Naval Ravikant: Twitter, Bubbles, New York and Start Fund [Interview Part 2]

Last week I posted part one of my interview with Naval Ravikant. This is the second and final part of that conversation.

Part 2: Investing, Investors, New York and Start Fund

Ravikant is the co-founder of AngelList, a topic which we covered in depth in part one of this interview last week. He is also a serial entrepreneur and is generally considered a top global angel investor and a Super Angel.

In this part of the interview we talk about: His investments, other investors, the New York TechHub equaling Silicon Valley, his radical views on Start Fund and enjoying the journey.

AngelList is where Ravikant is now, but I wanted to know how it all started, more to the point, why he decided to become an investor? “I’ve been a serial entrepreneur and I started 6-7 companies, depending on which ones I confess to, and how you count them,” he said jokingly. He then went on to explain that it was his need to work on multiple projects that committed his path as an investor:

“After a few initial companies I sort of developed ADD [Attention Deficit Disorder]. I didn’t like sticking on one project, but I really liked to be involved in many projects and I liked to be in on the early intellectual stage, rather than the later stage, where you have a hundred people.

“I wasn’t really as much of an operator as I was a thinker. Sadly you don’t get paid in Silicon Valley to be a thinker, but you get paid to be an operator. And the best way to get paid for thinking and creating is by investing. You have some leverage that way.

“So I went out there and raised a small fund from people like Marc Andreessen, Tim Draper and about 20 entrepreneurs in total. I was originally planning to do an incubator.”

I interrupted him there, The Hit Forge Incubator, I wanted to know more, why didn’t it come to fruition? He said earnestly with a laugh, it was because no one would join him:

“I started meeting these great companies that didn’t want to join my incubator. I met Dropbox and Drew Houston [CEO and Founder of Dropbox] when he was first at Y Combinator, and I was trying to convince him to join my incubator after YC [Y Combinator] but he didn’t join.”

Ravikant then went on to tell me that he stopped pursuing the idea of an incubator when he met Twitter co-founder, Evan Williams. He went on to explain in more detail:

“Shortly after talking to Drew about the incubator idea I met Evan Williams from Twitter and everything went out the window. That’s when I said to myself, “I need to straight out invest. Because the best companies are run by the best people and they don’t need me to succeed. But if I can come in and bring some money and something more then I have a chance to participate and be involved.””

We left the topic of Twitter for the moment. I wanted to focus on how he knew the company was right for investment and what characteristics a company must have for him to invest. He told me about his ‘investment thesis’ and how it has evolved to be what it is today:

“I have had many versions over the years [investment thesis] and I have two that I go by now, one personal and the other for AngelList. In terms of personal investing there are three things I look for in a company. You need a great team, a huge market, and some sort of unfair advantage.

“I use Warren Buffett’s criteria for assessing the Team: Intelligence, Integrity and Energy. You want someone who is really smart, very hard working and trustworthy. A lot of people forget the integrity part, because if you don’t have that, then you have a really hard working crook and they will find a way to cheat you.”

Ravikant then went on to talk about how the criteria for Team was the deciding factor on funding Heyzap, a leading social games platform.

“First and foremost, in a team, they have to be really good people. When I invested in Heyzap I knew the CEO Immad Akhund from his previous company Clickpass and I liked and trusted him personally. I had never met his new co-founder, Jude Gomila . He and I had a 20 minute IM conversation and I thought to myself this guy has such an amazing energy, and I decided to invest in them there and then. They both have such great energy, integrity and intelligence. I just wanted to be involved with whatever they were doing.”

He then returned to the other criteria of Market:

“The Market has to be huge because everyone makes mistakes. You never quite get it right the first time. I believe that the Internet is very efficiently arbitraged. Anything you can think of has been thought of and tried. The only way you’re going to find something is if you stick to it, at an irrational level and try a whole bunch of things. Companies that don’t do giant pivots are always doing micro pivots. “You need a large enough market that you can pivot in and you still have a customer base. Another related point to that is – it’s just as hard to build a large company as it is a small company, so you might as well build a big company. It’s roughly the same effort.”

