitter, that's why; we're doing our own marketing.
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What makes an interesting tweetstorm?
The tweet thread works really well, which is why I'm now doing one a day. In terms of topics: how do I fundraise? How do I angel invest or how do I get started as an emerging fund manager? The topic that I actually like to tweet about, even though it does not help as much, is customer acquisition.
Coming back to these investments, do they have to have a product? How often do they have one?
In almost all cases, there has to be a product. I would caveat that the products that we end up seeing are very bare bones. Sometimes it's just "I have this landing page and I'm driving people towards it and getting conversions off of it." MVP is fine.
When you receive an inbound or a referral, how many of them make you think "this is worth having a quick conversation with the founder?"
On a hundred deals that we see, about 8 to 10 will get an interview. And then of those, 1 to 2 will get a check.
For the 8% to 10%, what makes you think "I have to speak to this founder?" And two or three red flags where you think "this is not worth the conversation?"
There's always this old question: which is more important, team or ideas? We do our filtering by ideas. I'm sure we're passing on a lot of great founders whose ideas we can't get behind.
What makes for a good idea is—this is gut feeling and totally subjective —do I think that, at scale, the lifetime value could be fairly high and the CAC could not creep up? That there's enough buffer such that you can scalably get customers? We will never know because we take companies pre-revenue, but that is more or less how we decide.
Additional filter: how differentiated is this idea? For example, health and wellness is a really popular category these days. We tend to avoid super crowded areas because it's just really hard to tell one company apart from the other. Crowdedness increases CAC. That's our first pass.
What are red flags where maybe it passes the idea filter, but you're like, "I don't have enough time to talk to this person because of X?"
Once we get to conversation, red flags might be how scrappy do I think the founders are? Scrappiness, or burn rate combined with how much you've been able to achieve with so little, that matters to me. The converse is if you have a ridiculously high burn and it seems like we haven't done anything with that, that's an automatic pass.
Obviously, things like trust are really important. Sometimes people exaggerate the truth or outright lie. That's a fine line. A concrete example is, you are on the verge of signing a pilot, but you haven't signed it yet and you tell me, "hey, we have three signed customers." I find out they haven't signed. That to me is an automatic no, rightly or wrongly.
The last thing is how go-to-market-centric you are. That matters a lot to me. I like founders who have thought deliberately about their customer acquisition and have even started to do some experiments or thought through what experiments they want to do.
What's your normal check size? How big is your fund?
My fund is called Hustle Fund. We're an over $30 million fund on Fund Two. It's a relatively new fund, so we have a lot of cash to deploy. We write a $25K check at the pre-seed level. On occasion, we will follow on, but most of the time we will not. We can make a decision after talking with somebody within 48 hours. I know for an angel, you can make a decision often on the spot. But we do try to get people a response ASAP after a call.
I know nobody is looking to raise just $25K, so one of the things that we do is help a lot of our founders. I'll ping my whole network and help them get meetings lined up. You need to have a lot of investors coming to the table around the same time to raise a successful round and command the valuation that you're looking for.
What are the actual things that are scrappy? Is it just a low burn rate?
I think scrappiness also has implied how much you have achieved to date with what you have. For example, one company is doing mass food distribution where this person didn't have any background in it and didn't have any money. He just starts calling up all these food suppliers and brokering these manual deals. There's no technology. He has nobody on the staff. We were the first investor in. But just was able to start selling pretty large numbers of quantities even without any other people or money.
What percentage of the portfolio is outside the U.S.?
Right now, it's relatively small. It's about 15%, but over time we want to expand that because I think that is where the best opportunities are right now.
I've had maybe five people pitch me a Mercury for Africa. They’re mostly in Nigeria. But I find it really hard because I don't know anything about Nigerian entrepreneurs' pain points. How do you figure out what makes sense by country or audience?
The honest answer is we're still figuring it out. We do a lot in Canada, but they're basically a friendlier U.S. We do a lot in Southeast Asia and my business partner sits in Singapore. In these other areas where we have done a handful of investments, which I would call "experimental," part of it is to learn as we go along the way. Those smaller checks do help us learn what we don't know. We take a very experimental approach in building out this firm as well. You invest a little bit and then see what happens.
Would you prefer a company that happened to be in Europe or Africa or wherever, but was attacking the global/U.S. market, or would you look for companies in those countries to be attacking the local market?
We've done both. For the former the advantage is cost: remote teams with a lower cost structure but equal talent potentially can go further. That's one case. But I prefer the latter. There's just untapped green field in a lot of places outside the U.S.
What is a typical valuation for that pre-seed $25K check?
Valuations are all over the board. I'll give you the range - we've done anywhere between $250K post-money to $32 million post-money.
Wow. It's still $25K at that $32 million?
