Seed Series: Floodgate Partner Iris Choi

Next in The Seed Series we welcome Iris Choi, the third partner at Floodgate, who joined founders Mike Maples and Ann Miura-Ko in 2013. We talk about how the firm has changed since her joining, their focus on Intelligent Growth, and how the exit market is faring in 2019. The following has been edited for brevity and clarity.

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Gené: Iris Choi welcome. What was it like joining Floodgate and the original founding team?

Iris: I have been at Floodgate for more than six years. I was the first non-founding partner to join the team. I came into a role that was less focused on sourcing, and much more about how do we optimize the outcomes for our portfolio. In seed, your portfolio grows very quickly. When I joined, fund IV had already been raised. We already had close to 100 portfolio companies. And so my pitch was, you guys are excellent at deploying capital. But I’m a believer that you do have to be intentional about exits. And have a sense for where this company is going to end up, even when you’re writing that first check.

I was in investment banking for a really long time. In practice, what that means at the firm is that I started taking on board seats. I worked closely with our founders on a bunch of strategic initiatives. I built up a network of contacts. And the most recent evolution of that role has been that I now own all the follow-on investing.

A lot of funds like to say we do 50 percent first checks, and 50 percent for reserves. But because our fund size has gone up over time, our reserves are now comparable to our fund two size. We have to be much more intentional. It can’t be an afterthought.

I invest out of the main fund. We want the bar to be just as high. If I am feeling greedy and want more of this company, I need to feel enough conviction that I’m willing to take away those dollars from what could be two seed checks that have yet to come in through the door.

Because we get in so early, we tend to get very emotionally attached to our companies. And yet we have a fiduciary duty that every dollar we spend is optimized for the return. So regardless of who led the deal, whether or not we actually put more money into the company, now falls under my mandate.

Gené: Are you worried about an adverse reaction for companies when you don’t do follow-on rounds?

Iris: We want to do right by the founder and so we are also realistic that we need to find ways to show our level of support. For companies that are oversubscribed, we get asked all the time to waive our pro rata rights. Ironically, in reality, our quote unquote best performing companies, at least from a fundraising perspective, oftentimes we don’t even get to put in follow-on dollars.

Gené: Not every tech company goes public. I looked at Floodgate’s portfolio and three companies have gone public. Most companies will get acquired. How does that make for a successful outcome?

Iris: Our expectation for investing in a company is that in the future, on a standalone basis, it will be worth billions. So we’re never investing with the intent that this company is able to sell in the short term. But I think in reality, as you point out, the vast majority of companies in any sector tends to sell, and not necessarily go public. We want to be supportive and aligned with a founder in what he or she thinks is the ultimate end goal. And make sure that we are putting in place the right support system. So if you are going to go public, when is the right time to have an audit committee, a compensation committee, and have a public company CFO come in.

If instead, at some point I am going to need greater resources behind me to be able to really accelerate the growth, and realize the vision of this company’s potential, then what’s important is that you, as a founder, have top of mind who are the three likely homes, where you would feel empowered to make the most of your company. If we can help facilitate some of those introductions, or if we have a good sense of what it would take for them to find you attractive, then that is important data as well.

Over the last couple of years, we’ve seen fewer exits at least in our ecosystem in the less-than $500 million dollar amount.

Gené: Fewer?

Iris: Yes, fewer, meaning that Yahoo is basically gone. There was a fervor around not only acqui-hires but also talent team tuck-ins in 2012, 2015, by Yahoo, but also by a lot of firms. A lot of these firms were willing to pay up for the talent. And a lot of these tuck-ins just weren’t well integrated. At that point they would rather just hire new teams.

One of the areas where there is money to be spent acquiring companies is private equity. Selling to private equity is very different than selling to a strategic. They value growth to a certain extent, but what they really are prioritizing is your ability to get cash flow profitable. We worked with a couple of our portfolio companies where private equity may actually be the more likely buyer, versus strategic, and help them to put in the operational discipline to make their profile look more likely to be a private equity type acquisition.

