Finding Genius: Rick Heitzmann, FirstMark Capital
Rick Heitzmann is a founder and partner of FirstMark, a prominent early-stage venture capital fund based out of NYC. Rick has led investments in StubHub, Riot Games, and Pinterest
KM: You started FirstMark Capital right before the last recession and found startup opportunities through that uncertainty. Can you talk about your process of seeing that opportunity at the time and your process of launching a venture fund?
I started in Investment Banking out of college and went into Distressed M&A and investing. In distressed investing, in general, you are fighting over a shrinking pie. In distressed situations often the value of the company is shrinking and you’re fighting for your portion of that shrinking pie. It is optimistic about the future. At the same time, the internet was emerging and I wanted to be part of the disruptors and growth story instead of being a part of the disrupted, shrinking industries.
I joined a venture capital fund for a short time and my main takeaway was that the internet was an incredibly disruptive force that would create tremendous opportunities that would last through my career. I graduated from business school, helped found a company called First Advantage, grew it, took it public, and eventually sold it for $1.2 BN. That’s a much longer story but for the purpose of your book, I’ll fast-forward to FirstMark.
When we started FirstMark, I partnered with venture capitalists that I had worked with prior to First Advantage and we began working on the strategy of the fund in 2005 before the recession hit. As an entrepreneur, you hope that what you’re working on lasts more than one economic cycle and that there will be plenty of headroom to grow. We started FirstMark on a couple of different themes.
First was to be geographically focused on New York (over 10 years ago that was completely contrarian) and it was unique at the time. People did not think venture could thrive in New York. Second, was to be industry-focused. Knowing an industry deeply enables you to build an ecosystem in that and gives you a proprietary advantage in deal sourcing and being able to help your portfolio companies. Third, was being focused on the early stages of development and knowing what was open-source at the time, AWS, or additional tools, to help founders get traction quicker and cheaper. This was all managed with an overlying thought that venture should be a service-based business.
Everyone now talks about VCs helping companies, but that has been a paradigm shift from the 1980’s and 1990’s VC who had a tremendous power distance from entrepreneurs which created a hierarchical structure. There was not much value-add form the venture capitalist and it wasn’t a collaborative relationship. These core foci, especially the idea of a collaborative partnership, were not obvious 12 years ago.
We asked the founders questions and helped them get to a solution. What are the problems you’re facing so you can’t sleep at night, therefore, can’t make decisions during the day? What problems are you solving for as you’re scaling an organization, customers, financing? We wanted to know how we can sit next to them and help solve those problems. How can I build a fund that creates an ecosystem around them?
My entrepreneurial experience was in data information services on the enterprise side. I believed that there was a bigger opportunity on the consumer side. Enterprise is great, but companies can grow faster because the internet can reach a broad base, faster. I believed companies could grow faster in a much more targeted way because of internet reach, with the advent of Google AdSense. The smartest AdSense customer at the time was StubHub so I invested in them as the first and only institutional investor when people didn’t know what paid search or longtail commerce was. Similarly, I invested in several themes in consumer. On the video game side, we invested in Riot Games, and in social discovery, we invested at the seed level in Pinterest.
KM: As a startup VC, how did you expect to compete for deals against some of the bigger, more established shops early on? How did you win mindshare?
We were competing our hearts out. It was competing for mindshare. It was competing for deals. It was competing just to get meetings with companies.
Without being pejorative to some of the older guys, when we were starting off, the older and more established VCs wouldn’t return our calls. Many of those guys don’t exist anymore. We’d see founders we knew at conferences where they’d ask us condescendingly what the hell we were trying to do with FirstMark. They’d look at us and let us know that they had the official Boston VCs behind them as if to let us know that we’d never fit in their picture. They’d often look at us like we were asking for a job. It was at these conferences — with entrepreneurs, or with organizers for panels, or with follow-on financing sources — where we saw that founders wanted to go where the heat was. We weren’t the heat at the time. In some cases, we got lucky because other investors canceled on founders and the founders would let us know that,
‘We had meetings with all the big ones and our meeting with a junior hire canceled so we figured we’d meet with you.’ We had no appreciation. It was starting a startup.
With some Limited Partners (LP), we built a relationship with them for nearly a decade before they invested in one of our funds. LPs sometimes wouldn’t even let us up to their office. I’d get emails but they would wave us off. Some would accept our meetings but then would keep canceling. They wouldn’t respond to our calls so we’d follow them up to Boston and show up at their office. Even knowing we were there, they would send down their assistant or a junior employee who couldn’t make a decision. It was very much like the Big Short movie. They would respond, ‘Today isn’t good. But I’ll send my intern down to meet you in the lobby.’
