Announcing Character, my new VC firm (plus some reflections on investing and hippos)

December 3, 2021

While living in Botswana’s Okavango Delta at nineteen, there were two lessons I learned quickly: Keep the toddler away from crocodiles, and bring an extra pair of long johns. The first came from my primary task as an au pair and occasional filmmaker’s assistant. The second was a diurnal regret as I shivered through each night in the bush. I learned both lessons the hard way — and both have stuck with me across the decades.

Now, this is a rather strange way to introduce a new venture capital firm. I am supposed to start with something like this: 

I am excited to announce Character, my new venture capital firm with John Zeratsky and Jake Knapp. We are bringing human-centric capital to seed-stage investing using the Design Sprint. Get in touch with us here! (Web/Twitter/LinkedIn)

However, this is my own slightly odd take on that introduction. Thanks for sticking with me. (And please go read John’s elegant post for a more conventional announcement.)

With the launch of our new fund I’ve been thinking about my time in the Delta, and how it has influenced my career journey more than I could have anticipated at the time. I don’t want to obfuscate the work we are doing now with boring personal history, but I think it’s only fair to share the foundation which led me to (eventually) co-found Character.

There is a sensible reason for this: After hearing thousands of pitches over the years, I have learned that founders who share their authentic and intrinsic motivations are simply better to work with. An authentic mission binds people together better than a slide deck ever could, and it forms the basis for meaningful partnership. 

So, if you are a founder thinking of working with us at Character, I want to be super transparent with you about my why.

To that end, I wish I had the usual entrepreneurial story: Scaling my childhood lemonade stand before learning to code in BASIC and realizing I was a natural for the startup ecosystem my whole life, and thus that’s why I’m doing it, QED! 

But the truth is, I had no idea. The short story is that I was born in Lexington, Kentucky to two moms. I liked nature and spaceships growing up. I spent the second half of my childhood in Pittsburgh, Pennsylvania and worked at a Subway. I never thought about startups until I was 19. And much to my family’s chagrin, I wasn’t that excited about going to college. 

My reluctance to continue school was based on an idea that I had become enamored with: that the only way to genuinely experience reality was through first-hand experiences. 

I didn’t want to sit in lectures; I wanted to see and experience things for myself. 

Into the Wild

Instead of going to college, I searched the internet and found a gig as an au pair and videographer’s assistant for a film crew on an island in the middle of Africa. If I was searching for a raw way of interacting with the world, what better place to do it than in the wilderness? Thus the stage was set to evaluate my philosophy in situ. 

On the ground, the reality was quite different than I had imagined. The clarity and purpose that I thought would materialize never appeared. One night in particular stands out: After a long day chasing a toddler and setting up for a shoot, I lay freezing in bed. I was kept awake by the sounds of hippos shitting (it sounds like a machine gun, by the way) and decided to get up for a stretch to warm up.

Puffing around in the dark, I looked up. The stars were at first dimmed by a passing whirr of insects, but then became perfectly clear — a million glowing pixels upon the velvet-black expanse — and I began to reflect on my time in Botswana.

I had come with the hypothesis that high-fidelity experiences (i.e. being there) would provide meaning. But in that moment, I realized my approach was flawed. I had sought to understand the world through individual experience alone, but the difficulties and joys I faced in the wilderness were fundamentally meaningless to the broader world.

I realized that passing from one experience to another without making a mark on the world was, frankly, a waste. I won’t argue this is true for everyone, but on that night I felt compelled to contribute to creation, and to do that as part of a community — not alone in a far-flung corner of the globe. 

Soon after, I made my way back to the States, went to college, and enthusiastically explored how I might serve this purpose. I thought about art, the Foreign Service, and a number of other paths to pursue, but nothing seemed exactly right. In my junior year, I attended a talk by a partner at a local venture-capital firm. I was captivated by the concept of being a VC, and I convinced the firm to take me on as an unpaid intern right there on the spot.

Venture Days

Working as a VC was a natural fit. I never quite had the inspiration to become a founder myself, but I have always been interested in a lot of different topics. Startup investing gave me the opportunity to learn about different industries while supporting founders as they built amazing businesses. And there’s the speed. Some days I had the impression I was watching the future happen, right before my eyes, in real time. I was hooked.

