In Palo Alto we talked with venture capitalist Alex Taussig about the investment process and investment criteria at Highland Capital Partners. Furthermore, Alex shares his learnings and advice for young entrepreneurs.

The transcript of the interview is provided below.

INTRODUCTION

Martin: Hi, today we are in Menlo Park, in the Highland Capital Partners’ office with Alex. Alex, who are you and what do you do?

Alex: Haha… Hi, good to have you guys here. My name is Alex Taussig, I’m a ventures capital‘s partner at Highland Capital Partners. We are a 26 year old venture capital firm with offices all around the world, and we invest in early stage technology companies. So, that’s both enterprise companies, everything from infrastructure software to application software to consumer internet companies, market places, social media, all that kind of stuff. So, we’ve been around, as I said, for a while.

In Boston, we have our offices where we started the firm. We also have our office out here, as well as in Geneva and in Shanghai.

Martin: Great! Awesome.

Martin: Can you tell us a little bit about your background? What did you do before you started being a venture capitalist?

Alex: So I have a bit of unconventional background in some sense. For a long time growing up, I thought I was going to be a professor. So I was on an academic track for the most of my life. Started labs when I was a teenager and did a lot different types of research expose into a lot of different technology in bioinformatics, computer vision. I ended up doing physics and materials engineering. Physics is an undergrad and then materials engineering as a grad student at MIT.

It was some point during the grad school days, I got a little bit bored of research. It’s a bit of a slower pace than we find in the startup world. And at the same time, I’ve known a lot of folks that I went to college with at Harvard, who had come out to the Valley to start a companies or a lot of them at that point of time, they’re actually going to Microsoft and then come to the Valley. That would seem to be a lot of pattern. And I was at Harvard when Facebook started, so it was part of this generation of sort of new entrepreneurs and decided that I wanted to be part of that in someway. And at the time, someone had told me about venture capital, which is sort of this of interesting intermediary between people that make the technology and the financial markets. And having grown up in New York City, and been in around the finance community in my whole life, I thought it would be a nice marriage of my passions for sort of helping capitalized businesses and then also working with technologists to help bringing their stuff out of the lab, out of the confined of small, little dimly-lit rooms into the real world and serving customers. So I decided to venture capital, I’d like to  learn more about what that was.

So I ended up going to business school. I left MIT, got out of PhD program and decided to get a Master’s instead, so I wrote my thesis. And then I went over to HBS, Harvard Business School and joined Highland out of business school.

So I’ve been with Highland for about 5.5 years now. And started working in our Boston office with one of our founders very closely. So that was sort of my apprenticeship, if you will. I worked very closely with him on a number of companies in the security software space, dataware housing. We invested in a robotics company, which I’m happy to talk about. It’s pretty cool stuff.

So we like really technically complex problems and really amazing engineering founders. And that’s really what I’ve been doing pretty much ever since. And I moved out here about 2.5 years ago to help build our West Coast office. And that’s kind of what I’ve been doing. But I’m sort of a career venture capitalist and I’m inspired by great innovations and great engineers. I’d like to help them explore their transition from inventing great technology and moving it to the real world.

Martin: Actually from my point of view, there are a lot of similarities between being a professor, entrepreneur or venture capitalist by building up hypothesis and testing them. The only thing is that, as a professor maybe you can only do the theoretical stuff, but as an entrepreneur and a VC you also see the consequences.

Alex: Well in a laboratory, you’re still isolated from the real world, you know. I worked on a project that was trying to create computer chips that ran on light. So, instead of electricity, the computer chip that runs on light. That’s a big idea, right. We were totally, I mean as a student I was totally unaware that Intel would just like totally control this market. There’s no hope for commercializing this technology as a small company.

Had I known, had I come from the business background, I probably would have figured out earlier, right. But with that being said, you know, you do a lot of really cutting edge stuff in the lab, but you do it as sort of scale and with a sort of mentorship that doesn’t really guide you down to the commercial route. I think that we still have a lot of work to do on a model that transitions a laboratory research out into the real world. You know, Stanford over here has done a great job at it. MIT is doing a good job, Harvard is doing a descent job, but there’s still a lot of work to do. And I think coming from that world, I can I kind of walk in both pair of shoes if you will.

I see some similarities, there’s a good amount of  hypothesis-driven testing you refer to, but the practicality is quite different. The emphasis here if it’s not valuable to customer, it’s not valuable to work on. Which is very different than academia.

