Larry Warnock: [00:00:00] This is a science meets art, wrapped in mystery with an enigma and a crystal ball bouncing in the background. 

It's better to pass than do a bad deal. Better to pass than do a bad deal. We can wait. We have 10 years, 

It doesn't help a lot when you're sitting around the board table and a VC says, well, I think we need to increase revenue and decrease expenses like oh. Really? Thank you. I'm gonna write that one down. Brilliant. 

It's do the milestones that get us the Series A. Then when we get it, get rid of all the things you were working on. Stop.

This is the ARR bandwidth you need to get to on your seed money, on your Series A money and lose money on every deal. That's okay.

For the first six slides, thought it was a joke.

I just visited a company last week that is [00:01:00] working on micro reacts to provide atomic energy for data centers.

Hardware is hot again.

That's the future of manufacturing the US, not stamping out rubber ducks, 10,000 units per day.

So you wanna get hit by a train, lay on the track.

Andrew Kazlow: Welcome to the Diligent Observer, the first podcast exclusively focused on helping angels see what others miss. I'm your host, Andrew, and every week we explore what works, what doesn't, and why through conversations with experienced startup investors and operators.

Today I'm replaying one of my favorite episodes. My guest is Larry Warnock, founding partner of Ring Ventures, former CEO of multiple successful startups and veteran with 70 plus investments. And in this conversation, Larry breaks down his three T's framework. Explains why he always bets on founders over ideas.

Ensures the craziest pitch that he's ever received. A plan to bring back the woolly mammoth. [00:02:00] I hope you enjoy learning from Larry as much as I did.

Larry, thank you for being with me today.

Larry Warnock: Hey Andrew. Good morning to you. 

Andrew Kazlow: I am very, very honored to have this time. So first of all, thank you for making the time. Look forward to sharing and just seeing where we go with the conversation. The first thing I wanted to ask you about, Larry, I've, I've heard you now speak on this several times, and you have a really simple framework for evaluating investment opportunities.

Uh, it's three pieces to it. I, I wonder if you could talk through that framework and then how you developed that framework.

Larry Warnock: Good. Yeah, a great memory Andrew, and thanks. What you do for the investment community, this is helpful. Um, so my framework is sort of the three Ts and I say TAM Tech. Team. So lemme explain each one of those and then talk about the priority. 'Cause those are not necessarily in, in priority order. So the TAM is, is the market big enough, the total addressable [00:03:00] market for what they're doing, that if they were to gain 50% market share, would it be that interesting?

Uh, very few companies get 50%, but the market itself has to be big, big enough. So I, as an investor and other investors should look at how big is the target they're going after, and that has to kind of hit a threshold. Next is the second T, which is tech or the technology. This is the offering, even if it's a service offering, does it work?

Is it interesting? Do the target audience believe it's interesting? And that's really, really important and investors need to kind of ask a question. Is this an aspirin or a vitamin? And aspirin solves a pain. A vitamin helps you for the future with a positive. Both are good investments, but it will really guide how urgent a customer will put this in their stack of priorities.

So the tech has to be [00:04:00] viable. It has to be work, it has to work, it has to be modern. And then finally it's the team. Is this founder or founders capable of addressing this problem in this market? Do they know this market? Have they been in this market? Is it just a dream of theirs or is this something they bring as far as credibility and per and and uh, background. Also, personality traits.

Do they have the ability to listen and to see the tea leaves and adjust? Because adjustment always. Happens even when I was an operator. Uh, as a VP and a CEO, what we ultimately got acquired on or went public on was not exactly what we started with. So it evolves, and you've gotta understand if the founders and the team has the ability to evolve,

take guidance and not be so stubborn. Now they can believe in their mission and their vision, but much like a running back has to cut and jig and jag and [00:05:00] the objective is always get into the end zone, but sometimes it's oh, double back and run back around behind the quarterback and go up the right side.

Can the team do that? And if they can't, do they have the ability to recruit a team around them that could? So those are my three high level criteria, and team is the most important for me. Um, if I look back over all of my successes and failures, and I've had had them both, uh, the team was the more critical factor, um, on the success, or quite frankly on the failure.

So, TAM, tech, team.

Andrew Kazlow: Why is that, that, that you feel like the team so clearly was the critical factor? Like I hear that a lot, you know, there's the, the eternal debate. Is it market or is it the team? Which is more important? Which would you rather have, but you seem pretty sold on the team aspect. Why is it that you think that element is so important. And then maybe as a follow on, how do you suss out this [00:06:00] ability to pivot? Uh, it's very squishy, perhaps in a, a limited conversation set. Uh, so two questions. Why is the team so important? And then two, how do you suss out the ability to pivot?

Larry Warnock: Sure. Um, great businesses become great business because of execution. It's very rarely the idea, and very rarely will this tech be the only one in the market. You know, if you're the only one doing it, you might take pause. It's like, wait a second. Why, why is no one else doing this? Because once some momentum happens, it will attract competitors, and that's okay.

Competition is good. It keeps you focused. But, um, it, it's really about business execution. And business execution is a result of human factors. It's the ability to stay organized, it's ability to set a plan, to adjust a plan. So, because business execution is what takes a great idea to a great company, execution is a function of the team. Period, stop. The [00:07:00] best tech doesn't always win. A great example I like to give, you know, operating systems for PCs, you know, Windows before the Apple dominant dominance was the dominant operating system. Okay, well, when people got a blue screen of death and had to reboot it, you know, once a week, okay. The operating system they put on the Mars Rover has never been rebooted.