Gené: The public markets have come back in 2018. Do you see that continuing?

Iris: There are over 100 private companies that are valued greater than $1 billion dollars, and then there’s probably greater than 10 that are valued at over $10 billion.There are companies with a profile which traditionally would have meant they are already public. There is definitely a pipeline of companies that could go public. The market seems to have been very receptive to most IPOs this year. Zoom has outperformed the market. I felt in December people were a little bit skeptical about how many people would actually make it out in 2019. And yet now people are waiting with bated breath for Airbnb, and a lot of others that people assume have confidentially filed.

I’m really intrigued about direct listings. Companies are staying private later, and longer, and finding plenty of access to capital. So for a company like Slack, they had over $800 million dollars in cash. So this concept of an IPO being an opportunity to raise another round of funding no longer seems applicable. For priorities like just having a liquid currency and being able to get cash out for some of your early employees, the direct listing is an interesting way to do it. Especially when it’s entities like Spotify or Slack where they are known.

Gené: You think is a good decision to do the direct list for those companies?

Iris: Yes when you don’t want to take on the dilution, but solve for the other factors and that is an interesting way to do it.

Gené: And dilution is paying the investment bankers?

Iris: Just unnecessarily raising more capital. Are direct listings going to become much more common? Some of the companies have had a little bit of choppiness in the market, and it may have been influenced by the fact that a lot of the crossover investors, who had traditionally been the brand names who you would want to get into your stock at the IPO, already owned it. If you’re having a big offering, what is their incentive to buy even more? If you already have those marquee names it is hard to incentivize even more marquee names.

Gené: Floodgate is an investor in Lyft. You got in early at the seed level in 2010. And then invested in the Series A and B. What is your view on Lyft going public? I think the stock has pulled back a little bit from when it went public. So what’s your perspective on that as a shareholder?

Iris: We were just thrilled to have been part of that journey. When you think about when we invested — it was a very different company than it is today. It was really focused on software for carpooling and the concept of Lyft that we know today didn’t launch until about two and a half years later. The bet we took with our investment was really the founders. They were interested in a market that felt like it was ripe for disruption. And there was going to be many different layers to the opportunity for what they could achieve. Being public is hard. And there are a lot of companies where that first year was rough. I would point to both Facebook and Square that have both outperformed expectations from the time of the IPO. And so I think it’s still very early innings for what you can expect in terms of performance as a publicly-traded stock.

Gené: What is your LP expectation for exiting from Lyft?

Iris: We’re lucky in that we have a very small LP base. And most of them have been with us now for several funds. And so we tend to have a fairly open conversation with them. They entrusted us with their capital. The expectation is that when we think it’s right will distribute.

Gené: Any key learnings coming out of investment banking to this world?

Iris: A lot of my experience historically has been with much more mature companies. Something that we really emphasize here at Floodgate is that even in the early days, you want to have operational discipline. And what I mean by that is not that everyone should be operating as if they are at scale. Rather what we often say to our founders when they raise capital from us is, this is the last capital you will see, until you do something incredibly worthy of a Series A.

Run as many experiments as you can with this seed round. Find your earned secrets, and then make sure you have an incredible value proposition, and you will start seeing evidence of product market fit. I say these phrases like, ‘Hack value before you hack worth.’ There is a right time to be focused on growth as a metric. First you have to make sure that you created a product that resonates with your target demographic, where they’re willing to actually engage and pay for it in some shape or form. I think that’s a perspective I have which is a little bit different than a lot of early stage investors. Because I’ve seen what it means to actually grow into operational discipline in the future, but there are fundamental values that you need to have in place upfront.

We have the concept of Intelligent Growth, where you’re not just revenue chasing. You get into trouble because you’re basically buying your customers, and then they churn. Rather from the very beginning, having something that is so fundamentally compelling about your product that your customers would be willing to pay for it and not just churn off.