HIGHLAND CAPITAL PARTNERS – INVESTMENT CRITERIA

Martin: Let’s talk about Highland Capital Partners. What are the typical selection criteria for you to invest in a company? And maybe you can build some kind of matrix, depending on ticket size, industry, at what stage is the company, etc.

Alex: Lots of different venture firms have different approaches. I think, we can talk about different stages of investing. At Highland, we are predominantly Series A investor. So we’re usually coming in as the first largest institutional investor in the company. We’re usually the first outside board director, that’s not always the case, but it’s usually the case. We like to think that we have a mark on the early formation and growth of the company.  And at some point, more capital comes in and other board members come on board, but we like to be the trusted, kind of first person that makes a bet on a group of entrepreneurs.

As such our criteria, different firms think about it differently. There are firms on this road here that focus a lot on market or they focus very much on the specifics of the product. I would say that my focus, and I think most of us here, tend to focus a lot on the team. We very much believe, that we want to be backing great founders who can really take it the whole way. So anytime, sort of a difficult exercise, cause you’re thinking maybe 8, 9 years in the future, but we think that we have over 26 years to develop a decent pattern recognition on what makes founders really, the kind of people who can lead the whole way. That doesn’t mean that they always do, but we try to find those criteria. And if we look at our own history of our biggest wins as a firm, they’re usually the ones where the founders did go the whole way.

So, what does that tell? For us, I think, in some sectors you need to bring to the table some sort of relevant expertise from that industry. Some sort of insight that you would have that a lay person that’s walking into that business wouldn’t have. I do think that having fresh perspective in some businesses is helpful. But if you’re building a security software company, having a good history of knowing what features are valued by customers is really helpful because once you shipped your product, that mission is critical stuff, right. So having the experience from the industry is very important.

We often talk about magnetism, like with founders. There’s some people that, I don’t know if you’ve met, but you just go, I really would love to work with that person. There’s a certain amount of optimism, a certain amount of what I call unflappableness. Someone who can’t be taken off their path. And those types of people are very rare to find, but they believe in it so much themselves that other people are willing to take the risk and go with them on the journey. That’s something we look for.

In some ways of shapes and forms that might be called leadership. But actually leadership has also some other characteristics as well. Leadership isn’t just the ability to guide, get people to go on the journey with you, but it’s the ability to actually organize those people into a functioning organization.

And so, even with very young founders, we look for people who have the ability to manage, who have the ability to partition the work and motivate and really help developed their employees. This is not easy stuff. And it’s helpful if you’ve worked in a high function organization before and have seen these patterns, but even first time founders sometimes have a knack for that.

If it’s a highly technical project, we look frankly for brilliant, world class engineers. The last company that I kind of let the investment for Highland is, the CTO is one of the guys who helped write Java. One of the other founders helped create MapReduce at Google. So we really look for people with world class technical talent, because what we’ve found is that there is, between a good engineer and a truly great engineer, there’s like a whole order of magnitude in productivity. It’s not just their productivity, it’s the other talent that they can attract to the team. So when you back truly great people, they actually form this sucking sound in this industry where they get the best talent into that company. And that of course reinforces the company’s success.

Martin: How do you test this magnetism and on the other hand industry knowledge, given that you often times invest in companies that are trying to reshape an industry and which is most of the time you don’t have direct insight in the industry as well?

Alex: I mean the way we test the team aspect is, we do a lot of references. Ideally, the ideal situation is you’ve already worked for this person for 20 years, right. And you already have the evidence. It happens occasionally, every now and then. But a lot of times, teams come out of companies that were successful and start a new company. You may have known them by reputation, or you may know them socially, but you’ve never worked with them before.

What we do there is, we do heavy, heavy deep reference checks. And we talk to lots of people that have worked with them, we talk to people that have work with them even like 20 years prior and we form in our own heads, a narrative about that person’s career. And we try to understand what makes them successful, what are their strength, what are their weaknesses. And we form a thesis around the team.

And, like I said, we’re not always right. But more often than not, we are. That often, when we are right, we actually find that those are the best companies. And so, personally when I go very deep on the team, and try to really understand, what they’re good at and what they need from us. And frankly, it helps us thinking about how we can be helpful as a partner. If this is a very strong technical team, but they don’t really have a good business development sense, that’s something we can try to bring to the table. We can try to find them someone. First of all, we can advice them on that. But we can also go try to find them someone to work in that function.