It just keeps going, so the best doesn't win off all evidently or always. And so Microsoft was a machine because of merchandising and marketing. They out executed everybody and then Apple beat them at their own game with design added to that element and ease of use. So, not to ramble, but, uh, team is most important because execution defines a great business and that's singularly influenced by the team in place.

I do wanna comment on, you know, the second thing. So, um, I get the word pivot and I use it in [00:08:00] sentences all the time, but pivot to me sounds too dramatic. It's really adjusting and, and zigging and going a little bit left, a little bit right? Like that, you know, for all of your viewers. Think about it, running back, making it through the line, or deciding to go around the end in a football game.

Um, how do you suss that out, as you said? Um, ask for examples of what this person's done in their past as an investor. Meet them as early as you can, and then watch them. Do they do what they say they're gonna do? I, I think the latest stat from meet to first check is six months. So over those six months before you as an angel or a venture firm

What do they say they're gonna do and what happens when it doesn't go exactly as planned? Do they panic? Do they give up? Do they just hit the brick wall? We're just gotta hit it harder. Do they adjust? So time and understanding how this team or this founder will adjust to problems and changes is how you suss it out. 

Andrew Kazlow: [00:09:00] Larry, I'm curious, have you ever passed on an opportunity because you weren't impressed by the team or the founder? You didn't feel like they had that capacity that then ultimately turned out to be a, a huge miss. Like, have you ever had that experience? 

Larry Warnock: Um, I have, but um, I've got pretty good instincts on the team. Um, I've absolutely made mistakes. We've invested in things. It didn't pan out. We missed investments that became wildly successful. But usually the miss for me personally, has been misunderstanding or not being able to grasp the tech and the TAM, not the team.

Is the team is for me, is the easiest to understand because you have an ability to interact, you know? How would you have ever drawn the TAM for the iPhone? It didn't exist. Like, whoa, whoa. Wait a second. It's so, it's a computer, it's a camera, it's a phone, it's that [00:10:00] apps, you know, what is that TAM? Well, the TAM is

planet Earth, every man, woman, and child. But that would've been irrational before it was shipped for you to use that TAM. So you had to have the vision that that tech could address the TAM. So if I look back at the misses or um, investments that we made and it didn't pan out, or investments we didn't make, it's usually not having a good grasp or not predicting what happens to the tech in the TAM, not the people.

Andrew Kazlow: It is really interesting 'cause I feel like that's the piece that is often the difference maker, right? How does the market ultimately evolve and we're looking at market making 

opportunities. 

Larry Warnock: Lemme interrupt you and give you an 

Okay. I knew of Slack when it started. Totally missed. Totally missed that this company, which by the way, was a gaming company that had a messaging app inside of their game and the games were not popular, they [00:11:00] weren't getting a lot of use of the games, so multiplayer games, they had this utility that let you smack talk between other players and Hey, what about this?

You know, where's the golden orb? You know, how do I get into this cave? You know, or shoot this bad guy, whatever. And so, their investors decided to get rid of the games and just focus on the messaging layer. And then the messaging layer rolled out and they gave it away for free and it went viral. And I knew about this.

I didn't have a chance to invest, but if I had, I probably wouldn't have. I had nothing to do with the team. It's that I didn't see that messaging would replace email. It really has for your generation and younger. Um, it, it's the de facto way to get into groups and to communicate. Then I didn't realize that the messaging really was, once it replaced email, would became a fundamental platform, not for only for people to communicate, for apps to communicate.

And then [00:12:00] Salesforce acquired them for billions of dollars. Added it because it's a communication layer also for their data platform is Slack talks to apps and enters data and gets data out, hands it to people. I didn't see that. Okay. Um, the team is a great team. Um, I'm sure, but that would've been a TAM and tech miss because it pivoted.

It changed. So if I had a chance to view it, it would've been a gaming company with mediocre games, with a cool way to chat with people playing 'em. Okay. Uh, probably wouldn't have invested in that, but things changed and the team was able to adjust. Pretty big adjustment. You're no longer a mentor. When your board comes to you and says, we're outta the gaming business, you're like, what?

I'm a gamer. This is I, this I, this [00:13:00] is why I did this. We're gonna focus on the messaging, like, what? Who needs that? Don't people already message? Don't people already email? So the team was able to take advantage and bring this quantumly, better messaging platform just like Zoom. And you know, everybody thought video conferencing was over.

There were already four or five solutions. They did it better. The deals I've missed have been not being able to have the foresight of where it could go, not just where it goes.

Andrew Kazlow: I feel like that's such a nuanced thing. 'cause even as you're talking through it, you look back, you still would've passed most likely based on what you just described. How, how do you.

Larry Warnock: Well, and I'll, I'll tell you why. I, I, I never met the team. I, if I had met the team, you're going, holy crap. I'll give you an example of a company like that. So I have an investment in a company called Proxy. They're outta Seattle, Washington. Uh, two female founders. Um, they would [00:14:00] be appalled if they heard this, but they're really struggling with their current platform and getting true product-market fit, but they are rock stars, so we invested to them because maybe this one won't work, but whatever they do next will.

Or might, and I wanna stay close to them, they'll probably figure it out for Proxy. They started with a consumer model. Now they have a business-to-business model and they're working it through and it's tough. But I invested because of the two of them. And if this doesn't pan out, okay, we'll write off that investment.

But when they come knocking for the next one, no question I'd invest. 