Gené: Many investors are traction focused. Are you saying you’re not traction focused?

Iris: At our stage it is really hard to see traction in terms of data. We want to know that there is feedback from your customer base that what you are providing is an actual value proposition, and that they are wanting to engage on that.

Gené: Your most recent fund is fund 6 in 2017 raising $131 million. I noticed it is much bigger than previous funds that were more around $75 million? Why a larger fund?

Iris: There are a couple of different reasons. Our team itself has grown. And so we’ve gone from being just Mike and Ann. I joined the team. And then we have our fourth partner Arjun Chopra. He has a really interesting background. He had been the founding CTO of a cloud-based services company. He understands enterprise sales cycles very well. There’s just more check writing capability that came with a larger team. I think the part that a lot of people haven’t picked up on is that our fund cycle has elongated a little bit. So if you look at the funds at III, IV, and V we were on a clip of about two to three years. And this fund will take us a little bit longer. We have the benefit of having strong relationships with our LPs, where we do not have to be out fundraising again. But the one thing we are very clear about is that seed is still our core product. So even though it’s a larger fund, it is not because we are looking to go upstream.

Gené: How much do you like to invest? I think when Mike first started he said there’s an opportunity to fund companies with a $500K check at the seed stage. How much do you like to put into companies at this stage, and what percent ownership are you looking for?

Iris: At least half of our deals we like to lead. And then if we are leading we are targeting ownership at the 15 percent plus range. But we also tend to be fairly flexible. I mean, there’s plenty of deals that we’ve done where we’ve been in it with other seed funds. And if you look back historically, that was a lot of our deals. With First Round and Baseline, no one had a fund size that was large enough to significantly lead. And all of us have had the benefit of being able to fundraise larger funds, and then being able to take more of a lead position.

Gené: How many new investments do you like to do per year?

Iris: Around 10 split amongst partners and some of those will be lead deals, and a significant portion will be smaller checks.

Gené: And are you meeting about a 100 companies a year?

Iris: We meet several hundred between the four of us. We will tag team these deals together.

Gené: As a firm who are you connected to? Either other seed funds or the upstream investors?

Iris: We are very sensitive to wanting to maintain a great network of angels, and also future founders. Our ideal founder is one who has yet to even start a company. Or is thinking about starting a company where we can really get in early and help them think through that opportunity. One of the ways that we try to actually implement that is by teaching at Stanford. Ann did here PhD there. She had been a graduate student, and a TA for a long time. Mike and I were actually helping Ann teach her class this Spring. We were evangelizing one our core tenets, Intelligent Growth, and how we evaluate investment opportunities.

And then I think on the other side, having a really great relationship with the future investors in our companies is something that’s important to us. In the same way that companies have a product roadmap, we feel very strongly that a company should have a fund-raising roadmap. We feel like it’s a mistake if you’re not intentional about knowing how much you are raising and why.

And so, oftentimes the company that we’ve invested in will come to me and say, ‘Hey, I’m raising a series A.’ And my first question is, what is the narrative for your Series B and let’s work backwards from there. So what we really care about is not just that our companies get funded. But that whoever is funding them is the ideal partner, because either they have expertise in the space, or they have something extra above and beyond the capital that they’re actually bringing to the company.

Gené: And how do you earn that trust with the founder?

Iris: One of the changes in venture that I’ve seen over the past 10 years is that venture is so much more than just capital. You see so many platform teams at other funds. We don’t have that here.