In my apprentice-like role, I also got to work on virtually every aspect of the VC business — first by reviewing thousands of interesting startups, later by deeply analyzing those companies, and eventually by investing in a few and joining their boards myself. (By 2015 I had been promoted to General Partner in our latest fund.)

But my favorite part of being a VC is meeting with founders. Without fail, they are fascinating and smart people who decided to take risks and make something new in the world. 

Among the investments I made, some highlights were working with people like Eric Horler, a repeat founder and experienced healthcare executive who teamed up with a wonderful pair of scientists to algorithmically evaluate treatment response in oncology patients. I invested in AIQ Solutions after being shocked to find that so many treatment decisions for cancer patients were not based on quantitative data.

Similar to Eric, Patrick O’Rahilly is a repeat founder who sold his last business to Tesla. In running that business, he saw how hard it was to find and hire skilled manufacturing employees. He started FactoryFix to build the best platform to connect manufacturing workers with manufacturers. This was a clear, compelling solution to a staffing problem that LinkedIn alone could not solve.

I was fortunate to be introduced to Ben Forgan by an angel investor in Chicago. Ben and his co-founder Pat Wilbur had a vision to make IoT connectivity seamless. At the time, there was a big debate in the industry about whether other wireless protocols would supplant cellular for IoT, but Ben and Pat’s clear foresight and strong execution were apparent even in the early days. Hologram was one of my best investments.

Finally, Anders Norremo built ThirdPartyTrust to help vendors quickly interface with suppliers without the hassle of sending a million emails back and forth. Anders is a relentlessly scrappy CEO who sends excellent email updates, which allowed me to finally catch-up with him and understand the opportunity after meeting him a year or so prior. 

In each of these investments I was grateful to the founders for allowing me to work with them, and for giving me the opportunity to support their vision, in some cases as the lead investor. 

I took my role very seriously. In every interaction, I thought deeply about what I could say or do as a committed investor to truly help these founders succeed.

But I found that my ability to contribute — even as a board member — had limits. We could address and understand problems together, but we couldn’t solve them in a board meeting or phone call.

These early experiences as an investor helped me codify a belief that I think about every single day: VCs have a responsibility to provide founders with support that is net positive, no matter what — even if that means writing a check and stopping there, recognizing that additional “value add” may not actually, in fact, add value.

I’m Helping! (Right?!)

One experience in particular helped me see the not-so-fine line between “value add” and “value destroy.” In 2012, we invested in a company developing a novel scientific device with the power to transform several major industries and make life better for millions of people. Exciting stuff, obviously. As a hardware product, it required exacting verification and validation to confirm that it would work as intended. When we first invested, we expected this work to take about a year and cost $1 million. Well... as these things sometimes go, suddenly it was three years later, the company had raised more than $3 million (not all from us), and tens of millions more were likely needed.

As a diligent and eager investor, I jumped in to help the CEO. We went back and forth, and back and forth again, through hundreds of iterations of a financial model. Tweaking COGS, the contribution margin, making downside scenarios, upside scenarios, etc. I would go to bed and dream that I was still in Excel, doing more modeling! Seriously! Come on brain, cut it out!

It’s obvious now, but these projects did not help the company solve their problems, which were scientific in nature. Meanwhile, we burned a bunch of the CEO’s priceless time on these back-and-forth exercises. Even then, it was hard to understand how exactly changing a number on a spreadsheet was changing the company. It turns out it wasn’t!

The line between VC value-add and value-destroy can be hard to spot, especially in the moment. It’s sort of like the Kármán line, which marks the start of outer space. One minute, you’re flying through the atmosphere, being helpful, and then you’re drifting in outer space, leaving the CEO back on earth scratching their head or cursing your name.

This situation gnawed at me for years. And as I worked with other VCs (some of them quite successful and reputable!), I saw them face similar challenges. Their value-add playbooks and heuristics, well-meaning and based on meaningful experiences as former operators or investors, were not always the best tools for helping a startup succeed. 

Character

In 2019 I met John Zeratsky through a fortuitous introduction from my wife. John had spent the past six years as a design partner at GV. His role was very different from the one I knew as a traditional VC investor because his focus was on helping companies after GV made an investment.