The intern would come down and say, ‘I only have 6-minutes but do you want to buy me a coffee.’ And there I am buying a junior associate a coffee from a place that is dismissing me completely. But that’s the thing. This is normal if you’re scaling a business. From the operating or investment management side, I’ve gone through both of those sides.
KM: We don’t hear about that side often. The relationship with the LPs. As money managers investing in early-stage startups, how do you balance that relationship dynamic and their expectations?
It’s very, very hard.
Especially in the last cycle. You alluded to it. Where ‘founder-friendly’ was the thing most VCs wanted to be called. Founders would shift to VC and say, “I get it and do not push too hard; therefore I’m founder friendly”.
Investors often view not pushing or raising issues as ‘founder-friendly’ and as a result, they don’t ask tough questions of entrepreneurs. That ends up being a huge disservice to LPs and entrepreneurs. The entrepreneurs have to understand that my job is to service them and that they’re one of my customers, but I also have a fiduciary duty to my LPs who are not only giving me their money but they are also investing with college endowments or pensions of NYC Policemen. They want us to invest their money wisely because they’ll eventually have to pay someone’s pension with the returns. We’re not in it to make friends with entrepreneurs.
We have the fiduciary duty to drive the highest return and sometimes that return is by sometimes doing good things and by sometimes doing hard things. Fortunately, we’ve been firm but fair.
I’ve seen funds make wild decisions under the guise of being founder-friendly. If some of the LPs were around that table, they would have been shocked. I think that era is over. As VCs, we have two responsibilities:
Responsibility to your LPs, drive investor capital wisely, get the best, fair deal with a long-term view of the relationship with that company. And secondly, manage that relationship. Part of being an investor is not being an ATM. Founder friendly does not mean to just keep giving entrepreneurs money regardless of progress. If it proves to not be a good investment, we won’t keep providing additional capital and we have to be firm about that.
I think a lot will change in this next cycle. The pendulum swings often. From 2000 to 2005, it was VCs realizing they could get whatever deal they wanted because there wasn’t too much capital in the ecosystem. In this last cycle, there has been so much capital, that entrepreneurs were driving the deals, the valuations, and the terms. It was often to their detriment. I think the pendulum will swing back as capital out-flows decrease and the quality of the capital becomes more apparent. I don’t see this being the apocalyptic ‘bubble bursting’ moment that happened in March 2000 or September 2001. At the end of 2009 — post-Bear Stearns and Lehman Brothers — there was no-market liquidity, especially with venture investments. That was a shock to the system given the broader market shock.
Now, valuations are inflated and we’re seeing them be deflated. The market, is looking at businesses and saying, ‘Wow, that was an aggressive multiple we were putting on those earnings. Let’s focus less on the revenue multiple and the long-term earnings multiple.’ Ultimately you’re exiting to the public markets and you’re accountable to those shareholders either directly or indirectly. If your ultimate buyer is becoming more discriminating, that’ll cycle back to the bottom of the system.
KM: Given you’ve seen these pendulum swings over the past decade, how have your investment theses evolved? How will it evolve through the next wave that you’re referencing?
It is necessary to change theses and let theses play out. You see different industries being disrupted at different times. As a VC, you’re constantly looking for the beginning of disruption. With Riot Games, there was a high enough penetration of broadband where users could play social games digitally. Secondly, there was high enough delivery on that broadband that you could deliver a high-quality game broadly. People were open to commerce digitally so you could pay for a game over the computer where the market could move from an item-based economy vs a pay-up-front economy. There were enough gamers out there that could absorb a broad-based game. There were multiple points of disruption, therefore innovation. Maybe online gaming was not as broad but that market has evolved to where people can pay online for gaming. As this has become more competitive, it opened up a massive market for E-Sports. So we watched this trend and it led to our investment in League of Legends. You’ve seen it to others investing in Twitch to great success. We looked for that theme and if it plays out to be big enough, we see it pull more things downstream.
With Pinterest, the world was moving mobile, the world was becoming more visual (small screen while walking), the world was more social, therefore curation would be important. All of those multiple points came together and Pinterest made sense.
As an investment thesis, we look for multiple points of disruption to occur that were never possible before.
