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On My Mind - #7
Here's my investment memo template
On my mind - by Michael Dempsey
This email spawns from this thread. The process for this will evolve but as you'll see, some thoughts are random, and most are unfiltered or poorly edited. Either way, let me know what you like, don't like, or want to talk about more.
Spoiler alert: There was interest so see below for my memo template and high-level thoughts.
1) Thoughts on Investment Memos
I’ve talked a lot about investment memos in the past and how I believe we should be more open/transparent about the overall structure. At times, I’ve even shared the exact internal memo with other friendly investors who were doing diligence for a round I was leading.
The summary of my thoughts are:
Memos are great internal snapshots of thinking. You can go back and see what you got right/wrong about each investment, and how you were thinking about a market and team.
For some firms (not ours) memos help convince the rest of the partnership to get comfortable with an investment and okay it.
Memos for follow-on investments are just as important as new investments (though probably impact decision making less realistically). I structure these differently than new investment memos.
Investors should share memo structure more openly. There is very little that is proprietary about a memo template, however there aren’t many that are public. Examples include the famous Youtube memo by Roloef Botha, Tim Devane’s post, and USV which uses their blog posts as memos. Steve Schlafman also once mentioned that he shows his memo to the founders before taking to partnership to see if they’d change anything. I’d imagine this is firm/partnership dynamic dependent on its efficacy/value.
There’s a lot of vulnerability to sharing a proper investment memo, especially after the fact. VC is an industry that is built on constant paranoia driven by massive information asymmetry. The last thing many people want to do is expose themselves.
How I Use Memos
I’d say ~70% of the time when I write a memo, I end up offering to make an investment in the company, so sometimes a memo goes nowhere but into my archives.
I start my memo usually after meeting #2 with a company and I’ve found it’s very helpful in figuring out what do I have left to understand about the business, what areas should I push on, and separates the company from the investment (i.e. a good company doesn’t always mean a good investment, often due to price).
At times where I have expertise overlap with my partners on an investment, I also will use the memo to bring them up to speed.
My memos traditionally run long for seed (8–10 pages on average) and have a separate attachment of all of the notes I’ve taken as I’ve been meeting with the company. If we’ve had phone calls/video calls, they are multiple pages and have multiple quotes that the founder said. If our meetings have been in person, I usually distill my notes after the fact, as I don’t love taking handwritten notes, and I don’t want to have electronics out in person.
For deals that move quickly, I almost always still try to write a deeper memo within weeks after we invest, to have that record of thinking.
The Actual Memo - CLICK HERE
Here is my investment memo template in google doc form (note: we don’t use a standardized memo at Compound, each partner has their own version/structure).
In a future post, if there is interest, I’ll walk through various parts of the memo. Please email or tweet at me all specific questions and I’ll do my best to answer them all in this post.
For now, here are the opening parts broken down:
This is straightforward. For information about the “required exit for RTF” section read my post on this equation.
I try my best to understand what are they key risks within a given business on both from going Seed to A, but also from becoming a fund-returning investment. The biggest learning as I’ve done more investing is that for many risks, there are no mitigations.
Sometimes founders are first-time founders who have never managed a budget before, others have been at big companies and you worry about their ability to move quickly and efficiently, sometimes they have to build really expensive and high-quality engineering teams. Often for these more amorphous risks, the *honest* mitigation is just a leap of faith, or maybe a small proof point in their past or that came through a reference we did on the founders. In most of these cases I will just write “N/A”.
Other common risks are (but not limited to):
Concern on the founding team’s ability to fundraise and the market dynamics within the industry — As an investor often investing in highly-technical businesses that won’t have major proof points at Series A, it’s unfortunately important for us to think about follow-on capital dynamics both in the sense of Have any other VCs made investments in competing companies (essentially boxing them out for follow-on)?, Is there a deep pool of possible strategic investors (these can be helpful for early commercialization or less-valuation sensitive follow-on)? Or even; is there a specific love for this type of technology from international, non-VC investors?
Raising enough capital to hit meaningful inflection point (this can be both technical and execution risk roped into one)— I think about investing as giving a company enough money and help to reach an inflection point of value so that they can raise more money (eventually leading to a successful exit). It’s kind of sad when put that way, but that’s the most capitalistic view on what we do as seed investors (along with partner with great founders, help people achieve dreams, whatever else we want to pander about on twitter to make ourselves feel/look better). For some businesses, related to the first bullet, it’s actually unclear *what* the right inflection point will be. My job as a lead seed investor is to help our founders know these metrics at a market level, and at an individual investor level. Unlike in more well known areas like enterprise SaaS where people generally have an idea of growth rate and ARR required to raise a strong A (until a hot company blows those expectations out of the water), the areas I invest in are less clear. For robotics, some Series A investors will want to see lots of pilots and customer data paired with LOIs, for some they just want to see a scalable MVP and an elite team, and others think they want to do series A robotics investing but really don’t and won’t get comfortable unless another firm outbids them.
Market Size — I admittedly don’t think too deeply about this nor (despite my hedge fund background) do I care to do a finance-style analysis on TAM, especially not in the businesses that I often am investing in. I have a general view of “can you build a $100M+/year business over the next 4–7 years, or not” and that’s about it. Projecting TAMs for companies that are solving previously unsolved problems is guesswork at best.
First-time founders — Again, I worry about this from specific skillset angles like ability to manage capital or inspire people to take less salary to join their company, but there isn’t much mitigation. For a few companies a mitigation has been on the acqui-hire value of the people based on their unique skillsets, but this often decays within industries over time.
More case-specific examples of mitigations include:
Simulation is built in-house — In AV-first simulation this was a key risk where I was concerned that behaviors from players like Waymo and Zoox. which had built fully-featured simulation software stacks, could continue to proliferate to any of the long-lasting AV companies over the next few years, as these businesses built up the early revenue before expanding into other verticals.
Mitigation: “Tech-heavy OEMs like Tesla, GM, Ford may be able to attract software talent but with projected rise of auto OEMs + Tier 1s, many won’t be able to hire software expertise to build. The key factor here is the delta in time between proliferation of AV teams (and thus the business that can be built) vs. when someone solves AV and we see industry contraction.”
Slowed market expansion means fast traction will come from large customers early on which may be hesitant to implement at scale. — This was for a company working on a massive, but highly technical industry and selling infrastructure to those building companies within that industry. My concern was that in this industry I had repeatedly seen companies be able to go from proof-of-concept to pilot but very few had expanded into scaled recurring revenue, leading to a bunch of bridge rounds to nowhere as everyone waits for the market to mature.
Mitigation (anonymized): (Strategic Investor) is investing $xM into this round and plans to pilot and then scale new tech product across multiple business lines. The company has shown an ability already on old product to break through procurement at large Fortune 1000 customers.
Deal Structure/Offer Context
The structure is pretty simple: How much are we investing, what is the valuation, what is the total price, and if there are any additional terms (is another VC fund or studio getting warrants for some reason? Is the liquidation preference non-market? Will the founders hold legal responsibility post an acquisition?)
The context is what matters far more: Who else is competing for this investment? What is it that we feel we must write check size-wise to win? Where in the process are the founders and what do they value most? Will we need to potentially bridge this company so should we hold reserves between seed and A?
There are many variables here that lead to where in our investment range we invest (both on the founder side and our side).