So that’s kind of how we set that out. I think the only thing you can do is, talk to people who have worked with them before and form an opinion about what they need.

Martin: And how can you find out if some founder is really able to manage pivots? Like before, most of the time, the first year won’t be the final idea when you execute a company.

Alex: So that another great reason to back teams instead of market sales. There is this idea that a great team will find a great market. The people that believe in the market say that, you could put Bill Gates and have him sell ice cream, and he’ll never build a 100 billion company because the market size for ice cream is only so big. Right. So, it’s more of a religious conviction, but I think that great teams tend to find new opportunities.

We’ve had companies in the past that started down on one direction and have made pivots into several, maybe several times, to the point where… I think the good ones tend to stick in the same market, but they try to change the business model.

So, a good example would be a portfolio company of ours called thredUP, which is an e-commerce company. When they started out, the idea was to basically to be able to exchange clothing with one another. So, you and I can trade our shirts, if we want to. That only has so much upside, because there’s just not that many people who’re willing to dig through other people’s closets and judge, I like that shirt has a little bit of stain on it, I really don’t want that one, but I’ll take that one. It’s a lot of work for a consumer, right. And it’s actually a lot of work for a seller, because they have to figure out, they have to go take everything, photos and put it online.

So, that company pivoted to become an e-commerce company. So meaning that they’ll actually just buy things from you and they know what they can buy and what they shouldn’t buy, and then they go sell it on the Internet. So for the consumer, it just looks like a normal e-commerce store. And for a seller, all they do is just put all their stuff they want to sell in a bag, and you send it in. They don’t have to worry about it. And that’s when the business really took off. And that’s when we invested.

But the founders are 2 guys I went to business school with, and I’ve known them for 5.5 years now. It took many years to really figure out what the right model was. But these guys, by the time they got there, they were experts on that market. There’s no one who knows that market better than these guys. And you have to be willing to support founders, while they figure that out because it sometimes not everything takes off right from the get go.

We tried to back great people, who we’ve believed have the ability to figure what the right business is.

Martin: Alex, I’m very sure that you see so many pitches a year. Can you tell us a little bit about what makes a great pitch and then maybe tell us a little bit of some examples where you say, this was a great pitch because of X and this wasn’t a good pitch because of Y?

Alex: So any great pitch is a great story, right. The best pitchmen and pitchwomen are the best story tellers. So the best pitches I’ve seen, have taken me through this opportunity. You’ve got to get people’s attention right away. One of the things that kills me is, when people don’t tell you what the product is until half way through the deck. Tell me what you’re building, tell me why you’re building it, tell me why the world needs it. Take me on the journey, tell me who you are and why you guys are the most relevant people that actually go on this journey and convince me that it’s a journey worth going on together. And if you take that attitude as oppose to just kind of giving me a bunch of facts, I think that you’re probably half way there. We of course, we decided if it’s a fit for us, but you’ll be surprised of how many people come in here and just regurgitate a bunch of facts about a market size and about product matrix  and stuff. And that works for later stage investors, who’re more interested in just, I want to invest a dollar and get 3 dollars out.

For us, we’re signing out for 8-9 years of work potentially, and we have to believe that this is going to change the world. We have to believe that any investment that we make is going to return our fund. That’s multi billion dollar company and to do that, you have to believe that it’s a generational type of opportunity. And for that, you’ll need to be able to tell us that story.

It’s not very specific feedback, but to be more specific, I think one of the most interesting thing I’ve seen in the slide deck that I really liked, I really don’t see this that often. It is the same company actually, thredUP. I remember when the CEO was pitching us, he said, here’s what you have to believe to want to invest in my company. He said, if you don’t believe these things you should not invest, and he listed them. And the interesting thing by doing that is, you kind of go through one-by-one, you go, Okay I believe that, I believe that, I believe that. And so like, then I should invest in the company.

So he led me down this road and it was a very logical argument. I think more founders should take  that type of approach, where they are like, “Look, there’s a lot of risk in this venture. Here’s what we believe. And if you believe what we believe, clearly there’s a massive opportunity here”. And it doesn’t mean that we’re going to get there, we have to execute on it, but what we see is, look for is the optionality.