Andrew Kazlow: Say more about how you see angels effectively build those relationships and assess.

that kind of thing. 'cause I think from a venture perspective, when you're writing a million dollar check, you're gonna lead around. There's a much deeper relationship that's naturally built compared to an angel who might be running a $25,000 check.

How, how, in [00:15:00] your experience, have you seen angels successfully build these relationships and do the best they can with the limited, uh, power that they have in the conversation?

Larry Warnock: Right. Well 'cause it, it's all, whether for a VC or an angel, it's all about deal flow. What are you getting eyes on? Because I think of some of the biggest successes that I missed. I missed them 'cause I never knew about 'em. Okay. That happens to venture firms too, by the way. So angels on the line. Don't worry.

It's not only you. Um, I think angels, personal opinion should focus on an area or a market that they know something about. And in that process, when they hear rumblings that there is a new idea or a founder reach out and offer assistance because they know something about the space they're targeting oil and gas companies, they're targeting industrial manufacturing.

Um, it's software. They may not know about software, but they know about insurance. And insurance is one of the markets. So I think [00:16:00] one of the biggest values angels bring is domain expertise as well as money. And then, um, join the angel networks. I'm a huge, huge fan of angel networks, uh, that, that may be popular with your viewers or may, may not, because you're gonna see so much more deal flow and you're also going to see the deals that the angel networks don't even look at.

You can ask to see the throwaways and one of them might get your attention. So it just gives, it takes you from seeing a deal a quarter to seeing ten, and if you take all the applicants that we're turned down twenty And so it, it's really a, a numbers game. And then as I mentioned earlier, uh, it takes time. So meet these founders early and then add value, not just your check, uh, but add value if all it is is introductions.

Let's say you don't know anything about, uh, maritime. You know, [00:17:00] software that tracks maritime shipping and you don't know any shipping, but you know, if you're an angel, you've probably got a whole career behind you. Somebody in your LinkedIn network knows about that industry. Make an introduction.

Andrew Kazlow: So it sounds like the value add piece is really something that you've seen successful angels lean into and perhaps unsuccessful angels, uh, fail to engage as much.

Larry Warnock: Yeah. And one of the reasons for that is, and um, is kind of one of the misnomers of VCs. So VCs manage a portfolio. Not a company, okay? And so you've got to have diversification for a portfolio to work for an angel invest, investor diversification's really difficult 'cause it's expensive. Therefore, the diversification should come from the number of the deals you look at.

If you write a check and you've only looked at four deals, the red lights would go off in my [00:18:00] head that that's not a diversified approach. And it's tough to be diversified. And that's where the angel networks can help you. 'Cause you can watch and you can share your ideas and see what other things there.

There is value in other people's opinion, but, um, VCs manage a portfolio and, and I, I, I can't remember the exact number, but, um, for a portfolio to truly be diversified, it must have at least 11 investments in it. Very few angels have 11 investments, so it's highly risky. So do something that, you know, if they're targeting oil and gas and you spent 25 years in oil and gas, that should go up in the um, level of, uh, of interest for you as an angel.

Andrew Kazlow: So most of your experience has been kinda on the venture side. Um, in addition to serving as a, an operator and the CEO seat in a number of companies, I'm curious [00:19:00] to just hear the perspective on how does venture broadly, and then maybe in your specific experience, think about the angel investor's role in the ecosystem because there are very mixed opinions about angels.

Uh, and I'm curious if you could kind of talk through your perspective on that.

Larry Warnock: Yeah, Andrew. Good question. Um, most of 'em I think are misconceptions, but, um, and I'll tell you why in a second, but VCs, from what I've experienced, aren't against angels at all. Um, it's part of the ecosystem and it fills in a gap. Okay. Um, what VCs do not like is a jacked up cap table. So angels be careful.

You don't do funny, crazy things that are out of the ordinary to the cap table. Okay. Invest, get your preferred shares, but don't do these side letters where you get five points of common 'cause you're going to help them. Well, you're not an employee so you can't be fired. And so the VC is like, wait a minute, this person has [00:20:00] five points of common.

But we can't fire them. We can't if they're not doing their jobs. So funny deals where there's some side stock that's common 'cause I'm gonna help you wanna give you a Rolodex? Okay, that's, that's what you get with your preferred shares is the obligation to help them. Okay? So VCs don't like jacked up cap tables, which is why angels should do safes all day long.

Because it's so simple. It's so easy. Every VC understands it. They understand that there's been, the premium's been given for the risk that the angel took and that it's easy to calculate. It's right there. They understand it, and it's not crazy. I think VCs like what angels do for the early stage.

What I would say though, and I hope this isn't controversial for the angels that will be viewing this, founders should meet VCs early, [00:21:00] even when it's just PowerPoint, because they'll eventually need them if they want more capital at the A or the B, and it takes, as you. As we just talked about six months before you write a check and you'll get feedback.

And it might be very clear from interacting with venture firms that you're not ready. And then you ask them, why aren't I ready? And then use the angel money to fill that hole to get ready for what the venture needs. But, um, you know, deal flow has shrunk deal pricing has come down. That's good for investors, but because of that, a lot of venture firms are writing $50K. $100K checks to very super early seed, um, stage opportunities.

So a founder should a meet VCs, even if they wanna take angel money, that's fine. What they'll find is that they'll take angel money because maybe they're not ready, and [00:22:00] then find angels that bring value besides just the check, um, is is my opinion.

Andrew Kazlow: Say more about the weird cap tables. Like what are the other examples of weirdness that would, uh, cause a VC to turn up their nose.