Ravikant then went on to tell me that there were three different facets when he considered unfair advantage: Distribution, Monetization and Technology. He then described those areas in more detail:

“Firstly the unfair advantage could be a propriety distribution channel. Maybe you have found a way to market the idea in a manner other people have not exploited. Last year it may have been the iPhone and the year before it may have been Facebook and the year before that it may have been email/viral marketing.

“Secondly if you have direct monetization, you’re the last person in contact with a customer and they are willing to pay you. Which means you won’t need to get to as a massive volume as some of your competitors do, because you can make money from the start.

“The third would be deep deep technology – you’re doing something that is really hard so that you’re going to have less competitors and even if you don’t have a large customer base you’re still a great value to an acquirer.

“So I always look for the team, market and unfair advantage, and on advantage, two out of three is a pretty good sign.”

Ravikant has made a number of high profile investments. I wanted an interesting investment story. He decided to tell me about his early investment with Twitter. But before he began the story he told me that “making an investment is like throwing darts in the dark. All of the companies I have invested in seemed like a great idea at the time, even the ones that didn’t turn out so great.”

I feel he wants to make a point about the process of making many investments to reach that one great investment:

“It is an extremely hit driven business, there is a power law distribution to the outcomes. Anybody that tells you that they know anything with absolute certainty is exaggerating or deceiving themselves.”

It was at this stage that I realized just how down to earth Ravikant is. With companies in his portfolio such as Twitter, Foursquare, Heyzap, Jambool, Disqus, Uber and Plancast, to name but a few, it’s hard to not know why he isn’t arrogant and proud. He said he is only in the top 20 or so angel investors in the Valley, when I would consider him to be in the top 10 and top 20 in the World, nothing to be coy about. But that’s what’s refreshing about Ravikant, everything about him shouts approachable, especially his Twitter story:

“I heard the buzz in the Valley. I knew Evan Williams in passing and I didn’t know him personally at the time, only by reputation. A friend, Kulveer Taggar, had been using it obsessively and he kept talking to me about it incessantly. So then, I tried it out and thought it was pretty cool.

“More importantly it was an extension of a problem that Evan Williams had been working on forever with Blogger, and Twitter was the next evolution of blogging and communicating with people. So I tracked him down and convinced him to let me invest. Some of my advisers told me that they thought I was crazy. I actually ended up investing a lot less than they allocated me in the round, something I am going to kick myself for, for a long time. People thought that I was crazy and that it [Twitter] was going nowhere, and that the valuation was too high, etc. etc.

“There were a lot of people that were exposed early on that didn’t invest or invested a lot smaller amount then they could have. Nevertheless it was a hot round, and my favorite part of that was that I had to get in there and sell myself.

“At the time I had been doing some Facebook viral marketing stuff with some success, and I laid out to Evan and his colleague how viral marketing at the time worked. How you do viral coefficients and optimization and email people. And I sort of went through this whole theory and laid it out for them on a white board. They looked at it and Evan sort of nodded his head. Then he basically said that what I was talking about was interesting, but that he wouldn’t be doing it with Twitter.

“I give him absolute full credit for that. Because here it is 4 years later doing phenomenally well. I sort of stopped using Facebook because I have 1200 FB friends, and there are 50 real friends in there and I don’t know anyone else. My news feed is covered with junk.

“But I still use Twitter because it’s a very carefully curated list for me. I only follow people that I genuinely listen to and care about so it still is very high value for me. Thinking back, Twitter never “went viral” on me. Twitter never pressured me to signup, never spammed my account, never forced me to follow people, never made me add lots of friends. So I trust them for a highly curated experience.

“Evan had enough vision and enough certainty and understanding of his market and product, that he basically did not take the easy way out. He could have grown Twitter a lot faster, but he knew doing so would have ended up having a lot less authentic community and I give him absolute credit for that.”

We then went to talk about the Twitter acquisition rumors. Ravikant said he wasn’t privy to much information and that he didn’t believe them to be true.