They look for, if the execution is good, can we actually have a huge opportunity? It’s a huge upside. So that’s what it’s all about. It’s not about necessarily convincing them that there’s no risk. Smart investors know there’s risk. It’s about convincing them that the upside is there. And for that, you need to believe in a certain set of things. If you don’t believe them, you’re not going to believe there’s the upside.

Martin: And when you’re saying that, entrepreneurs tell you stories, do you mean that they should give you a big picture in terms of, “Okay, in 5 to 10 years we would like to own that and that on that market”, or do you want to say, “This is what we want to do in the next 2 years”?

Alex: There’s the story, there’s a combination, so here’s what I say. There’s a 10 year road map. Like this is a 10 year vision, that’s what I say. A 10 year vision and there’s like a 6 month plan. So you’ve got to believe in the 10 year vision, and you have to believe in the 6 month plan. Like what’s the next logical miles from here to here. So you’ve got to simultaneously sell both of those things.

I remember when we have a company in our portfolio called 2U, which is an online education company that recently went public. I remember, the very first meeting with them, one of the founders said that, look there’s plenty of online colleges you can go to, but they have the wrong incentives system. Like if you are, I don’t know if you have this in Europe, but this for-profit education like University of Phoenix, or Capella.

Martin: Open university in the UK, I guess.

Alex: You borrow money from the government via Title IV, to go to school and then, so you load yourself up with debt as a student, and then you come out with a degree that’s not that valuable actually, in a lot of cases. Or you may not even finish. Why is that an endemic problem? Well, it’s because they actually don’t really have that much incentive for you to be a great, like have a great job and a great profession. They’re kind of in a business of signing you up and covering their acquisition cost and then moving on to the next student. That’s how they make their money. And sure they’d like to keep paying your tuition, but if you ultimately not a successful in job market place, it doesn’t really affect them.

Whereas if you look at non-profit schools, like Harvard, or MIT or YALE or USC, or Georgetown, whatever, great schools, they’re non-profits and their mission is just to educate people who’ll go out into the world and have great careers. And they build their reputation on the fact that people are educated, and also can have a great career with the degree they get.

And in particular with graduate degrees, it’s very, very tied to your career, because you’ve already graduated from college and you’re going back to school because you want to get to the next level in your career.

So, instead of building another online school, let’s go build a company that helps bring these non-profits on the internet, because then they can take their mission and take it global. You can go from being the number 10 program in your field to being the number 1, and we can help give you those tools to go online. We’re now align with our school partners. So to me, it was a very compelling vision of the future. I think in every vision of the future, where it actually ends up in retrospect working, it’s always a bit controversial when you first hear it.

Like today, this was like 2009 or something when we first heard this. Today, online education is like, kind of going mainstream. Back then, it was not. So there was a lot of controversy. Will school sign up for this? Will school want online students coming to their universities? Will that dilute our brand? And it turns out, it was the best thing in the world for their brand. Because they basically, you know, there are students around the world that never heard of these guys and now they’re getting degrees and now they’re going into workplace and  people are seeing that on their resume.

So, it’s a transforming of a company but it was very controversial at the time, and require you to think differently, but the story made sense. If you believe this, if we can get there, this is a massive opportunity because we’re the first online education company that actually aligns with the students for outcomes.

ADVICE TO ENTREPRENEURS FROM ALEX TAUSSIG

Martin: Alex, imagine a friend of yours or a friend of friend of yours comes to you and says, Alex, I would like to start a company. What would be the best advice that you would give him, in terms of financing the company or maybe setting up a team, or later on, after he finds a managing relationship with the board?

Alex: First thing I’d say is, why do you want to start a company. So starting a company is really, really hard. It’s almost impossible to describe it, how hard it is to most people.

I guess starting a venture backed kind of company is extremely hard. You have no resources, it’s incredibly difficult for people to hear your cause, it’s hard to get that initial traction, and you devote so much of your life to actually making this work. And you put yourself and your ego and all that stuff into it, your blood, sweat and tears. For something that will, you know, probabilistically not worked out. And by the way, if you are really good, you’re probably leaving some job that was very high paying and some lifestyle that you’re really accustomed to go and do this.

So, it’s like a very, very difficult thing to do and I actually think that starting a company is not the right choice for most people. I don’t believe that most people are founders or have the ability to be founders. But I also believe, that in this culture we have right now, what seems to be very popular to romanticized people who’ve founded companies, that a lot of people think they are that person.