Larry Warnock: Angel comes in, but they also wanna be considered a founder. So they get, you know, the value of their investment in preferred. And then they, I kind of, uh, alluded to this. Then they also get 10 points because they're kind of a founder, but they're not really working at it every, each and every day.

And then a venture capital firm comes in and says, you know, they have a model. They have to get X percent at the seed stage at the A, at the B, they calculate dilution into it. So it's when they end up after a series C, they have X percent of the company. And if you've got 10 points allocated to this person, that's not really day in, day out helping the business,[00:23:00] 

the VC is gonna go well, I could force them out or make them sell my shares, but now I've started the relationship with contention. Life's too short, we pass. We don't want to be known as that VC that's kicking people outta companies. It's just there's two other deals. So do a safe, and if you're an investor, you're an investor.

Help. You're an investor, don't do these side letters and start digging into the cap table because you know shipping.

Hmm.

Okay? Then write your check. Get your preferred share and then help them because you know shipping, don't do these strange things because when a VC sees that, it's just difficult to unwind that because remember, a VC has to do the math.

'Cause remember they have a portfolio. Of what happens if something goes bad. And most of the [00:24:00] conditions in a term sheet and documents are for the negative condition, not the positive. So preference overhang, uh, drag along, rights, converting preferred to common if they don't step up. These are all when things go bad, okay?

So don't give a VC as an angel. Don't give a VC an opportunity to look at all the onerous things they're gonna have to put on it, the deal, if it goes bad, uh, just keep it simple. A simple safe note. And then, um, then coach your angel invested founder. Um, great. You just closed the seed round with angel money.

Next week you're meeting VCs. Oh, we don't need it yet. Yeah, you do. You are always, as a CEO, I've been a CEO, you're always raising money forever. Doesn't matter how big you are, so get out there and start meeting those VCs to get ready.

Andrew Kazlow: Larry, I think that's such an [00:25:00] important point because the whole point of the side letters and these extra terms are to increase the upside and reduce the downside for the angel and all of this energy ultimately ends up shooting the company in the foot before they even get out into the world. 

Larry Warnock: Right, because, because Andrew, as you know, you're, you're smart and you know, I've watched you build, you know, your career and, and what you've done. Um, the last term sheet in defines everything. So if the VC looks at the structure and says, oh my God, we've gotta change all that, then they have to measure in their head, well, okay, that's gonna piss a bunch of people off.

Do we really wanna start this relationship with pissed off angels and pissed off founders? And the answer is no. It's easier to pass. It's a, a, a great venture investor from way back in the day at Austin Ventures once told me. Because I didn't get [00:26:00] this. Before I got into venture, I was an operator. Okay? And operators don't get to pass on anything. The problem is in front of you and you have to solve it. You can't say, I choose not to. I'm gonna opt out of that problem. As an operator and having to execute every problem you get has to be solved. And so when I went into venture.

I looked at every deal and I said to myself, well, we could fix that. This is a little bit wrong. Their messaging is not good, but we could adjust it because as an operator, I never got to pass. You always had to fix whatever you got. And many times as an operator, I was brought as an executive to a cat hairball.

It was all jacked up and I had to fix it, and I willingly signed up for that. As a VC, you can pass. And a VC who I have a tremendous amount of respect for, told me when I made that transition into venture, it's better to pass [00:27:00] than do a bad deal. better to pass than do a bad deal. We can wait. We have 10 years, we can, we have five years to deploy the money and five years to watch it grow.

We don't have to deploy it all this month. And as an operator, and most of your angels are probably operators. It's all about, oh, we can fix it. Well, for venture firms, if it's got hair on it or it's a mess, it's easier just to pass than dive in and try to unwind that mess. So kind of in summary, 'cause we kind of talked a lot about this topic.

Angels, keep the cap table clean. Don't do anything too fancy. Don't overthink the market, um, and stick with safes. Uh, you get an upside of typically 20% for taking that extra risk. And when the it's priced, there's not enough information to price around anyway, so it, it'd be futile to try. They haven't [00:28:00] even finished

the product or made it. So you don't know if the tech works in the TAM, so you're gonna set the price how? So the fact that there's convertible notes and safes, I'm a huge fan of that for angels. 

Andrew Kazlow: Well, Larry, I'd love to hear more about some of the specific deals in your experience that either passed on or that you went on, went in on. And maybe if you could talk through kind of how you leveraged your, uh, three Ts in each of those scenarios. What are some of the more interesting or crazy deals that you've been pitched?

Larry Warnock: Yeah, so I kind of three categories I'm gonna talk about, um, ones that we didn't do, we missed out on. Uh, ones that I did, and then I got a good story for the craziest deal ever, which we ended up not doing. Time will tell if it was the right decision or not. So, so first of all, a, a venture capital investor and an angel should not use regret as a measure.

Uh, [00:29:00] this is a science meets art, wrapped in mystery with an enigma and a crystal ball bouncing in the background. It, it, it's not an exact science. I often tell people that, you know, if it was so easy to predict where it'd going, the company would get money from Wells Fargo Bank, so it's inherently risky and unknown.

So you can't have regrets 'cause you'll win some, you lose some, you make the best decision you can. And if you have a portfolio, you then manage the portfolio for that risk. You know, you take some wild ass bets, you know, imagine when Elon Musk first told people, yeah, I'm gonna build a rocket. And we're gonna go to Mars and in the meantime, and make a ton of revenue delivering food to the Space Station and then bringing garbage back.

