20VC Why Market Is More Important Than Team, The 4 Key Roles of A Board Member & Why Founders Get Market Sizing So Wrong with Rory O'Driscoll, Founding Partner @ Scale Venture Partners

In this episode of "20 minutes vc," host Harry Stebbings interviews Rory O'Driscoll, a founding member and partner at Scale Venture Partners, known for his focus on early-revenue software companies and recognized by Forbes Midas List for his investment acumen. O'Driscoll shares insights on the impact of valuations on investment decisions, emphasizing a preference for operational risk over valuation risk, and the importance of market conviction over management in determining investment outcomes. He also discusses the role of a board member, highlighting the critical tasks of hiring/firing CEOs, financing companies, setting broad strategic direction, and determining exit timing. O'Driscoll's recent investment in DroneDeploy, a software company leveraging commercial drones for enterprise advantage, illustrates his investment philosophy, combining a promising new market with a familiar SaaS business model.

• Harry Stebbings hosts the 20 minutes VC podcast, available on Snapchat and a blog named mojitovc.com.
• Harry expresses pride in the current episode and introduces Rory O'Driscoll, a founding member and partner at Scale Venture Partners.
• Rory is recognized for his investments and has been acknowledged by Forbes and other entities.
• Harry also promotes Xero, online accounting software for small businesses, and Headspace, a meditation app.

"Hello and welcome back to the 20 minutes vc with your host Harry Stebbings on Snapchat at H Stebbings, and on the amazingly named new blog mojitovc.com."

This quote introduces the host and the platforms where the podcast and blog can be found.

"So time to meet the man himself, Rory O'Driscoll, founding member and partner at Scale venture Partners."

Harry introduces the guest, Rory O'Driscoll, highlighting his credentials and achievements.

• Rory is Irish and has lived in England for eight years, where he had his own business.
• Rory moved to the U.S. in 1991 during a recession and started working in a graveyard doing bookkeeping.
• He joined the venture capital group at Bank of America in 1993 and has been in venture capital since.

"I'm irish, as I'm sure you can tell as a Brit, though sometimes over here people get confused."

Rory shares his nationality and acknowledges the potential for confusion in the U.S.

"I actually emigrated to the States literally with nothing because I had no money."

Rory describes his move to the U.S., emphasizing his financial situation at the time.

"I literally worked in a graveyard. Not I always had people digging the graves, but actually doing the books for a cemetery in LA."

Rory recounts his first job in America, providing context for his early experiences in the U.S.

• Rory explains that venture capital is not a replicable model and his path to venture capital is unique.
• The conversation is going to be broken into three sectors: macro, scale, and Rory as an investor and board member.

"So not quite a replicable model in terms of how to get into venture capital, as I always explain to people."

Rory acknowledges that his path to venture capital is not a common or easily replicable one.

• Rory and Scale Venture Partners focus on early revenue software companies transitioning to SaaS and cloud computing.
• They invest primarily in mid-stage companies with a couple of million dollars in run-rate revenue and early customers.
• Rory discusses the challenges of valuation increases, particularly in the late-stage business, and how they focus on mid-stage investments to find value.
• The firm does not wait for valuation environments to change but rather takes on more operational risk in exchange for less valuation risk.

"Yeah, I mean, to state the banal, you don't like them, right? You try and find sectors where you avoid them."

Rory comments on the dislike for valuation increases and the strategy to find sectors where these can be avoided.

"What we see, I suppose, fundamentally, what we've done over the last five years to avoid valuation risk is we've done few, if any, late stage deals and we've really focused down on the mid stage because that's where we still can find some reasonable amount of value."

Rory explains the firm's approach to mitigating valuation risk by focusing on mid-stage deals.

• Scale Venture Partners aims for one to two deals per partner per year, limited by the number of board commitments a partner can take on.
• Limited Partners (LPs) generally do not pressure General Partners (GPs) to make investments, understanding that it can lead to losses.
• LPs are more concerned about valuation, given their ten-year blind pool commitment with little control after investing.
• Valuation is important but not as critical as in leveraged buyout (LBO) or public markets due to the nature of venture capital investments, which involve more variables.

"We aim to do one to two deals per partner per year, so there's not much difference."

Rory outlines the typical investment cadence for partners at Scale Venture Partners.

"No. I mean, I think most lps understand that pressuring their gps to make investments when they don't want to is a very good way to lose a lot of money."