“I don’t know anything about it. I am a small investor from the first round and the last thing I helped them with was getting the t.co URL shortner. I don’t really talk much with the founding team unless it’s very important. I helped get them t.co URL and that was my last action for them. I would be surprised if it happened. I don’t think the founders want to sell and I don’t think they are going to sell. I think they will build a very large standalone product. Twitter has a realtime network affect that is going to be really hard to replicate and will be very valuable. It is sort of the messaging queue infrastructure for the web, in the sense that FB is becoming the identity graph for the web. So I don’t think they want to sell.”

I personally believe it would be very bad for the internet if Facebook acquired Twitter, as the rumors were saying. It would lead to a monopoly and Facebook would be too powerful. There needs to be a competitor, for the consumer to benefit. Ravikant told me there were many buyers but he would be surprised if Twitter did sell to anyone. He went on to add:

“I have now learned to recognize entrepreneurs like Evan. It’s the same way that I feel about AngelList. It’s a project you just have to do and it’s within you. So if Evan goes and sells Twitter he would just turn around and start another one, the next generation.”

He isn’t that active in Twitter because it’s in a later stage. But I wanted to know how much he gets involved in his active investments. He told me:

“There are cases like SnapLogic where I am a large investor and I am on the board with Ben Horowitz and Gaurav Dhillon. I go to the board meetings and stay involved and engaged. There are some companies where I just have 10k-25k invested, a small amount, so I am just on demand. If they need me for something, they can call me or stop by the office. I don’t want to check in on a regular basis nor do I have any scheduled meetings with them. The truth is most companies don’t need their investors most of the time. It’s just once in a while they need you, and when they do, you have to drop everything and respond and when they don’t, they don’t.”

The drop everything attitude to help your company must be reassuring for the companies Ravikant is involved with. I wanted to know what other attributes founders should look for in investors. He gave a really interesting response:

“There are the obvious ones. You want someone that is very smart, you want people you get along with. I think one very important one is humility. That one is often forgotten. Investors are on the buy side and entrepreneurs are on the sell side, so as an investor, what you are doing all day long is thumbs up or thumbs down. Almost like you are a Roman Emperor or something that sordid and the Gladiators are in the ring. And that corrupts you over time because that is power and power corrupts. Over time you end up with this mentality where you think you are always right. And as an investor you really have to fight that.

“You have to remember that the entrepreneurs are the one in the trenches and they are the ones with all the data. Often they are smarter than you and they are focused down. So your job is to bring them data from the rest of the world. To give them patterns you have seen but not to pretend that you are any smarter than them.

“So I think humility is a very important trait in an investors. Especially the more money you take from someone [investor] the more control you give them [investor] over the company. The more important it is that the investors realize their limitations and that they are in a service business to you. Rather than thinking that they are your bosses or your managers. Because, I think a lot of investors fall in to the trap where they think they know better than the entrepreneur and they are going to tell the entrepreneur how to do it. It’s actually one of the reasons I stopped taking board seats. I only have 3 board seats, one from a company I started and two from large investments I have made. But I stopped taking board seats, because I just hate watching the board member and entrepreneur dynamic. Where the board member walks in, throws forward an idea he just had. The entrepreneur who often understands the market better is forced to listen and nod and be polite and go and follow up on it because of the power dynamic. But the reality is people are just showing off and exercising power. I don’t like it.”

He followed this with a really good analogy about the importance of a good relationship between investors and founders:

“If you have to spend a lot of time preparing for your board meetings, and you fear your board investors than it’s a really bad dynamic. Creating a company is a creative process. It’s like being an artist – you are creating a company. If someone is coming along and saying you should use a little more red paint over there, it’s going to ruin your creativity and your frame of mind.

“A great example is in the movie Amadeus. There is a great part, where Motzart has composed an opera for the emperor. And it is a fantastic opera, and afterward the emperor walks up and says, oh it was very nice, but “there are simply too many notes.” Sometimes I feel that is what investors are doing in board meetings. They are looking at the entrepreneur and saying “too many notes.” It is important to find an investor that treats you as a peer and is humble and is not going to tell you that your symphony has too many notes.”