And oh, by the way, on the way to Space Station, I'll shoot out some little satellites to offer Starlink service to homeowners to get broadband to rural areas. [00:30:00] They're like really? Good luck with that. You just, you can't, you don't know what's gonna happen, so you're gonna miss out some things.

So, lemme tell you about, um, a couple I missed and then, you know, lessons learned and also ones that we did do. So, um.

I tried for a long time to get into a local Austin company called ICON, which is 3D printing houses, and the rounds were oversubscribed every time and never got in, and I think they're gonna be a really big deal. They've since won contracts to build structures on the moon and do all kinds of stuff. Uh, they might have to shift and jive and pivot a bit, but, uh, built a relationship with one of the founders there, but didn't get in early enough and just kept missing out is every time that a round open, it was oversubscribed. So, you know, I'm still hanging out there. And that's kind of the message is you may not get in the first round, but maybe you'll get in the third.

Of course, the pricing changes [00:31:00] substantially. But that was one that, um, I was enamored with the team. I liked the tech and I liked the TAM. Um, missed that one. Um, another one we missed is, uh, a company called StackLit. Uh, it is an open source piece of software and again, I liked the team, but I miscalculated the TAM and the tech because after we passed, they pivoted and when they pivoted to is actually working.

And if I'd gone back to my formula. I should have been more true to saying, this dude will figure it out. But I didn't. I overthought. And so the, the founders a great guy, Travis, and he's doing wonderful things. But again, the TAM, the tech often changes. So I, I missed that one. 

Andrew Kazlow: I just think that's so common [00:32:00] where an angel will go, I don't get the idea, and they just walk away without spending time with the founder.

Larry Warnock: Exactly! And, and, and again, I'm, you see, I'm, I'm kind of even flogging myself here. My message is, I was so impressed by the team. I should have just ignored the TAM 'cause they were there, but I overthought it. And, um, you know, and by the way, sometimes that doesn't work. This isn't perfect. But, um, the TAM and the tech is gonna change.

It does. Okay. So there was a deal that we ultimately got into, and so my message here is stick to it. Uh, their early seed round tried to get in it, it was oversubscribed. We couldn't get in the Series A, uh, we couldn't get in it. And then they did a bridge round, sort of a note, a convertible note that would price it the following round.

And we are able to wedge ourselves in. [00:33:00] Mainly because the founder who had built a relationship and had made some introductions for him and was helping where I could, um, you know, free of charge, wasn't asking for anything. I think he felt sorry for me. He is like, oh God, Larry, we've said no to you three times.

You've been so helpful. Thanks. I think we can let you participate in the note. If you'll agree to the, you know, the terms, you can't change 'em. The terms of the terms, someone else is leading it and so we were eventually able to get in, it was called Starfish Space, and they're outta Seattle. It's got a founder from A&M, as well as a founder from Stanford, and they're building an autonomous space tug. This is a small little device that orbits earth and will sneak up onto a satellite, grab it with this new technology with like a net or fingers, like a squid, fingers or something. They actually call it cephalopod, interestingly enough, um, and move, nudge it back [00:34:00] into the correct orbit so the satellite doesn't fall the sky.

So huge value proposition. If you have satellites, you don't want 'em falling. They eventually all. Unless you keep refueling and refueling the satellite's really hard, so unless you keep nudging it up, it's eventually gonna fall into the ocean. So we loved the idea, we loved what they're doing. Loved the team and I couldn't get in and it just, it just, but I stuck to it and eventually they did let us in and we got good terms and they've since have added capability.

For instance, you know, as they grew, 'cause we would've never seen this and they weren't articulating it, they're now not only gonna deploy these fingers to grab a satellite and move it up, but they've got this new net technology to collect space junk. Collect space junk, ball it up, drop it into the Indian Ocean.

Well that's huge because if that space junk hits a [00:35:00] commercial or defense satellite, it's a really big deal. So that was never in the story. So again, tech is tech to the TAM squishy person a hundred percent. I watched these founders over the course of two years, execute, execute, execute. It's like, whoa. And I just kept chasing them and they finally let us in.

Andrew Kazlow: And I'm hearing you speak, I'm hearing you speak in that again to the

importance of value add, give first, right? Contribute. You have to earn your way into the best opportunities.

Larry Warnock: Right, right. Um, another couple examples and, and stop me if I start to drone on, um, I wasn't responsible for the investing in it, but um. I first didn't see it. Eventually it did, but I was at the firm that invested, but it wasn't my deal and it became game changer in the economy. Um, [00:36:00] and I think back, if it had been singularly my decision, I would've probably passed and that would've been a mistake.

And that is a company called HomeAway here in Austin, Texas. And HomeAway was funded as a rollup, almost looked like a private equity deal to go buy, um, home listings for rent, you know, vacation rentals by markets. So they went and saw who's rents the most in Hawaii by that company. Who most rents the most in the US Virgin Islands.

Rent that. Who Mo rents the most in Florida? Who rents the most in foliage country and Maine. And they took a bunch of capital and bought all these companies and made a common platform. Well, if you know your history, HomeAway merged with VRBO. VRBO was acquired by Expedia. Huge financial impact, but the first story about[00:37:00] 

taking $230 million to do, to buy mom-and-pop operations around the world. I don't know if I would've done it. And I know the vent, the VC that did do it. And if you were to interview him, he would say it was because of the guy, the team. We didn't know if that was gonna work, but we knew he would make it work.