Outside of my portfolio with Uber, there were multiple points of disruption that made that possible. Granted, others tried it so execution was important but several factors led to the existence of that type of service and it was important to build a thesis to track those. The penetration of smartphones was such that every person that drives a cab or a car has a smartphone, Everyone who wants a cab has a smartphone. The GPS embedded in mobile phones is such that we’ll always know where those people or cabs are. There is now an advanced ability to pay and track those people. All of those abilities came within a year of the founding of Uber. Disruptions occur on multiple levels. Most of those disruptions came within the same time as one another.
KM: Are founders presenting their ideas like that to you or are you drawing those connections behind the scenes? Most seem to think linearly about their problem and why they’re solving it
Founders don’t present it like that. Not really. They kind of hint at it, but mainly they’ll focus on the problem side. This thinking is from a structural, investment thesis side. Instead, the best founders focus on user behavior.
Pinterest was focusing on the users that wanted to share the things they like. They were obsessive over that. They tapped into this understanding that people want to see what other people think about the things they like and their collections. They realized people like social endorsements when someone likes their stuff or someone wants to buy it.
For Pinterest, instead of ripping out a folder from my bag of clippings, I can do it on my phone and collect the best things I like. This is an age-old behavior now moved to mobile. Hey, I want to let my friend, sister, or girlfriend see it and give me their opinion/approval? How will I do that for clippings? That was the problem set and each feature stemmed from that. The best founders tend to be product-focused from a user perspective and give it a mirror image to the way we see these trends or thesis play out.
With fundraising and what some founders do, I call it bad business development. I’ve done it when I was younger. You take a customer-centric perspective as a founder. What you need to realize is that as a founder, it doesn’t matter that you need money. What you need doesn’t matter to Venture Capitalists. Just like if you’re selling enterprise software and no one is buying it, your customer doesn’t care if you need to sell your product to feed your family or pay your employees. It doesn’t matter. People have shareholders. VCs have LPs.
The biggest thing that frustrates me with entrepreneurs is that almost quarterly, without fail, I sit with founders who want to be entrepreneurs. They have business ideas but they say, “I have a certain quality of life. I don’t want to leave my job, but if you give me the money then I’ll quit and I’ll go do it.”
I get that such a scenario works for them but it doesn’t work for me. It’s frustrating because I have 1000’s of entrepreneurs on the other side that have already burned their ships and showed that they’ve got grit. If you’re an entrepreneur looking for money you should look at the VCs criteria and ask, “Am I, as a founder, meeting those criteria?” You should look at the blog posts, tweets, videos, public talks, to see if I’m hitting milestones for the series A and Series B. I’l meet founders. I love to.
If I find it to be an interesting idea but it’s too early, I’ll say, ‘come back to me when you have 100 dollars in sales or 5 customers’. I’ll share my concerns and ask them to report back on how they’ve worked against those concerns.
But without fail, those same types of founders, 9 months later, will come back and say they’re getting ready to raise their round but they still haven’t done those milestones I mentioned. They’ll say, ‘I know we have a meeting set up but I still haven’t done the things we discussed.’ In short, the founder is saying, ‘I’d rather raise now because I’d rather have cash in the bank.’ I’ll postpone the meeting. Your desire to have cash in the bank doesn’t mean anything to me. Did you listen to what I was looking for? There are some known, semi-known benchmarks within each industry that you should know for raising financing. All I think as an investor is that the founder didn’t listen at all when I was offering feedback or signal. Instead, report back, even if it’s months later when you have hit the milestones. I want to see that the founder understands the market primers, communicated well, and was honest.
KM: As someone with a fiduciary duty to your LPs and the dollars that they represent. How do you view companies like Draft Kings or Airbnb, or companies with huge regulatory hurdles that are seemingly great ideas but still early and without much data to go off of? Where do you as an early-stage investor see the most potential for a company like Pinterest — Purely the amount of revenue this can eventually generate as the number of users that it can acquire? At first, especially at the time you invested, it likely did not click on how this can be a business.
I think I keep more faith that in that collaborative process with the founder, we’ll work that out over time. Going back to earlier in our conversation, I want to invest in businesses that will last longer than an economic cycle so we have time to figure that out.