John had worked closely with Jake Knapp at GV to develop a process called the Design Sprint. The concept boils down to this: In five days a startup can prototype and get customer feedback on an idea before building it. They had also struggled with the problem of how to best support startup teams, and the Sprint method was their solution. They had led Design Sprints with more than 150 of GV’s portfolio companies, including some massive wins like Flatiron Health, Blue Bottle Coffee, and Slack. (If you’re interested in reading more, check out their book or website about the process.) 

As John and I began to talk, we realized that there was a natural alignment between our skills and experience. 

I was a classical VC investor, and had learned just about every facet of the VC business, but had struggled to find a model for deeply supporting portfolio companies over time. Meanwhile, John had spent the last six years focused specifically on helping founders validate and grow their businesses with the Sprint method, and had fine-tuned this model with the GV portfolio. Wow! 

We decided to team up and quickly realized that Sprint was not just a way to be helpful to startups after we invested, but it was also a differentiated way to meet founders (who were interested in the Design Sprint) and earn the ability to invest (by promising to run sprints with their companies).

I was excited and relieved to have an approach for not just investing in companies, but contributing to their success beyond making introductions and giving advice. 

And, in my own small way, I gained clarity about the revelation I experienced in Botswana all those years ago. Here, with the Sprint method and our new VC firm, was a clear way for me to engage in creation — and to actively support the founders I find so inspiring. 

I believe that the Sprint method is the best way to support startup founders. It’s not the only way, and it’s not a panacea, but it’s a format that enables investors and startups to truly collaborate on solving problems together. And that’s powerful. It will always be the founder who has the deepest knowledge and the best ideas, but if we can help them surface and validate those ideas with speed and focus — that’s a win.

That’s why we’ve built our new firm, Character, around the Sprint method. We still do all the normal investor stuff (introductions, advice, board service, etc), but we want to be the first call when a founder faces a big problem that’s keeping them up at night. Let’s run a Design Sprint! In five days, things will be much more clear.

And thus:

I am excited to announce Character, my new venture capital firm with John Zeratsky and Jake Knapp. We are bringing human-centric capital to seed-stage investing using the Design Sprint. Get in touch with us here! (Web/Twitter/LinkedIn)

Alright, that's the announcement you were promised 😎

Startups and Category Theory

I miss the big data days.

For a few years I received an onslaught of pitches from startups in the space – sometimes “big” wasn’t even big enough and we’d get into superlatives to describe just how enormous it really was.

Then, quite suddenly, big data had its own K-T extinction event and the ML/AI mammals crept out of hiding to rule my inbox.

But if we step back there’s an interesting connection between the two: the build-out of big data primed the ability to do interesting things with that data. I think of this dynamic as one part of a slow march to a world that will be understood through category theory.

Category theory (CT) is sort of the Agamemnon of mathematics, a king-of-kings in the field. With CT it is possible to find patterns among whole realms of mathematics. There are many beautiful things you can do with CT – like proving a topological theorem such as Brouwer’s Fixed Point Theorem by porting it into algebra. Tai-Danae Bradley explains this much better than I could here.

My theory, very non-precisely and unmathed, is that the big data/AI dynamic can be thought of as focused on morphisms within a category and most companies are only concentrated on a limited slice of that. The next few years could be interesting if startups broaden their framework, and start to address IT with things like functors, which define the relationships between categories. (I say this with many apologies to real mathematicians for my inexact descriptions and worse).

A few other people have been interested in this topic – I know Conexus was evaluating early-stage companies in the CT space, but I’m not sure if they ended up making investments. I would also argue that Golden fits here with their self-constructing knowledge database.

If you are a startup or investor doing something interesting related to category theory I would love to chat!

Techne – A Midwestern Marvel

It’s Tuesday. Let’s talk GOAT.

If you’re a startup founder you are probably concerned with raising your next round, demonstrating traction, and positioning your company to be acquired. The way you measure and plan for those events is often based on metrics. There are a lot of metrics out there, but today I want to focus on only two: revenue and profitability.

Starting in the late 1980s Minneapolis-based Techne had a track record of profitability that would make Apple blush. From 1991 to 2012 Techne had net profit margins that averaged 26%.

That’s high. Really, really high.

I’m going to focus on the “golden years” from 1985 to 2012 when Thomas Oland was at the helm. (Techne is now called Bio-Techne and doing interesting things, but I’m not familiar with the recent history).

How did they do it and why is it relevant to start-ups today?