Yeah. The way we think about it, and this is where I'll disagree with a lot of VCs, is everyone talks about ownership, but that doesn't make sense. I think it makes sense if you are a series B fund and there are few opportunities and you want to cram as much money into one of those few opportunities. But when you're talking about pre-seed and seed, a good counter-example is if you put $5,000 into Uber or a pre-seed or seed or whatever you want to call it, you would have made a lot of money at the IPO, but you didn't have very much ownership at all. So it's about multiples. To this question then, well, why would you invest in a $32 million valuation company? You have to get a really strong conviction that we can still get 100X from there, which means that we're looking at a $3.2 billion outcome at a minimum.
What was it about this $32 million? What were the characteristics that you thought, "this is a bit of an outlier for us, but we want to do it?”
We already knew this person super well, a successful serial entrepreneur. Really large idea, that does require a lot of money. One of the other major funders was going to be a distribution partner as well. When you think about all the amazing things that people like to check the boxes on, this company had all of them.
But it is rare for us. Most of the founders we back tend to not be serial entrepreneurs. We've done our own customer persona exercise and we have three customer personas. We have ambitious Alan, we have serial Sally, and we have hot-shot Carey. And if I were to do the breakdown, 80% of our founders are ambitious Alans. And the other two categories are 10 and 10.
I feel not that long ago, maybe two years ago, people thought about seed investing as mostly lighting money on fire. Suddenly, especially in the last 12 months, everyone's trying to get into private companies. What do you think changed that?
One, the number of unicorns in the last four years or five years has changed. Before you could count the number of unicorns on two hands, globally. But then there was one year, relatively recently, where the number of unicorns exploded. That partly is a function of the public markets going crazy. But I think the opportunities on the internet are much bigger now and you can make more money and you have a larger audience.
Thought number two is around actually the public markets themselves. I think previously people liked the idea of, "Let's invest in the public markets. We can get anywhere between 2X and 10X multiple within a short period of time, very liquid.” Now a lot of people feel like their companies are just too frothy: should Airbnb be worth near a hundred billion dollars market cap? So people start to go earlier and earlier, and some of these funds are a combination of both public and private funds. All of a sudden you have Series A funds in seed or pre-seed.
If you get a “no” from a fund as an entrepreneur, is there a good way to reapproach the fund later on?
I think it depends on what the reason was. I would definitely ask. If the no was, "you're too early," then you should definitely reapproach. If the no is "this is not in our wheelhouse," then presumably it is still not in their wheelhouse.
Don't you think the reasons given are often fabricated? When you give a reason, is that often your real reason?
When I give a reason, it is a real reason. There may be five reasons why we're passing, but I will give you one. The one that I will give you is definitely truthful. It doesn't necessarily mean that if you solve that, we're going to invest per se. But I do agree with you, I think there are VCs out there who give fake reasons or half reasons, and I'm not even sure VCs sometimes understand why they have a reason.
Do you feel like pitch decks are still the best way to raise as pre-seed or seed round, or do you like memos or videos or some other format?
I like written pitches because it's faster to process. Whether it's a notion page, which is all the rage these days, or a deck, I don't care. I think a video of somebody talking for 10 minutes is challenging.
I’d obviously find text way easier than memos or notion pages. I know people are really into memos and notion pages, but I want to see graphs and pretty pictures. Maybe I'm just outdated.
Well, it's funny, because in the old days people didn't have one-pagers, right?
Does it have to be someone that's already a hundred percent in or would you fund someone that's not fully in?
Unfortunately, I don't know any VC who will fund somebody who is part-time, including ourselves. "Can this company get to roughly a hundred million a year by year five?" That's hard to do. And certainly part-time, it's even harder to do. I understand that it's hard for everybody to go full-time, but unfortunately, that's how it is at the moment.
What type of investor updates do you like to see and how often?
I think it's important even for the company's own discipline to check, how am I doing from month to month? I think an ideal is monthly updates in the beginning, like pre-seed/seed, because things change so much every month. Eventually, maybe if you're later in seed, it becomes quarterly. We are making an investment in you, so we would love to know what's happening in the company, even if we're not day-to-day.
Is there a structure that you particularly like?
Sometimes people overthink it. People want to write these long reports. I think for me, your KPIs, revenue one way or how much runway you have left, maybe CAC. Maybe two bullets on what you're doing, that's it for me. I think sometimes people feel a lot of pressure to write these long things and it doesn't need to be that way.
How much dilution is okay to take at various rounds? I feel like sometimes nowadays people do a pre-seed, an accelerator, a seed, and the seed extension. And before Series A, they diluted 60%. What are rough things you think are okay and are worth avoiding?
Before Series A, I wouldn't dilute more than half of your company. Obviously, less is better. If you can get there on, call it two rounds, pre-seed/seed or something in between, and 15% on average dilution on each round, then maybe 30% to 35% diluted by the A. It's ideal.
You want to avoid something super extreme where you'll have to recap investors. Where I tend to see that is when people pivot and they're out of money. So they're fundraising from scratch on this new idea, but they're dragging along 10% to 20% of their cap table from before. That gets hard.
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The Mercury Team