One could probably argue that sluice gate, the Bay Area-based startup company, is above its weight. The 15-year-old company has only about $500 million in assets under management — including a $150 million fund it quietly closed in January — and it makes only a handful of new investments each year. But with investments in Okta, Lyft and Starkware, which were valued at $8 billion in May, among others, the concentrated approach seems to be paying off.
Writing so few checks, especially in a booming market, can be frustrating for some investors. But over the years it has forced Floodgate’s small team to sift through many thousands of pitches and identify the pitches that he believes have the most potential. Now co-founders Ann Miura-Ko and Tyler Whittle, a senior employee at the company, have developed a new program to help student teams similarly understand what big ideas look like — and why most concepts aren’t big ideas.
To get more details about the program — as well as to hear Miura-Ko’s current perspective on the startup scene in the launch phase — we spoke with her earlier this week. Our chat has been adjusted in length.
TC: This summer you invited a lot of students to work on startup ideas with you here in the Bay Area. Are you incubating companies together? How did it all go?
AM: We went to a builder’s community that we had built the year before, and to [Stanford’s] technical school [where I teach], and to the CS department of some universities and said, ‘Hey, if you’re interested in becoming a future founder, and you’re a great builder, we’d love to talk to you.’ The main message there was: ‘We don’t need you to really have an idea of what you’re working on. We just want you to be a great builder with an incredible amount of curiosity.” Partially, [that’s because] you have to be able to build fast and actually throw product away [sometimes] but you should also be curious about the history of the industry you work in. . .
The goal is to help them identify big ideas. What is your definition of a great idea and how do you know when you see it?
I’ve come to realize that there are two types of businesses that can really get big. One is, you have an idea, and most people actually understand this idea already, but you’re just operationally better, and so you execute everyone else. What I realized is that as a seed investor, we don’t really have an advantage investing in those companies because we don’t see enough of the operations to know who’s the best at running that kind of startup. So when founders hear, “[You] need a little more grip before we make a decision’, that’s most likely because you’re running a business that’s more operationally oriented, rather than the second type, which I think is insights-oriented.
An insight-led business is basically about identifying what we call an inflection point, which contains a few components. First, there is some kind of change event that has taken place. It could be technical – CRISPR was invented – or a regulatory change like telemedicine is allowed across state lines, or it could be societal. The most common thing people are referring to right now is just working from home.
The change event enables a new feature, or it makes it possible to build a product cheaper or faster, or you can also have a completely different business model that is enabled. [For example] you license it instead of having to pay for it monthly, or vice versa. Or the business ecosystem changes fundamentally.
If that happens, if you can tie it [that inflection point and change event to]’This will therefore create a fundamental attraction and acceptance of my product in the next two to three years’, now you have the insight that seed investors [funding]. [And] that’s the kind of thing we’re really looking for for our students to really find out.
Do you finance these students?
Yes. We write $50,000 checks in all the companies, and then some of them at the end will just say, ‘We’re not going to do this anymore’ and in that case they close the shop. [But] we had two companies that are [going concerns] with an investment from us, and then one that may involve additional investment and one that [already] made an external investment. And so we have four out of ten companies that continue to operate.
How much of a stake do you buy for that $50,000?
We’re still reviewing that for next year, so I don’t want to pin down what we’re going to do. But it is a SAFE note. And then for the follow-up funding, it varies in terms of what the person needs and also [it’s tied to] when we invest in that company, so it varies in valuation as well.
Four out of ten is a pretty good hit rate. Were these students mostly from Stanford?
What’s really great about it is that we had Stanford students, but we had students from the University of Texas, with other students from Yale and Penn and the University of Texas, so it actually included several different universities. . . and we are very excited to try to expand to as many universities as possible. One interesting piece we learned is that Stanford students are just really well educated when it comes to startups. The great thing about having Stanford students in this network was that our Stanford students pulled the other students into the networks that the Stanford students are so lucky to have.
I remember speaking to a 19-year-old Stanford student, probably 10 years ago now, who said he felt pressured to become a founder because of the culture at the school. Is that up to you?
Yes. That’s why I designed it very consciously so that you have a way out. I think it’s so important to recognize that not everyone is supposed to be a founder. And in the relationships that I have with my students, I will actually say to certain students that I know very well, ‘You have these incredible skills that are so unique and not in many people that you should go to a big company. ; you have so much impact there.’ I will actually advise students directly not to become founders [because] it’s such a specific desire or [requires] such a specific skill at a specific time that from my own personal perspective it shouldn’t be for everyone.
I agree with you. I think to some extent there is a lot of pressure for people who are technical [and] for people who have good ideas to go in that direction. But I hope that by giving them this kind of exposure, they can find out if there is a founder in it.
Out of curiosity, does Floodgate use scouts?
We do not have a Scouting program. I think our network of friends, family and founders are technically our scouts. But we don’t have a financial program like many people. I have such a network of “unpartners” that I meet regularly – these are angel investors and small fund investors – and what we do is we literally share three or four interesting companies that we’ve looked at in the last two weeks. And then we share with each other how we would strive for it. And if the other people are interested in looking at the company, we invite them.
Somewhat related, Y Combinator has just concluded its last day of demo. Do you follow YC closely as a seed investor? What do you think of the organization as it exists today?
I think they provide a great service to founders, and I think people want to get that exposure [it]. I have a lot of respect for the product they offer, the community they offer, and the way it makes fundraising possible.
For me, it’s just a harder platform to deal with. If I only make two to five investments a year and am asked to submit a check with a revolving SAFE note that, if I sign tonight, you know, it’s one rating and if I sign tomorrow, it’s at a other is, and [the founders] don’t even really know me, but they are willing to sign with me – something like that doesn’t feel quite right. So the ones I’ve interacted with are actually founders I knew before joining YC.
But I do understand why founders love it and I think there’s a tremendous amount of work they’ve put into the product and I wouldn’t count YC. I know every year some people say the classes are too big and everything is too watered down and too expensive. But you know there will be one or two runaway hits in every group.