'Cause interesting story when they originally pitched, 'cause I was in the early pitch meeting. Um, it wasn't to rent the homes, it was to buy them. They were gonna make a fractional ownership play where they would go buy all these vacation homes. You'd pay as an individual a, a fee to be in this club, and then you could have access to these homes.

And he, the founder, came to the conclusion, the money is not in owning the home and trying to get upside from the equity. It's to aggregate all the homes in one place so that consumers can shop and do vacation rentals. So again, [00:38:00] the TAM and the tech evolved, but the founder did not. And if you were to ask Phil, uh, who led that deal, I'm sure he would say it was my confidence in the founder.

Okay. I've got one more deal that I'll share with you. That's really interesting. I think this one actually, I was the CEO of, so I stopped being a VC, went into the operative side, and then later went back into VC.

Andrew Kazlow: Okay, so you took a pit stop for this one. 

Larry Warnock: I took a pit stop. It was funny. My mom was living at the time. She was so worried 'cause she just thought I couldn't keep a job.

It's like, no, no mom, this is, it's okay. Like we sell the companies. I get paid. It's okay. Oh, but you wanna have a job. I don't need a job. We're okay. I had to always explain to her that it wasn't that I couldn't keep a job. So I went into a company called Gazzang, um, and we then raised money immediately and started to grow very, very quickly.

And then the market [00:39:00] fell out from under us. It was classic crossing the chasm. We were doing fine and then we weren't. And it turned out that we didn't really pivot. We just sort of adjusted. So we had so security software to secure database and that we were focused singularly on the MySQL database and the market just stopped.

We were like, what? Why are people not buying it? Come long story short, come to find out, at that time the big data engines were becoming popular. Um, like Cassandra and like Hadoop, um, and these other open source big data stores. There's a whole period of time when big data was a new term and no one understood what that meant.

Now it's default, but. We simply listened to our customers and adjusted and extended the platform to offer the same level of file level security for all of the [00:40:00] newfangled next generation databases, none of which had very robust security. And then we were within a year acquired for a very nice multiple because we had this cross-platform capability.

And the reason I'm bringing up that story, Andrew, for your angels, is, the original TAM and tech was singularly focused at MySQL, and we thought that was gonna be good enough, but it turned out it wasn't. But we as a team had the real, the resiliency and the ability to modify the platform and the message to go chase something that was

ancillary. It wasn't a total shift, it was a little bit on the side. So you wanna understand the TAM, you wanna understand the tech, but it was myself and my team and I give my head of development all the credit, quite frankly. 'cause all I did was ask him to extend it. So that was my contribution is you need to extend it.

And we got three months. That was my [00:41:00] contribution to the decision. And then the, the dev team did it and was phenomenal. And that got us exited at a 14x multiple. Um, so it all, it all worked out. 

Andrew Kazlow: I'm curious from that experience at at Gazzang specifically taking a few years out of VC and then coming back into the VC role, what are a couple of lessons or takeaways like when you look at that season coming back into VC, what, what changed in your approach to investing thanks to those few years? 

Larry Warnock: First of all, I like VCs that have somebody on the team with some operational experience, uh, 'cause it's just more valuable with the feedback they give you. 'cause it, it doesn't help a lot when you're sitting around the board table and a VC says, well, I think we need to increase revenue and decrease expenses like oh.

Really? Thank you. I'm gonna write that one down. Brilliant. Like, okay, how, finish the sentence. But, so I, I like, [00:42:00] um, I gravitate toward VCs that on the team has some operational experience, what I learned and how I operated differently. I guess. I, I, there was a lot of things, but let me just give you a nugget or two.

I shifted as an operator to understand that in the VC's mind, there are a set of objectives for that round, and they want you to singularly focus on the set of the objectives to get to the next round and to not get ahead of the headlights and try to build the next great, fantastic software company.

It's do the milestones that get us the Series A. Then when we get it, get rid of all the things you were working on. Stop. What do we need to do to get the B? And that's what you're focused on. Build the company to focus on the B. When we get to the C and beyond, then we're gonna worry about, worry about EBITDA, positive profitability, sustainability.

But you know, for an angel or a [00:43:00] series seed investor to ask a company about, um, cost of customer acquisition or renewal rate is ridiculous. Those aren't metrics for that early stage. Early stage is get customers prove product-market fit. The seed round is to help you get closer on product-market fit. The A is to lock that in and then after the A, B, and C, D is to build business around that, that's sustainable.

And so that was new to me after being a VC, becoming an operator. When I'm talking about one day when we do such and such, they're like, no, and I'm gonna, I'm gonna be, um, to make my point, I'm gonna be a little bit more flamboyant than actually happened. But, um, as a Series A CEO, in the board, we never talked about EBITDA, it never came up.

It did not, that was not important for the B, [00:44:00] it's top line. What is your annual recurring revenue, ARR? This is the ARR bandwidth you need to get to on your seed money, on your Series A money and lose money on every deal. That's okay. That's okay. So it got me in tune with the way VCs think. 'Cause VCs see, see growing companies in step functions with the round funding something specific.

The Series A round is not getting SpaceX to Mars. It's getting the ability for those legs to come out. Not even land just come out explode. Series B, we now want the legs to come out and it to land without exploding. Got it. Series C, now we wanna do it and take something to orbit. So if they had been focused on all the things out there in the future, those are important and, and a good CEO has the [00:45:00] vision and gets the employees on board with the vision.

But operationally, um. Please, angels don't demand that your seed check gets them to profitability. Um, too much to ask for a tech startup.