History

Techne was started as a shell company in 1981 by local venture capitalists George Kline and Peter Peterson. The shell was private, but had goals akin to a special-purpose acquisition company (a “SPAC”, which is back in vogue these days); went public in 1983, and acquired a firm called R&D Systems in 1985.

R&D Systems was the actual operating company that would come to define Techne, but the late 1970s and early 1980s had not gone well. R&D Systems offered products that precisely measured blood samples for laboratory tests, but was struggling from a lack of strategy and deeply in debt. Roger Lucas, one of their executives, reached out to an accountant named Thomas Oland to help right the ship. Eventually Oland became CEO and George Kline and Peter Peterson were impressed enough to acquire the company.

The cost? $1.9 million.

So What Did the Company Do?

In some ways Techne was the paramount example of selling shovels during a gold rush.

The 1980s and 1990s were the dawn of companies like Amgen that developed biologics – i.e. drugs that were created from biological, rather than chemical, sources.

One of Techne’s early insights was to develop the first commercially-available cytokines (short-lived proteins that serve as intercellular messengers) that were in very high demand by laboratories and biotechnology companies. Techne continued to devote resources to R&D over the years, developing new ways of producing their products without solely relying on vendors for human blood and tissues, among many other advances. The Company also acquired a number of companies which brought new products into the fold. Although Techne divided their business into two segments (biotechnology products and hematology calibrators and controls), the vast majority of revenues came from the biotechnology division.

Essentially Techne sold the shovels to help labs and biopharmaceutical companies develop a whole new field. Because they were suppliers of research products rather than drug developers the Company escaped many of the difficult regulatory and developmental barriers that plague pharmaceutical companies.

That Sweet Printing Press

The results were super-fantastic:

Techne’s strong leadership and continued ability to innovate enabled them to return world class results. For the annual reporting period that ended in June 2012 they also had a fortress-like balance sheet: $720 million in assets and $45 million in liabilities. This Company was thriving by any metric that a VC could deploy.

Sharp local public equity investors took notice starting in the 90s - Steven Crowley of Kopp Investment Advisors initiated coverage of Techne when it was valued under $100 million in 1995 and they owned 14.1% of the Company. (Kopp Investments shut down in 2019 when Lee Kopp retired after a storied 60 year career…not bad!)

This is How They Did It:

• Thomas Oland was a first-rate manager. A friend who knew him says that he was “absolutely brilliant.” He was also a hardworking guy – at one point he was Chairman, President, CEO, CFO, and Treasurer. (Sadly he passed away in 2013 shortly after leaving Techne).

• Techne developed a string of differentiated products that required unique insight to conceive. When they developed their first cytokine, transforming growth factor-beta (TGF-beta), it was sold at the equivalent of $9 billion an ounce. That probably led to some interesting unit economics...even if Techne never was a SaaS company.

• The Company focused on a sufficiently large market, and executed beyond all expectations. Techne never strayed from its strong technical origins and developed a slew of products in a specialty area. Could a startup today resist the temptation to use their expertise to compete in the drug development game? I think it would be tough.

Why Is This Relevant to Startups Today?

A strong business can generate awesome revenue and profitability, but showing strong sales does not necessarily indicate a great business. Revenue can be bought relatively easily so it pays to think carefully about the foundation of your business. The paths that a solidly conceived business, with truly differentiated products, can take are many. Techne's remarkable revenue and profitability speak to this fact. The startup that exists primarily on purchased revenues has far fewer options.

Sources:

-With a great deal of debt to: http://www.fundinguniverse.com/company-histories/techne-corporation-history/

-10-Ks from 1995-2012

Due Diligence

If you’re an entrepreneur those two words often precede waiting. (Sometimes a lot of it!)

VCs don’t mean to be opaque, but the highly subjective nature of early stage investing seems to encourage murky processes. It’s like saying “I’ll know magic when I see it, but first answer 400 questions so I can tell if you’re a wizard.” My personal philosophy rests on one concept: transparency. I believe that being specific and upfront is a great way to build trust with an entrepreneur. I try to give the full picture - along the lines of “my colleagues don’t quite believe in your customer acquisition strategy and I am still analyzing the spreadsheet you sent me last week” rather than “we’ll talk about it at our Monday morning meeting.

More on LinkedIn here.

Light Guide Systems – Investment Process and Rationale

[Update September 1, 2020: Light Guide Systems was formerly known as OPS Solutions. The post below has been lightly edited from the original in January 2017.]