This attribute is very common with some of the more well known investors like Ron Conway and Albert Wenger. Ravikant went onto add that this was a way that some investors branded themselves. “Other investors have a different brand. Where they basically say, “we roll up our sleeves and build big companies.”  He was “more skeptical of that group” of investors.

I then asked him as an investor, what number of investments would he say that an individual investor could manage. He answered:

“It depends on your level of involvement, if it’s 250k-500k and you are taking board seats or you are investing millions and taking board seats; you can’t do more than 5-10 startups like those. If you are investing smaller amounts and are available on demand you can probably handle 12-24, depending on how much of your time you allocate to angel investing. There are definitely people who handle hundreds. Dave McClure, Ron Conway are examples. But those people have staff, they have processes. In Dave’s case he has an incubator. So at that point you have to institutionalize it. And of course YCombinator is a great example of an investor that handles an enormous amount of companies. However I would say for an average angel investor, its not worth being in the angel investing business, unless you are going to invest in 12-24 startups on the web side. Because so few of them actually hit, and the ones that hit usually return the money for the ones that don’t. But so few of them actually hit, that the odds of you actually finding one of those in your portfolio, unless you are in at least 12-24 is quite low.”

If the odds are so low, did Ravikant have any suggestions as to what are hot startup spaces right now for investing?

“There is a human tendency to extrapolate from previous experience to future experience. So, I don’t think I am going to come up with anything incredibly out of the box. But the trend I find most interesting and I still feel like it’s an early trend, is the use of smartphones as sensors in the physical world. What I mean by that is the number of people that use desktop / laptop computers in the world actively might be 500M. But billions of people use phones, and all of those phones will be smartphones. So imagine you are going to have 10 times as many people using phones. And we use our phones all the time, in restaurants, while driving. We use them in crazy places we shouldn’t be using them, but we use them constantly. So the usage of the smartphone globally will probably be 50x or 100x the usage of laptops/desktops. So, given that, phones are where the action is. Mobile is where the action is. And what is incredible with the iPhone or Android is the number of sensors built into these things. Accelerometers, Gyroscopes, Wifi networks, Bluetooth, GPS, Brightness sensors, Proximity sensors… They are adding more, Near Field Communication, RFID, etc. etc.

“What is really interesting is startups that use the smartphone as a sensor to bring computing to places it was not possible before. Yesterday while coming back from LA, at the airport, there was a guy flying an AR Drone, which is a small, stable helicopter. But he is doing it with an iPad. And on the iPad screen there is a streaming video from the camera on the AR Drone. As he rotates the iPad it controls the Drone. And it’s just zipping through LAX. It’s like an Unmanned Aerial Vehicle, connected to an iPad.

“Another great company that I saw was using an iPhone with a pick attached to it with a gyroscope inside to play an air guitar, so you can sound like Guns and Roses. And as you get better, the assist on it goes down and if you get worse it assists you more. So it makes learning the guitar an enjoyable experience. There are of course lots of people doing mobile based services. Everything from flirting to mobile coupons, to friends tracking other friends, to finding lost and stolen devices and so on. There are even diabetes monitors. The idea is using phones as sensors to bring computing to the real world and extending them further and further with hardware addons. I think it’s a really interesting space and we are going to see a lot more than that.”

I then went on to ask him to tell me about any recent hot personal investments he has made. He answered laughingly that his fund was all but spent and he was not able to talk about some of the ones he has funded because they are still in stealth. He however did talk about a company from New York that has found recent funding through AngelList that he is excited about:

“However a company that I can talk about that has announced publicly, is called MileWise. A great group of guys that came out of Hunch, it’s a frequent flyer mile search engine. They haven’t fully launched and are in stealth so I can’t tell you much. They found their financing through AngelList.”

