The Secret Weapon Behind this $28B Fund

During times like these, you’re going to see some hyped-up companies. Valuations won’t make sense, crazy (silly?) ideas will get funded, you get the picture. I want you to have the tools and strategies to see through hollow startup pitches. Today I’m going to share a story about one of the most successful investment funds in history and a little strategy they used to build a $28B investment empire. The exciting part? You can use this tactic too.

In 2021, the amount of venture funding in the US increased 106% to $311B.

That type of money makes people crazy (like Mike Tyson when he bought a tiger 🐯)

CB Insights: US Venture Funding

During times like these, you’re going to see some hyped-up companies. Valuations won’t make sense, crazy (silly?) ideas will get funded, you get the picture. 

I want you to have the tools and strategies to see through hollow startup pitches.  

Today I’m going to share a story about one of the most successful investment funds in history and a little strategy they used to build a $28B investment empire. 

The exciting part?  

You can use this tactic too. 

Let’s dig in! 

Today we’ll explore: 

  1. The “Secret Weapon” that Built a $28B Fund: The Story of A16z
  2. The Valuation vs Traction Matrix: The signals to look for in startups

The “Secret Weapon” 

Some of the greatest business minds found successful companies, others make millions knowing how to identify them. Marc Andreessen and Ben Horowitz did both. 

  • The duo started working together in 1995 when Horowitz joined Andreessen at Netscape 🤝 
  • They founded Loudcloud in 1999 💡 and took it public in 2001 🚀
  • In 2002 Loudcloud was transformed into Opsware and then sold to Hewlett-Packard in 2007 for $1.6B in cash 💰
  • Two years after the exit, the long term business partners founded a16z and made it one of the highest-returning VC funds in the world 💸

Their fame as two of the most influential VCs overshadows their past as angel investors. Between 2005-2009, Andreessen and Horowitz separately invested a total of $80M in 45 startups. 

As of today, Marc Andreessen leads the list of Top 50 Angel Investors in the US with 73% exit rate and a total of 37 investments. In 2009, Andreessen was among the earliest investors in still fairly young Linkedin (2002),  Skype (2003), Facebook (2004), Twitter (2005), Groupon (2008) and Airbnb (2008). 

The “Secret Weapon”: Writing smaller checks at a startup’s earliest stages allowed Andreessen to diversify his portfolio, lower the risks and skyrocket the returns. This strategy later became his “secret weapon”: leveraging his personal money to gain insights into promising companies before any fund would get involved.

To recap:

  1. Invest a small amount into a portfolio of companies at the earliest stage
  2. Use this access to gain early insights (Track revenue growth, etc.)
  3. Triple down on your winners

Angel Investing Strategy: 

When it comes to the evaluation of early-stage investments, VCs like a16z with billions ($28.2 to be exact) in funds prioritize the idea, team, market opportunity and business model over valuation. Angel investors with much smaller checks can’t afford this. The strategy is to use valuation to help size your investments according to the expected ROI and diversify your portfolio. 

Entrepreneur and investor Jason Calacanis with over 350 investments and 10% exits has come up with The Valuation & Traction Matrix for easy estimates.

Valuation vs Traction matrix - Jacon Calacanis

The chart consists of two variables: traction and valuation.  

The green line represents an average startup in its 3 phases: 

  • When there is just the idea and mockup, the value ranges around $1M-$2M and the funding usually comes from friends and family
  • MVP or unpaid pilots range between $2-5M in value and attract angels and seed round investors
  • Paid pilots and revenue bring in syndicate investors and catch the eye of VCs

Those in the upper left quarter tend to have less real value while the startups in the lower right quarter have more. 

To get above the green line, startups normally have either of these: 

  1. Founder(s) with a successful track record 
  2. Artificially fueled demo day FOMO by accelerators like YCombinator and Techstars 
  3. “Otherworldly” product or engagement
  4. Dumb money injected by those that fail to see the opportunity to invest in several startups with the same traction and lower prices

This 4th scenario is the most common mistake among Angel Investors and this is what I’m trying to make you avoid doing. 

Let’s take an example and play around with numbers. 

Andreas is an Angel Investor with $100,000 ready to invest. 

He’s approached by Pete, the founder of early-stage Startup #1 with an overpriced valuation of $20M. Pete, with a successful exit track record, tries convincing Andreas that the high value comes from the greatness of the product and things will be wonderful once the startup becomes a Unicorn. This could be true but it assumes there are no other similarly good deals for Andreas, which we know is not true. 

While Andreas is contemplating putting all his 100,000 eggs in one basket, Jane, the founder of Startup #2 with a $2M valuation and equally promising opportunity, approaches him. 

Andreas also learns about Startup #3 valued at $5M and Startup #4 at $3M valuation with equally innovative solutions, large market opportunities and competent founders. 

The risk of overpricing the startup and raising big money at the early stage usually results in failure to reach the set milestones and raising too little in the follow-up rounds. For example, Pete, who raised $1M at $20M valuation, will have  less than 12 months (startups raise every 12 months or so) to make the company worth $20M if burning $75k a month to reach $100-200k monthly revenue. And if Startup #1 fails to do this (which has high probability), Pete will have to either: 

  • Lower the company value for a round down ⬇️
  • Or raise a bridge round from existing investors 🆘
  • Or shut down/sell the company at a lower price ❌

Either of these would harm Andreas’ earnings had he invested the $100k in Startup #1 alone. 

You probably see where this is going now. Andreas choosing to divide his $100,000 into four $25,000 checks increases his chances of higher returns. On average, out of every 10 investments, angels experience 5 business failures and an additional 3-4  exits that bring only a modest return. Fewer than 2/10 investments provide most of the portfolio returns, with a 10-30X ROI.

To avoid learning the hard way, it's important for you to have a strategy before writing your first check. Start with understanding:

  • The risks of angel investing 
  • Your total investment size and the size of each deal
  • Deal returns and the need to diversify 

For new investors, Calacanis suggests to do their first 25 deals in the 🟢  box area below to eliminate the founders who can’t get to basic level of product/market fit. Avoid investing in 🔴  box. Investing in the 🟡  box is for those that like a little bit of adrenaline rush. 

It's important to point out that the valuations listed above have likely increased since Jason created this chart - the market for startup investing is red hot - everyone is getting involved, and startup valuations have increased as a result of that. 

Make sure you get a sense of where approximate valuation bands (e.g Pre-Seed, Seed, A) stand today so you can be more effective in your approach. 

Hope this was helpful. See you next week! ✌️