So the first thing I tell people is just do a gut check. It’s just to basically say, am I willing. Here’s what I would tell people. Are you willing to work on this idea for 2 years with no traction. Like if you’re willing to do it for 2 years with 0 traction, then you probably have the grid and the fortitude to actually make it the whole way. Because I have a lot of friends who have started a very successful companies, for which the first 2 years of that, they had nothing.

What separates them from everyone else that went by the way side, was the fact they actually stuck with it. So you’ve got to be able to do that. If you can do that, you’ve a  higher chance of being successful. So that’s the first thing I would say to them is, do you want to spend 2 years of your life on something that potentially have 0, 0 traction and still want to go for it. So that’s what I would say.

Martin: Okay. Great! And in terms of financing, what would you recommend to your friend? He is very young and he’s trying to set up a not that much capital intensive business.

Alex: The first round should honestly, I mean, I had some good advice from a professor in business school. Business school is funny. You don’t remember a lot of the stuff you’re told, but every now and then, there’s a little nugget that sticks in your head. And this one is always stuck in my head. Which was, the person who is likely to write you the first check, is not going to do it because of your business, they’re going to do it because of you.

So they’re going to do it because they want to see you succeed. So I think the first thing you should do if you are financing a company, when you’re just starting it, is go find the people who want you to be successful and will back you because it’s you. So get those people. Then, the next people you get, should be extremely high profile and have a great reputation in the industry you’re focused on.

So instead of trying to go out and  raise money from like 100 random people, focus on like the 10 highly relevant people. Because it turns out the way fundraising works is once you get 1 or 2 of those people, everyone else will want to be in the round. So you spend 80% of your effort on the really relevant, highly visible people. Once you get them, it’s like going bowling. All the other pins will just start to fall over.

So that’s usually the advice I gave people at that stage.

I would honestly take money from as few individuals as you can and still be able to raise enough. The more people you add to the cap table, the more angry phone calls you have to deal with, “Where’s my money? Oh, how you guys doing?” Often times the most annoying ones are the angry ones, it’s the, “Hey, how are things going? can I come and check it out?” You don’t want to manage a lot of, a lot of people. You want to have a low maintenance investors and have as few of them as possible, in my view.

Martin: Because you want to focus on the building the business and not on managing the investor’s relationship.

Alex: Fundraising for most entrepreneurs is a nuisance. There are some that actually enjoy it. They tend to also be very good at it. But most people I know, really dislike fundraising and would prefer not to spend a lot of time on it. And I think that’s probably right.

When I meet people and interested in investing in the company, I tell them, look here’s what I need to do to get to the point where we’re going to decide we’re going to make an investment, and I want to use your time as judiciously possible, because I know this is not the fun part. The fun part is building the business. And then when I go on the board, we’re going to have a long, long relationship to work together. So right now is the time where we need to fill each other out and I need you to answer some questions. So I think good investors will be judicious with their use of your time and bad investor will waste your time.

Martin: Alex, you have seen so many startups. What learnings or mistakes have you seen when young entrepreneurs are trying to scale the company?

Alex: I’ll tell you a couple of things.

  • I mean there’s the classic trying to scale your company before you’re really truly a product market fit. Investing a lot of dollars behind, say, a paid marketing campaign, when you really don’t even know what your contribution margins are, or if that’s not the relevant matrix, when you don’t know the type of users you’re trying to acquire. Doesn’t make a lot of sense. There’s always, test you can perform but really scaling on those efforts prematurely that can burn through a lot of cash very quickly. Ideally, when you’re in that early stage, the cash you’re spending is really should be going to support your team, not in much else.
  • One other thing is, I’ve seen is relying on business development to drive early traction. It turns out that other people are never going to be as good at selling you product as you will. If you’re going to rely on channels or partnerships to push your product through, it’s really, really chunky and it’s really difficult to motivate those parties to actually work hard for you, because they have a ton of other parties as well. So, I’m not a big fan of channel businesses early on, I’m not a big fan of businesses that are driven by business development partnerships early on. I think, you need to find a way as a startup to control your own destiny in some sense. Develop direct relationship with your customers or your users and figure out how to get those people to actually help you grow.

So, I’ve seen those mistakes probably most often with regard to scaling.

Martin: Alex, thank you very much for your time. Next time you are pitching Alex, now you know how great pitch looks like and please consider that. Thank you very much.

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