Rory addresses the notion of LP pressure on investments, emphasizing that LPs typically do not exert such pressure.## Venture Capital Investment Factors

• The growth rate of a startup is a critical unknown factor, with a high growth rate being amazing and a low growth rate being disastrous.
• Potential competition in the future is another significant unknown to consider.
• The size of the market and the investor's conviction in that market are paramount.
• Valuation is important, but it is weighed against the investor's conviction in growth and market size.
• Historical example: Google's investment in 1999 was done at an absurd valuation but succeeded due to market size, leadership, and company traction.

"The reality is the big unknowns in a venture capital company, in a venture startup that's doing a million or $2 million in run rate revenue, is the growth rate. Is it 210 20 or 2461? Is amazing. One is a disaster. It's the potential competition two years out. And it's more than anything else, it's the size and conviction you have in the market."

This quote emphasizes the importance of growth rate, potential future competition, and the investor's belief in the market size as key factors in venture capital investment decisions.

• Entrepreneurs often overestimate market size in their pitch decks.
• Investors use bottoms-up analysis and comparative estimates to determine market size.
• Historical example: eBay and Amazon started in niche markets and expanded significantly.
• Market size can be underestimated when a product finds new use cases and widens its applicability.

"Someone comes in and says, it's a software market, that's a $20 billion market size software company. And then you say to yourself, well, Windows, the operating system, is a 15 or $20 billion year business. Are you likely to be bigger than Windows? Maybe not."

Rory O'Driscoll points out the common mistake of entrepreneurs overestimating market size and compares it to established giants like Windows to provide perspective on realistic market potential.

• Founders are expected to claim billion-dollar markets to attract investment.
• Investors must discern realistic market sizes and potential for growth.
• Founders should articulate a clear path from dominating a smaller initial market to expanding into a larger one.

"If someone says to me it's a $30 million market right now, expanding at 100%, I'm intrigued. If someone says to me it's always going to be a $30 million marketplace, I got to turn it down."

Rory O'Driscoll explains that a market with high growth potential is intriguing, regardless of its current size, while a stagnant market is not appealing for investment.

• Conviction in market trends and the potential for disruptive change is the primary investing stance.
• Management determines the ranking within the potential market outcome.
• Markets determine the size of the prize, while management determines the investor's share of that prize.

"The number one thing for us is, do we have conviction that the trends are going to drive disruptive change in that market that will allow a new company to be built? Markets make outcomes."

Rory O'Driscoll highlights the importance of believing in market trends and the potential for disruptive change as the primary criterion for investment, underscoring the role of market dynamics in creating successful outcomes.## Importance of Management and Focus in Business Success

• Management quality and focus are crucial in determining a company's success.
• Google's success attributed to its management and clear focus on search.
• Yahoo's example of losing market due to lack of focus and changing CEOs.
• Market opportunities can be significant, as seen with search being a $200 billion opportunity.
• Execution by management teams, along with luck and timing, can decide the outcome in large market opportunities.

"But some part of it was management and Google's crystal clear focus on search in a world where Yahoo kind of focused on everything and became a media company and changed ceos multiple times."

This quote highlights the importance of having a clear focus and stable management, using Google's success and Yahoo's struggles as examples. It emphasizes that a company's strategic clarity and leadership stability are critical for capitalizing on market opportunities.

• The concept of a "truly successful" board member may be less important than avoiding a "bad" one.
• Competence in executing the board role is undervalued.
• Board members have four primary responsibilities: hiring/firing the CEO, financing the company, agreeing on broad strategic direction, and determining when to exit.
• Board members must communicate clearly and directly, especially when addressing a CEO's performance issues.
• A board member's ability to have difficult conversations with the CEO is crucial for the company's success.

"As a board member, you have four jobs. And the definition of a job is if you don't do it, it doesn't get done. The four jobs are you hire and fire the CEO. You finance the company... You agree with the CEO, the broad strategic direction... And last, and finally, you determine in conjunction with the CEO when to exit."

This quote outlines the four essential roles of a board member, emphasizing that these responsibilities are critical to a company's success and must be executed well. It underscores the importance of alignment between the board and CEO on major decisions.