What you do get when you take Floodgate’s investment is all four partners committed to working with you. After the wire is in, we actually have them come back in, and we say we’re all on the same team now to tell us the truth. Partly because we want you to know every single person in this room and understand what each of our superpowers is. You’ll know when to call Mike versus Ann versus Arjun and me. We want to know the three things keeping you up at night, and then all of us are going to be in place to help you through those things. Unfortunately, we may not be able to do your PR for you, or your hiring. But as for the real strategic support and advice, all four of us are available to you. So I think it’s that level of commitment, and that we try to do right by the founder. Now we’re by no means everyone’s cheerleader. We’ll expect excellence from you. But when things get rough, we are not going to be the fund that says you have to sell now. If you still have fight left in you, we will be fighting with you.

Gené: Any notable exits?

Iris: One of them is probably Okta. That’s the one where we were lucky to have gotten in at the very beginning when Andreessen Horowitz did as well. And the company has continued to perform extremely well in the public markets. And it’s the one where there were so many competing with them. Then it was not obvious that they were not only going to be able to survive, but excel.

I tip my hat to the the team there because the grit and perseverance and they weren’t daunted by having incredibly well-funded enormous companies like Microsoft or Salesforce who were willing to compete directly head on.

Gené: What wave of technology are you riding?

Iris: One area where we were early investors is the on-demand or gig economy. We were in TaskRabbit, Lyft and one investment we made recently is in Dumpling. And what resonated with us about Dumpling is that we spent a lot of time saying, the gig economy as a way of working is here to stay. And so what is the infrastructure that gig economy workers will need? And so we spent some time looking at accounting systems and other software that they need. But what was compelling to us about Dumpling is that they will provide a platform for workers that would be similar to the benefit of being a franchisee.

So their first market they are attacking is if you are a grocery shopper and you have real skills in that space…You don’t necessarily have to have it on a platform, you can actually make that your own business and Dumpling will help you in terms of CRM, payment systems, and whatever else you need. And now you are a solo or micro-entrepreneur. We feel like that’s interesting because there’s obviously been a ton of research and data showing that this concept of having gigs that you put together to make it a career of yours instead of working full-time at a company is here to stay. If anything it is only going to become more popular in the future. And so trying to find the software systems, and the infrastructure that is going to make those individual entrepreneurs really successful going forward, we think is a huge opportunity.

Gené: Are there are a couple of companies that you’re excited by that you want to mention.

Iris: There are two that you would find interesting, both in markets that are large and growing. The first is called Applied Intuition. The two co-founders, Qasar Younis and Peter Ludwig, we like to say they were in Detroit before they were in Silicon Valley. They come from backgrounds in industrial engineering. They built software for simulation testing for autonomous vehicles. Instead of physically having to run autonomous vehicles in Arizona in a quarantined off area, you can do billions of test runs, in various scenarios, using software. There is a benefit to having a mutual third party, instead of everyone building it in-house whether you are an OEM or a rideshare provider. This is only going to become increasingly necessary in the future.

The second one is a company called Cheetah, which is focused on the value chain delivered as a service for SMBs. If you are a restaurant, and you need to go get fresh ingredients, you have one of two options. One is that you get one of your line chefs to go to restaurant depot, fill up the truck, bring it back and then unload everything which is going to take some of your time. The other option is that you have a big incumbent come by and say, what are your orders for this week and fill it out. There is very little pricing transparency.

Well, why not have a service where it’s all via an app. You know exactly what it is that you need to get, what the pricing is and then it gets delivered to you. You think that must already exist. I remind everyone, DoorDash did not exist when I started at Floodgate. Nor did Instacart. So a lot of this type of behavior is now assumed to be true in B2B. But it is actually still only true in B2C. It doesn’t have to just be your ingredients for food. I could easily see this as supplies for daycare or a retirement home. But having it be one app with a high level service for all of the last mile delivery, where the logistics are being taken care of by someone else. And so that’s one where Michael has this phrase, where there are industries with a ‘rent seeking middleman’ that are still ripe for disruption. Cheetah plays in one of those spaces. They are live in several cities, the Bay Area and Los Angeles being two of their largest markets.

Gené: Thank you Iris.

Iris: Thank you

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Illustration: Li-Anne Dias.