OPS Solutions produces an augmented reality solution for manufacturing employees.

2016 System Architecture

How Did I First Connect with OPS Solutions?

I cold called Paul Ryznar (CEO of OPS Solutions) after seeing OPS on a list of attendees at a conference in Michigan. The deals I see can be approximately split into three buckets with different quality characteristics:

• Sourced from my network: 25% of deals annually, 75% high quality and 25% low quality

• Sourced from trade shows/conferences: 25% of deals annually, 10% high quality and 90% low quality

• Sourced from research/thesis driven: 50% of deals annually, 5% high quality and 95% low quality

OPS was one of the rare, high quality companies from the “research/thesis driven” sourced category. (I included them here instead of the trade show category because I did not meet them or hear the pitch). Like many venture firms we prize referrals from our network because they often pass along high-quality companies. But I personally love cold calling new potential portfolio companies. It strikes me that if everyone focuses on investing with friends or friends-of-friends it must encourage regression to the mean.

Initial Research

I started researching OPS in December 2011. I looked at Paul’s background (knowledgeable in the space – positive), the Company’s performance (some revenue – positive), and the competition (including pick-to-light which suffered from enormous limitations and delivered questionable value – also positive). After determining the idea might have some legs I reached out to Paul in March 2012. For some reason Paul decided to take my call, and have several follow-up calls with me alone. This was unusual because (1) Paul was not raising money and (2) I was a lowly analyst with little understanding of the manufacturing market.

I was becoming more and more excited about the company. I pestered my boss, one of several at the time, Alvin Vitangcol to meet OPS and he connected with Paul in mid-May. Alvin had a very positive meeting and diligence was proceeding smoothly. Then we spoke with some of our close advisors and experts. They had a problem.

Robots

Our advisors believed that robots do everything and that soon no one would really “work” in a manufacturing facility in the United States anymore. Two graphs seemed to prove their thesis:

So what to do? One of the most important aspects of venture investing is clarifying what is true. It sounds stupidly simple. However; it is entirely possible to base an investment decision on a belief about the world, and then how a company will change it, and end up failing, not because of how the startup tried to change the world, but because your belief about the current state of the world was wrong.

I started calling and printing 10-Ks.

More Cold Calling

I cold called small manufacturing shops. I cold called snowmobile makers. I cold called large public companies. I spoke with people who had no horse in the race about whether the fund should try to invest in OPS. A lot of people hung-up on me, but a surprising number of them were willing to chat. Over-and-over they told me the same thing – robots do a tremendous amount of work in factories, but there are still people doing manufacturing and there is not a great way to automatically ensure quality, improve cycle times, and gain visibility into the process.

I then went through every company in the S&P 500. I identified 113 companies that had a service or product that involved a manufacturing process with some potential relevance to OPS. Then I counted their manufacturing facilities and searched for any and all information about those plants. For these companies I kept coming back to the same questions: how many manufacturing employees are there? Can I identify plants that could use this product? What can I learn about these plants and their automation deployments? Part of the summary spreadsheet:

I then looked at major Wisconsin companies and created a separate spreadsheet with the contact information and automation status of specific plants. These would be diligence sources and potential customers. The results were clear: robots play a huge role in the manufacturing process, but there is still work being done by people, and there was potential for OPS to sell into this market.

Trends

After conducting full diligence we ended up investing in OPS Solutions in October 2012. A major reason we invested was because we could credibly answer the question of whether humans had a role in the factory versus complete automation. There is also an interesting angle if you think about OPS Solutions from a trends perspective.

What does this company really do? It is an augmented reality/virtual reality play for any manual process. Our investment thesis was not predicated on “virtual reality” becoming a trend, but it did: 

Source: retrieved from Google on January 5, 2017

Capital Midwest does not invest based on trends, but we have found that many of our successful companies end up in the vanguard due to a combination of technology advancement and customer-oriented product development.

Summary

The team and product at OPS have grown tremendously over the past six years. The features of the Company are ones I hope to find over and over again:

• Management – honest, results-oriented, and knowledgeable about their industry

• Product – validated with revenue from an arms-length customer transaction

• Technology – solving a problem in an unconventional manner, often from a different angle than comparable start-ups (i.e. not another robotics play, but understanding where robotics does not apply and tackling that problem)