With Pinterest, I met with them and signed the term sheet before the market bottom. They had a friend at NYU and were looking for investors. There wasn’t much there yet and they decided to go through the NYU Business plan contest. They went through that together and lost because of a concept that never launched. This is at the end of 2008 I met with them and liked the way they thought about that concept. One of the founders said he wanted to finish his MBA and he said he wasn’t going to go on with the team that eventually started Pinterest. (The happy ending for that founder is 3–4 years later, he re-joined the company. He led many of the efforts in New York.)
We raised our fund in 2005. Pinterest was one of the first dozen investments but not the first. They were a great team.
I would generally fund a team that I think is great. If an idea is great and has traction, I might fund an A-team. I would fund an A+ team with a B- idea (amorphous idea). This would be serial entrepreneurs with specific domain expertise. That happened with TapAd. I trusted him and we decided to figure it out together.
We’ve invested in several serial entrepreneurs who see the pieces of disruption. For TapAd, we saw internet identity was split, and that pulling data about a person would be important. We don’t know how or why, but we’ll figure that out together because we know it’ll be valuable.
A serial entrepreneur with an ability that has proven themselves and is willing to iterate and find the solution collaboratively is what helps make an investment work. If someone from American Express worked for the past 30-years and told me they’re excited about mobile marketing, they haven’t’ really shown that they’re willing to think outside the box and I can’t get behind them.
Through portfolio companies and their board meetings, we’ll go through it together and see the product change. If the founding team is fond of playing in space, is listening to their customers, is listening to the market, and iterating on their product, I want to back them. You learn a lot more from failure than success.
You mentioned regulation, Yes, Draft Kings, and Airbnb are, or have, faced increased regulation. And I saw that problem play out negatively with Aereo. We were seed investors that didn’t put too much in, but it was worth a lot, especially during the court decision proceedings. We believed that the regulators and courts would side with us. But still, the court didn’t find it that way. If you said, that we can take a risk and mobilize the laws and work with regulators, it would have still been a good investment. We look at regulatory risk as just another risk we take. In an accelerated tech market, regulation lags further, and we see that as an opportunity of having a conversation, publicly.
Uber has done a very good job of getting consumers to buy into those conversations. In Massachusets, through that dialogue, the governor admitted that ridesharing was good for the people and that through discourse, they’ll figure out a way to bridge that gap. In Miami and LA, Uber has worked within the parameters of what the regulatory bodies have set. Understanding that it’s the taxi and limousine commission primarily battling the concept of their business, Uber has gone and proven regulators wrong about congestion in cities like New York.
In these cases, as we’re having the conversation, we want governing bodies to use real data and not theoretical data. Let’s figure out how we compromise. Airbnb is having those conversations. Draft King is having those conversations. At some points, the regulatory bodies or Attorney Generals are often being overly aggressive in personal/political self-interest where they believe that if they take a controversial company, regardless of it being great for the people, down, it’ll make them popular. It’s not about theoretical good or bad. Let’s quantify it, and then let’s see if the law proves it to be illegal or legal.
Our legal teams did work on Aereo before the investment. We also leaned on people with Draft Kings that we had confidence in to get a sense of what the market says. Even if you’re right on the regulatory front, you get a 60% chance of winning. That’s the shame of it. But do we think of that as a risk factor and we factor that into our LPs and as part of fiduciary duty. When we think of the risk/return on the investment if we win, will it lead to a massive opportunity for the company? Was there a risk seed investors in Uber wouldn’t get a series A? Hell yes. But if you overcome that risk, is the return significant enough where Uber will be one of the best investments ever? Yes. For every Uber, 100s failed because of regulatory decisions but this is part of the investment decision process.
KM: General thoughts on managing competition?
Microsoft was the threat in the 90s. In the 2000’s, the question was why can’t Google do it? Now it’s why can’t Facebook, Amazon, Microsoft, or Google do it?
The truth is that most of the big companies can do it. They try to get involved. We tend to suspend disbelief around that unless it’s something abundantly clear. We invested in a company called Hop, Skip, Drive, when most people passed because they said Uber or Lyft will do it. The company has proven they’re in a big market and servicing a need those companies are not. For Stubhub, they said eBay would do it.
But the truth was, that E-bay was thinking about other key categories and they hesitated on tickets. Was there something unique about it? Yes. Stubhub guaranteed tickets and others were not willing to do that. There was a supply chain around the system that they build. Delivery, pricing, accessible to all, are some points I look for when assessing a company. Those are also multiple points of disruption that make sense where the larger competitor can’t do what a startup can. What’s the real competitive advantage? What’s the innovation and why can/can’t they do it?