Andrew Kazlow: Super helpful. Okay, so tell me about this crazy deal that you passed on. 

Larry Warnock: Oh, okay. Yeah. Yeah. I said I would a little bit of a setup, so I'm at a, uh, restaurant with my wife and I saw a VC over the table that I know, Hey, come on over. And I walked over and he was having dinner with, uh, a founder and my wife's standing there and I'm being polite 'cause she doesn't like me to die too deep in the deck.

Just like, really? Can you do that tomorrow? So, um, we chatting and he goes, oh, you need to meet this guy. You gotta hear this deal. It's amazing. You gotta do it. And I said, well, can you tell me about it? He goes, no, let me get on your schedule and we'll do that later. I said, okay, fine. So a week or two goes by, I get on the schedule, I get on the call.

And they start out, the head slide [00:46:00] is using CRISPR technology, we are gonna recreate the woolly mammoth because we have got DNA from a woolly mammoth out of the tundra. And we're gonna put it inside of a pregnant elephant, an African elephant female, and we're going to bring back to earth the woolly mammoth.

And then the next slide is they were gonna do the same thing for the saber tooth tiger. And what's going through my mind is, this is a joke my buddies has set me up for this, and all that's going through my head is, have you not seen Jurassic Park? You know, what? And, and, and then by the way, is there a big market for woolly mammoth?

Is the meat good? You know, are we gonna kill them? You're gonna create it and we're gonna eat them. This is what's going through mind. I was polite and I'm listening, and I literally, six slides in before I finally stopped him. I said, you're serious, aren't you? He goes, I'm dead serious. I said, this isn't a joke, and this is not a joke.

[00:47:00] And I said, okay, what's the end game? You know, are you gonna sell them to Disney World and have these woolly mammoths walk around or zoo? He goes, no, we are gonna use the CRISPR technology to attack genetic diseases like hemophilia, Parkinson's, blah, blah, blah, blah. And the, we've determined that if we can prove we can edit genes to bring back an extinct animal, then investors will believe we have the ability to edit genes to kill these.

Um. To, to change the course of these diseases, noble cause. Uh, we did not invest because I felt they had way too much attention on the wooly mammoth. But it was crazy. I literally, for the first six slides, thought it was a joke. And I was just keeping my mouth shut. Like, you know, and, and, and the questions just write themselves, what if it gets out?

What if the tiger eats the elephant? What if, you know, you can just, so this is what's going through [00:48:00] my mind. But it was a serious pitch, but it was crazy. I've never seen anything crazy. We passed, they since have raised a ton of money. Um, they've focused less on the woolly mammoth and now more focused on the disease and I'm sure they'll have, um, success and, um.

But that's gotta be the craziest and we're gonna recreate the woolly mammoth. It's like, wow. Okay. So that was zanious one.

Andrew Kazlow: Amazing. Well, maybe in a few more years.

Larry Warnock: Yeah, exactly. And, and by the way, they may end up again, you know, if I was perfect at this stuff, I'd be, I. I, I own Lanai Island, not Larry Ellison. So, you know, I, there's, uh, you make you win some, you lose some, but there's some really interesting ones and that, that kind of takes me to something ' cause you and I had, when we chatted a little bit about this, so I'll go back.

So I know you haven't asked me yet, but I'm, I'm gonna go there 'cause I wanna make sure it gets in this, uh, video. [00:49:00] Um. There's some VC investment trends right now, and some of 'em surprise me, but in a good way, and I wanted to share with you what those were. So things come in and outta style with VCs and angels should understand that it takes some time to do the research, you know, from NBCA or whatever it's called, to see what categories are in getting investments.

Because as an angel investor, a VC most typically is gonna have to come behind you and get excited about the market space. So, you know, Wayne Gretzky skate to where the puck's going to be. That's his secret to success is look at where the trend lines are going of VC investing and what industries and those are good industries to jump into for an angel.

Um, and, and, and don't be behind the wave. Like for instance, right now, AI. Well, [00:50:00] AI platform investing is pretty much over. That was about five or six years ago. It's now application of AI engines, platforms, um, LLMs, large language models to a very specific business problem in a vertical. That's hot right. So if you find AI applied to a specific line of business or a vertical with people on the team that have a deep understanding of that vertical, that is a good area and it's trending. If it's just a generic AI platform, it's like good luck. You're competing with Microsoft and Google, you know, Open AI. The platform play has been taken out.

You should have done that six years ago. Another thing that's interesting to me, and I wouldn't have forecasted even eight years ago is hardware is hot again. Silicon chips, silicon. You know, fabless, SEMICON are getting investment and that's singularly because of Nvidia. Nvidia, um, is now more [00:51:00] valuable than Apple.

I think I read that this week and they're gonna acquire a ton of stuff. And remember, VCs know most exits are acquisition, not IPOs. So you've got AI driving a chip set called A GPU, which is a graphic processing unit, which is basically an ancillary chip to the CPU that helps with other processing, and it just so happens it's very, very good.

At, um, inference and probability and, and using, doing things like AI. Okay, but that's not what it was designed to do. It was for a game box. The GPU from Nvidia was to paint real time better color graphics on the screen so the CPU wasn't dragged down with image presentation and pixel management for video games.

When they came out in 2001, it was a chip for gaming consoles. Okay. So it evolved. Well now because there's this whole new [00:52:00] category of chip sets and they still call 'em GPUs, although they're not doing graphics, the name is just stuck for whatever reason. There's this whole new set of chips that are being built that are purpose built for very specific things, doing AI processing on a mobile, doing AI processing in the cloud, you know, whatever it happens to be.