Which raised the question, do startups outside of Silicon Valley get funded by investors based in the Valley as frequently as startups here. Ravikant said that if you were to ask the investors they would say no, however if you looked at their investment portfolio it would be yes. He then went on to explain further:

“They do it all the time, especially for startups that are in New York, and to a lesser extent in Seattle, LA, Chicago, and Austin. What happens is that investors in those other cities have no choice but to invest in Silicon Valley startups. That leads the remote investors to build a good relationship with investors here. Then when the remote investors invest in a company in their home towns, that indicates to Silicon Valley investors that they should get in on the deal. It’s social proof again.”

Ravikant then went on to tell me in an excited tone about the New York market and its explosion in both funding and creating startups.

“The market there has exploded in the last year. I would say it has gone from one-tenth the size of Silicon Valley’s early stage investment market to being one-third. If you were to extrapolate linearly the current trend line, which is always a mistake, a year or two from now it will be hard for me to say that you would have any real advantage moving here from New York. Today there is still an edge to Silicon Valley for sure.”

A strong statement if ever I heard one. I am sure the startups in New York will be happy to hear that. This naturally lead to the question, what was it about New York that enables it to beat all the other locations vying to be the next Silicon Valley across the globe? Ravikant went on to explain:

“New York has other rich industries, like fashion, advertising and finance. What’s happened is that as the web and smartphones have expanded out more and more into the reaches of life you’re seeing more fashion, design and advertising startups and those naturally belong in New York. They actually have an advantage not being in Silicon Valley. The pre-existing industries is part of it. Another part of it is the US climate, is just more business friendly then the European climate. I think the Europeans are going to have a harder time of it although it’s happening and is absolutely possible. One of the secrets of global seed investing is, I can tell you right now because of AngelList, where the high quality companies tend to reside. In Europe the majority of them are London or Estonia.”

London I could guess, Estonia I could not. I asked why Estonia and Ravikant said:

“If I see a company coming out of Estonia I am reasonably assured that it will be executed well. This was a surprise to me and I only discovered it through AngelList. That is because there is a lot of Skype alumini in Estonia and the surrounding countries, like Lithuania and Latvia. For their size, these countries are generating more high quality startups then you would expect. There are hot spots forming around the world. Before it would have been hard for these hot spots to get a critical mass of entrepreneur talent and investors. But now because of the web, transparency and open communications and a few big companies being built outside of the USA, it’s starting to happen.

“New York has definitely hit a certain critical mass. There has also been a shift in the startup culture there. Before it was very “who you know,” but networking is a waste of time when you’re a startup – it’s best to focus on execution. [In NY,] startups are focusing more on execution. You don’t get as many banker heavy teams anymore. Two years ago you would see a startup with three bankers and one developer in the back somewhere, that’s flipped on its head now. Last thing about New York – people want to live there.”

I couldn’t argue with that, it may be colder in New York but it also takes half the time to fly to the U.K, and airfare is less expensive. If New York comes up to par with Silicon Valley, I might just move there. On the topic of things out of the ordinary, I asked whether Ravikant thought we were in a Bubble:

“We might be in a series of micro-bubbles, seed round prices being driven higher by VCs competing with angels for good seed deals. I don’t think we’re in a macro bubble.The total amount of money in the market or at risk is still very small. I wrote a piece on it a while back”

Paul Graham last week wrote a post on Hacker News also agreeing that we were not in a Bubble. Which lead to the question of Y Combinator and Start Fund. I wanted to know his thoughts on it. He had a very powerful view on Start Fund:

“I think it’s going to be quite disruptive. The people that are saying it’s not going to make a difference or it’s just a one time or a one off thing or it doesn’t signal anything are sort of more hoping than acknowledging reality. If you think about it, VC was a bundling of advice, control and money. The rise of angel investing was really about people investing smaller amounts in these companies, so that the control went away and now people are getting bundles of advice and money.

