Dave McClure: Inspired by Dr. Seuss and Disrupting Venture Capital
[Corrected 3/7/14, 6:45 am. See below.] In the four years since Dave McClure co-founded the venture fund and incubator program 500 Startups, he has acquired a reputation as an outspoken geek, an entrepreneur’s entrepreneur, and an irreverent Silicon Valley insider who invests in Internet startups.
When he came to San Diego last week, McClure was all that and more. He was profane, opinionated, thoughtful, and disruptive. He tossed F-bombs with abandon. When I asked a mildly provocative question during an Xconomy-organized lunch with San Diego tech leaders, McClure stood on his chair to respond. Later that day, he stood barefoot while giving a presentation at UC San Diego, telling an auditorium packed with entrepreneurs that they don’t need an MBA to be successful.
“You can fail at building a startup and still learn a lot,” McClure told the crowd. “I would argue that it’s better to fail at your own startup than to read about someone else succeeding at theirs.”
In the audience, one entrepreneur tweeted:
— Greg Crisci (@gregcrisci) February 26, 2014
That kind of reaction is a testament to McClure’s emergence as a leading voice for the latest generation of Web entrepreneurs. At 500 Startups, he is raising capital for a third investment fund, after raising more than $74 million for two previous funds and overseeing more than 700 venture investments. And in the process of disrupting the VC industry, he sometimes reveals a mischievous side that is reminiscent of a Dr. Seuss character.
This is no coincidence.
McClure writes about innovation, startups, and entrepreneurship on a blog he calls “500 Hats,” an allusion to the Dr. Seuss’ book, “The 500 Hats of Bartholomew Cubbins.” His Twitter icon is the Cat in the Hat’s hat. In 2007, he marked the occasion of Dr. Seuss’ birthday by writing: “He’s one of my most favorite childhood icons & cultural heroes, along with Marlo Thomas, and Jim Henson. I wouldn’t be who I am today without them, and the wonderful characters they’ve brought into my life.”
Suffice to say, Dave McClure is not your average venture capitalist.
There is a distinctly Seussian quality to the way he’s working to disrupt traditional venture funding—as if he’s offering green eggs and ham to an entire industry of Sam-I-Ams. Bear in mind that Dr. Seuss (also known as San Diego’s Theodore Geisel) created The Cat in the Hat in response to a moribund education establishment that could not see how ineffective “Dick and Jane” primers were in teaching kids how to read.
Yet he isn’t going about this in a frivolous way.
“We definitely have a very different strategy than most folks in the market,” McClure says. Instead of investing $5 million in one startup the way VCs did 10 or 15 years ago, McClure says he would rather invest $50,000 in 100 companies.
He’s making lots of little bets and coaching the startup founders to either grow fast or fail fast. He’s looking for entrepreneurs who can develop a minimally viable product, get immediate customer feedback, make quick improvements, and use Internet marketing and distribution to get customers and revenues snowballing.
“Most of venture capital has not figured this out,” McClure says—and he contends that most VC funds are failing.
“Do you know what venture capital is?” McClure rhetorically asked the crowd at UCSD. “It’s overblown mortgage processing. It should be more scientific. There should be FICO scores for entrepreneurs.”
Instead of spending weeks or months on due diligence, McClure contends that the relevant questions for VCs come down to: “Can you build a product? Can you make money? Great! Let’s turn on the faucet.”
As McClure explains in his blog, 500 Startups “is ideologically more focused on being an organization that teaches great hitting & fielding, rather than one that aims to find the best hitters & help them negotiate the best contracts. In other words, we’re happy to discover we have a few black swans, but our MISSION is to groom ugly ducklings.”
McClure also acknowledged during his San Diego visit that one of the central tenets of his strategy is more specifically at odds with the conventional thinking of the VC industry.
Many VCs say there can only be a relatively small number of successful outcomes in any given pool of venture-backed startups. There are economic constraints and other factors that limit the number of home runs, so there are only so many deals with Facebook-scale potential to go around. As a result, the biggest VCs bid up the valuations for certain startups by fighting to get into those deals.
But McClure contends the number of successful outcomes is much more elastic. It might even be unlimited.
This contrarian view is based at least partly on his hypothesis that entrepreneurial people—the folks with the ability to start a business that can grow to generate $10 million a year in revenue—represent at least 1 percent of the population. This wouldn’t matter to most VCs, McClure says, because most VCs are focused on finding deals with the potential for many times that sort of value generation.
Yet, he says, a program like 500 Startups that provides decent mentoring and venture support invests much earlier, and can help these businesses grow to bigger market valuations of $50 million and more.
[Corrected to delete specific invested rates of return] “Initially, we were thinking we might screw up the first check, so we were looking to follow up on the second and third checks,” McClure said. In other words, they assumed 500 Startups would generate its biggest returns in later investment rounds. Instead, he said, returns have generally been higher for 500 Startups’ seed-stage investments than for later follow-on rounds.
If 1 percent of humanity is entrepreneurial, McClure says that means there should be about 70 million entrepreneurs around the world who are capable of building $10-million-a-year companies. This is the reason why McClure has been doing so much globe-trotting over the past couple of years, and why he has worked to establish outposts for 500 Startups programs in Mexico City, Brazil, China, Indonesia, and elsewhere. He’s also been working to build additional investor syndicates like Angel List—trying to figure out how to create other sustainable ecosystems for startups.
This struck some of the San Diego investors in the room as ironic. San Diego’s innovation ecosystem has struggled for decades to overcome a regional deficiency of startup capital—especially in the tech sector. So why hasn’t a venture accelerator like 500 Startups taken root here?
McClure’s approach seems like a great venture strategy for early stage Internet startups in the consumer segment of the market, said Joe Markee of San Diego’s Express Ventures. But he added, “It seems to me that Dave’s general approach is biased to the Bay Area. And if you can’t easily transfer this to San Diego, how are you going to create it in an even more problematic area like Rio de Janeiro?”
David Titus of the San Diego Venture Group agreed, saying capital and liquidity are real issues in developing markets. “If you think you have trouble selling a $15-million-a-year business in the U.S., wait until you try some of these other countries,” Titus said.
Titus also takes a long view of venture investing. He’d like to see how well 500 Startups will do over a longer investment period.
McClure founded 500 Startups in 2010, just a couple of years after joining San Francisco’s Founders Fund. As McClure tells the story, Founders Fund partner Sean Parker gave him “a really long leash” in late 2008—amid the worst days of the financial crisis—by allowing him to make investments from a small seed-stage fund.
McClure says he invested in roughly 40 deals over the next 15 months, including some decent picks in Twilio, SendGrid, Credit Karma, TaskRabbit, and others. By 2010, he had gathered enough financial support from Founders Fund, Mitch Kapor, Michael Birch, Fred Wilson, Brad Feld, Marc Andreessen, and others to raise the small seed-stage fund that became 500 Startups.
“I think it’s fascinating that he’s trying something different,” Titus said. “The VC world did not innovate at a time when financial services companies were developing exchange traded funds and buyout guys were reinventing themselves as private equity. Venture capital needs innovation.”