So hardware, it is back and surprised me. You used to be able to invest in hardware you used to. It used to be. Don't do it.

Andrew Kazlow: When you say hardware, it, what I'm hearing you say is, uh, the physical element that enable AI scale. 

Larry Warnock: Yes, that's one. So silicon chips that enable AI or silicon platforms, 'cause you stack a bunch of GPUs together, they generate a huge amount of heat. How are you gonna heat it? But then all the downstream hardware that comes from that. So I just visited a company last week that is working on micro reacts to provide [00:53:00] atomic energy for data centers. And it has VC funding. If you had told me eight years ago that you could go raise VC funding to build a reactor about the size of a small car, that will go on the corner of a data center with a uranium powered unit. With the, you refuel it once every 25 years, kinda like an atomic sub. Um, it uses the same technology that are in research reactors on every university.

You know, I, I'm an Aggie, as you are. A lot of the students don't know there's a reactor on campus. It's right next to the water tower. It's been there for, since I was there, so a very long time. So this technology that's used in research reactors is the same fundamental technology. So it's very safe. It, it's on the campus at TCU.

There's, there's a reactor in Fort Worth. There's a reactor in Houston. There's a reactor in College Station. They've been there for 20 years. So, but if you had told me that, that that would [00:54:00] happen. So what's interesting is these reactors, Microsoft just bought three Mile Island to bring 2024 technology to reopen it.

Okay. It's because of the data center, because of AI. So you can look at the chain of how the decisions are gonna be made. And then finally on that, the other one that is, is a surprise to me, but I'm excited about it, um, is advanced manufacturing for defense and aerospace. Um, again, 10 years ago you wouldn't see that, but here in Austin there's a company that's making an autonomous boat.

You know, it's smaller than a ski boat and it's for the Navy. Uh, I have an investment in Venus Aerospace outta Houston, which is making an rocket engine that potentially can go Mach 8 and 9. Uh, the Starfish Space is a tug that orbits and all of these companies are manufacturing their [00:55:00] stuff.

They're buying lathes and welders and you know, advanced manufacturing and that's the future of manufacturing the US, not stamping out rubber ducks, 10,000 units per day. China can keep that. But this advanced man manufacturing, highly skilled, it's gonna create a lot of jobs, it's gonna bring a lot of business back to the US and VCs are on board.

And that's surprising to me. So, you know, these companies are raising venture capital money to build highly specialized manufacturing facilities for. Uh, defense purposes. You know, defense is popular 'cause you know, we've got two wars going on right now. People are like, oh, you mean wars not over? Like we might have it wars with us for the rest of humankind, but now it's top of mind, so it's getting money.

So, uh, I'm starting to ramble, but. Um, those categories are back, and let me message that back to your angel viewers here. Spend the time to research what are the hot categories over the [00:56:00] last quarter, and compare that to two or three quarters before to try to get some trends of what VCs are interested in.

And when you make your angel investment estimate, get in front of 'em. So you wanna get hit by a train, lay on the track. Where are they going? Where is the venture community going? That's the track you should get on. 

Andrew Kazlow: Well, Larry, any final thoughts or comments? Uh, I know we covered a lot, but any other comments? 

Larry Warnock: Yeah. Okay. Some of your angels are also gonna have the opportunity to invest as an LP in a fund. Okay. And a lot of funds guilty as charged, talk about a, a metric called MOIC, multiple on invested capital. It's a good, it's a good metric. The real metric you should look at is DPI, which is distributions to paid in.

That shows that the, what you've invested in is actually coming back distributed, you know, after the carry and [00:57:00] everything else, and that those funds have a track record of returning actual capital to the investors. Young funds won't have a DPI number yet. But the LPs should ask for that. Those investors track record.

What did they do before? Well, they've never been a VC really. What'd you do? Well, I mowed lawns. Hmm? Not sure. Not sure I'm gonna be an LP in your fund. Although there's nothing wrong with, I've got a neighbor two doors down that is a multimillionaire 'cause he owns a lawn care company. So there's nothing wrong with lawn care, but I don't know that the relationship to VC is there.

So look at DPI. Also, kind of the dirty little secret of venture. Most all of the returns you read about is in the top quartile or top two quartiles of performance. If you add in the bottom bottom two quartiles of venture, it doesn't beat the S&P. It just doesn't. So, [00:58:00] and then if you look at the S&P, the index funds tend to perform as well, if not better, as the individual pick.

Okay? Um, so if you're gonna invest in a fund, you wanna make sure that funds track record as they've been in the top two quartiles of the past performance. And if they don't have those numbers yet, wait, don't take the risk. Continue to do angel investing. Um, but be aware of that. That's the venture capital industry is amazing, you know, 16% and North annualized return for the top quartile.

So do your research before you, uh, invest in a venture fund. Um, and I think, I think that's it. 

Andrew Kazlow: Larry, I think we can wrap there. Um, this has been fantastic. Thank you so much for your time today. 

Larry Warnock: Cool. Andrew, love what you're doing. Keep it [00:59:00] up. Um, valuable asset for angels out 

there.

Andrew Kazlow: Thanks for listening to this episode of The Diligent Observer. I'm your host, Andrew, and if you're an angel investor looking for essential angel intel in five minutes every week, I think you'd enjoy my newsletter. I send my best stuff, interesting deals, and more straight to your inbox so you never miss a thing.

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