• Board conflict and CEO non-compliance are distinct issues that require different approaches.
• Success can forgive a CEO's non-compliance, but board members must be prepared to intervene in case of fatal errors.
• Board conflicts are natural due to diverse opinions and experiences.
• Rational decision-making is a non-negotiable trait for board members to resolve conflicts effectively.
• Working with rational decision-makers on the board can facilitate reaching agreements, even in case of differing values.

"The only time you take preemptive action, and this is the CEO not listening, I'll come back to the board separately, you take preemptive action when it's a fatal error."

This quote explains the threshold for when a board member should intervene with a CEO's decisions, emphasizing that intervention is necessary only in the case of potentially fatal errors, not just mistakes. It highlights the importance of discerning the severity of issues before taking action.

• Enjoyment and learning often coincide when working with other board members.
• Different board members can offer varying experiences and lessons.
• The speaker expresses appreciation for working and learning from certain colleagues like Mark Suster.

"I enjoy working with people, generally learn a lot from the people you enjoy working with."

This quote reflects the speaker's personal experience on boards, indicating that working with enjoyable colleagues can lead to valuable learning opportunities. It suggests that positive working relationships contribute to professional development and success.## Learning from Experience

• Learning occurs not just from those we align with but also from those we initially disagree with.
• It's crucial to recognize when someone else, often more experienced, has valuable insights.
• Young and hopeful professionals can be resistant to the advice of seasoned veterans.
• Experience teaches that early disappointments can be indicators of long-term patterns.

"And what you invariably discover is quite often, the grim old bastard is right, and that people who disappoint you in the short term disappoint you in the long term."

This quote emphasizes the lesson that initial judgments about someone's approach can be misleading, and that experience often provides valuable insights that should not be dismissed.

• Recognizing when to make strategic changes in a business is critical.
• There is a tendency to stick with failing strategies or investments due to hopefulness.
• Experienced board members often provide insights based on patterns they've seen before.
• The advice to shut down or sell a company can be hard to accept but is sometimes necessary.

"We should close this company down right now."

This quote reflects the tough decision-making that can be required in business, particularly when an experienced individual advises that the best course of action is to cease operations.

• Incremental learning can improve the accuracy of forecasting.
• Experts often overestimate their predictive abilities.
• Understanding forecasting is beneficial in decision-making businesses.

"Philip Tetlock makes the point how to predict things, a point that is actually very apropos, given today is the day after the US election and about how incremental learning can lead to better forecasting, whereas experts consistently overestimate their ability to be correct."

This quote underlines the importance of incremental learning in improving forecasting abilities and acknowledges the common overestimation of predictive skills by experts.

• Founders need to be ambitious but also realistic about market sizes.
• Misunderstanding of large numbers in pitch decks is common but forgivable.
• The key is whether founders understand the practical steps to grow their business.

"Anyone who puts a trillion dollars is obviously a buffoon and an idiot and just doesn't understand macroeconomics."

The quote criticizes unrealistic financial projections in pitch decks, highlighting a lack of understanding in macroeconomics among some founders.

• AI and ML are exciting but often overhyped technologies.
• There is potential for AI to make business processes more efficient.
• Societal impacts of AI and ML are expected to be significant.

"I think that's absolutely the place to be investing right now."

This quote expresses a strong belief in the potential of AI and ML as a worthwhile investment, despite the tendency to overestimate the current state of these technologies.

• Reading industry-specific updates is essential for staying informed.
• Email newsletters like the term sheet update are valuable resources.
• The volume of content available can be overwhelming, making triage necessary.

"The one thing you got to know is what happened in the business you're operating in."

This quote stresses the importance of being up-to-date with the latest developments in one's industry as a critical aspect of operating a business.

• DroneDeploy's software use for leveraging commercial drones is a recent investment.
• The decision was based on the company's growth, market potential, and experienced team.
• SaaS business models and new markets like drones are attractive to investors.

"It's all about an entirely software cloud-based architecture that takes cheap consumer-level drones and enables business to get enormous advantage from them."

This quote explains the rationale behind investing in DroneDeploy, focusing on the innovative use of consumer-level drones for business efficiency through a SaaS model.

• Acknowledging the introduction to the guest which made the podcast episode possible.
• Expressing appreciation for the insights shared during the conversation.

"What a fantastic guest Rory was to have on the show. And again, a massive thanks to Sharon Weinbart at Hack Bright Academy for the intro to Rory today, without which the show would not have been possible."

This quote shows gratitude towards the individual who facilitated the guest's appearance on the podcast, emphasizing the importance of such connections.