“What YC [Y Combinator] has done is come along and say, “we are going to give you the best advice.” So DST has stepped in and said, “if these guys are giving you the best advice and providing the best filter function, then we are going to give you the money.” So the Venture Capital industry itself is being unbundled, it’s being modularized and I think that is what we are watching in action. So people who are extremely high value-add, and of that set, YC is definitely among the top of the ranks, have nothing to worry about, they are beneficiaries because people will come to them and give them equity, essentially for their advice. And it’s fine for the people that have huge amount of money like the DSTs of the world.

“There are other funds like that out there, and they are more than comfortable competing on price. But anyone who is competing on a blend of advice and money and maybe packaging in control, like the traditional Sand Hill Road VC industry – they should be very afraid. Because, if this is the beginning of a larger trend, where billions of dollars are flowing from outside and follow sort of the best advisors, then a lot of the current venture industry needs to be restructured. The current branding model doesn’t work.

“This is just the beginning. Yuri is coming in with the Start Fund, and saying here is a 150k per startup. But what if the next one comes in and says we are going to fund every startup with $2m at 6m pre. And just laying out some standard terms.”

Shocked I asked, do you think anyone else will do the same thing as Yuri? Ravikant answered:

“I think it’s entirely possible. I am not one of the big money players. So, I am waiting for the shoe to drop. You know the flip side of it is that the Venture Industry on the whole tends to have a negative return. So you can’t go in there willy-nilly spraying capital because you lose it on average – you really have to get in the top tier deals. Which means you have to define a top tier filter function. That’s what the super angels were really – super angels were angels that went out there and invested their own money, proved that they were a good filter, and then investors gave them more money to invest. So similarly, YC has gone out and proved that it has a great filter function and starts great companies. So, someone is coming along and saying we will give you more money to invest. Except we are going to do it at incredibly favorable terms to startups, so that none of them refuse and there is no adverse selection issue. As long as each YC class finds or creates another AirBnB or Dailybooth or Heroku, then they [Start Fund] will be fine, it will more than get paid back.”

Ravikant invested in four Y Combinator companies in the last batch and one in the current [so far]. Surely if he is going to get into more deals he will have to raise a new fund. He told me he didn’t have any immediate plans to raise:

“Even if I did intend to, I couldn’t talk about it – it’s a violation of SEC rules. I may get around to it at some point. It’s not imminent.

“One of the problems with having a fund is that if people think I am investing they are always asking me for money, and I would rather just point them to other people that are a good match for them. I don’t like saying no and it’s just easier to go and say, I am not investing but here are some awesome people. That being said I am investing small amounts but generally intend to invest in people I have known for a little while and spaces I am genuinely interested in. And there are not that many of those.”

I then went on to ask him what are the most interesting lessons he had learned as an investor. He replied:

“I have learned a lot. One would be, don’t go in to a deal alone. Because especially in angel deals, the entrepreneur has a lot of power. And they can even mistreat you at the exit, unless there are other investors on the table who can bring some social pressure to bear. The second is, most companies die not because they miss their market, which is a common reason, or because the founders fight which is also a common reason, but very simply because they failed to raise the next round. So you have to factor in what is the ability of this startup to raise another round in the future?

“Another good one is, price matters. It allows you to place more bets. But of course for the occasional company that comes along that is great, you just have to ignore the price, and hold your nose and invest.

“The most important one I have learned so far. And this is the reason that invest less than I used to, is that you should only invest in founders that you genuinely like in spaces that you have a personal interest in. Because if you don’t – if you invest just because you think its going to make you a good return – then you aren’t going to care enough about the company and you aren’t going to put enough attention in to it. You aren’t going to put your spare time in to it. And then when the company inevitably, fails to live up to expectations, you will be disappointed. Rather, you should be in it not for the outcome but for the journey. It’s very Buddhist, like they say, “There is no way to happiness, Happiness is the way.” In that sense, with startups there is no way to a great outcome, the experience itself is what matters. You want to work with founders that you enjoy talking to and you are interested in the problem they are working on. You don’t view it as time poorly spent, and you don’t view it as a cost to yourself.”

A very positive note to end our interview on; enjoy the journey. Ravikant will undoubtedly help many other startups through their journey and continue to disrupt the funding ecosystem with AngelList.