Paul Arnold, founder of Switch Ventures, explains data driven investing in venture capital. He gives real-life examples of founders sharing information to prepare for a deeper discussion in the first meeting.
Paul Arnold, founder of Switch Ventures, explains data driven investing in venture capital. He gives real-life examples of founders sharing information to prepare for a deeper discussion in the first meeting.
Do I have some reason to believe that this person can build something big and people will follow them and they have insights about what they're doing and clarity of vision and ambition about it all.
[00:00:12] Gopi Rangan: You are listening to The Sure Shot Entrepreneur - a podcast for founders with ambitious ideas. venture capital investors, and other early believers tell you relatable, insightful, and authentic stories to help you realize your vision.
Paul Arnold is the founding partner at SwitchVC, an early stage venture capital firm based in San Francisco. He invests in talented entrepreneurs at the earliest stages and takes a data driven approach to his investment decisions. He's a lawyer turned consultant turned venture capital investor and a good friend of mine.
Paul, welcome to The Sure Shot Entrepreneur.
[00:00:59] Paul Arnold: Thanks for having me.
[00:01:01] Gopi Rangan: Tell me about yourself, a little more detail about your background.
[00:01:05] Paul Arnold: Yeah, where to start? I mean, I grew up in a small town on ranches in Wyoming, which is a very unpopulated state full of cowboys and oil fields and cows and it was a great place to grow up. I spent the first 19 years of my life there, not knowing any different really. I went off to college, went eventually off to New York city and back to school. And then at some point it was kind of committed to this idea of coming up Silicon Valley and be involved with startups and technology. I came out here and have been here ever since. I've worked a number of jobs out here.
Worked for McKinsey, I've worked as a startup executive and then now doing what I'm doing now with a Switch Ventures as a seed stage venture investor.
[00:01:44] Gopi Rangan: How do you think about investments? How is your philosophy different from other venture capital investors?
[00:01:50] Paul Arnold: Yeah, the biggest way that I probably am different than other seed stage venture investors is how seriously I use data driven approach using predictive analytics.
And to founders, it probably doesn't look any different than any other venture fund that they interact with, any other manager. But on my side, I really do take that seriously and have invested money and time and lots of thought into how do you take data about founders and startups and going back for long periods of time and accumulating that data large scale so that you can think in probabilistic terms about what kinds of companies and teams are better positioned for success.
And how can you stack the hands a little bit in this very hard job of picking good venture investments so that can have a roster of people and how can you use the method to me? It's really interesting. It's intellectually interesting. You know, it's, it's professionally rewarding because it works pretty well.
And I do think that's pretty different. Some of the later stage, larger funds do it in a serious way. Sequoia does it very seriously. Several other larger funds have serious data science efforts. I think at a seed stage, it's unusual but it's something that I really value and believe in.
[00:03:04] Gopi Rangan: What kind of data do you use and how do you use it? Can you give a description of the predictive model that you use?
[00:03:10] Paul Arnold: It's data around founding teams. It's historic set of data. Hundreds of thousands of founders, frankly, and and all the venture investments and all those people that ever happened and the outcomes of those venture investment.
That's sort of the quick brush of what the data is. And then lots and lots of information about those people. And what I try to do is engineer our features and identify characteristics about these founders that end up in kind of simple kind of linear regression type models, but also complex machine learning, creating boosted type of models, predicting profiles of success.
[00:03:43] Gopi Rangan: This is this is fascinating. You talk about predicting success in the startup world, which is one of the most difficult things to do. Do you feel like the time has come for information is because there's more data available? Or do you feel like the whole industry is kind of maturing just like how it happened in mutual funds where it all became algorithm driven?
Is that the direction in which we're going?
[00:04:03] Paul Arnold: I would not want to do venture investing in an algorithm driven way. Nate Silvers, who became famous before his politics and journalism became, you know, famous in some communities for building models that predicted players performance in baseball. And he tells a story about when the Quants, the famous story of Billy Bean and the Oakland Athletics and Moneyball. When the Quants came to baseball, they were able to outperform the average scout.
These talent scouts would go and they'd sit down at high school baseball games, they'd watch people and they would, through some magic, some combination of magic and intuition, whatever else they would, they would pick the players that they thought would become great. And it is notoriously difficult. It was really, really hard to pick the future great players in baseball from high school teams.
But some scouts were really good at it. The Quants beat the scouts on average, for sure. But what they could do is beat the best, they could have beat the best scouts. The best scouts could still beat the quantitative models. And that was, that's interesting right there. That's full stop. Pretty interesting.
But what's even more interesting than that is that when you combined an average scout with a quant, they could beat the top scouts. So there's this lesson about using rigorous mathematical models in combination with human intuition. That is this really powerful combination. The exact same thing's true in chess.
There's no player alive that can beat the best computer anymore. But a mediocre player, not, not a grand master, but just a regular good player combined with a computer can beat any computer. And so you get this kind of similar combination where you get the powerful sort of analytical models combined with human intuition really leads to the strongest results.
[00:05:37] Gopi Rangan: When when you meet an entrepreneur, what kind of information do you look for that helps feed into the model?
[00:05:43] Paul Arnold: I don't. At that point, it's done. At that point, I'm just getting to know people and I'm just getting to know their their businesses. And so by the time I'm talking to them, that that part's ended.
And I just really want to understand the model. And but still a pretty aggressive pipeline for me. I talked to a lot of companies for each investment I make. And it's that part to the founders is going to look a lot. It would look how can other venture investors where I'm trying to understand the product, the market, the people themselves at a personal level, the customers, the market dynamics, competitive dynamics, the unit economics, that kind of business, all that kind of stuff is really, really digging into it.
And then trying to paint a constellation from that information and deciding whether, you know, it's, it's something I have conviction about or not. So that part of the model has become irrelevant. But the model steers me kind of in the early process.
[00:06:30] Gopi Rangan: Okay, so for an entrepreneur, it really makes no difference whether they talk to you or any other VC firm.
They engage with you in the same way they engage. It's not like they need to produce their credit history or things like that.
[00:06:42] Paul Arnold: No, as far as they're concerned, there's no, no difference at all. No difference at all.
[00:06:45] Gopi Rangan: So this model and the predictive analytics is your superpower. And that's in your back pocket.
And that helps you prepare yourself and look for maybe certain industry sectors, certain trends, which trend is a real trend, which one is a short term thing that might disappear, some opportunities where underserved markets deserve some innovation. Those are the type of things that you prepare yourself for.
Is that a right way to describe it?
[00:07:10] Paul Arnold: Absolutely.
[00:07:11] Gopi Rangan: Okay, great. What do you look for in entrepreneurs when they meet you? I know there's no standard answer to this. That's the reason why I started this podcast.
[00:07:20] Paul Arnold: People always boil down these answers to exactly what they're looking for.
There's this one, there's this magic trade or something. And I'm always a little suspicious of that. I sort of have this view that there's this huge difference between greatness and mediocrity, but greatness can kind of look a lot of different ways. And so people who are extremely different can each be extremely successful and most people aren't, if that makes sense. What I'm kind of looking for is, do I have some reason to believe that this person can build something big and people will follow them and they have insights about what they're doing and clarity of vision and ambition about it all. I'm looking for them also to have pretty well thought through insights about why there's something that really can be done that they're trying to do and why they can recreate, usually recreate the industry that they're going into.
And really kind of pressure testing how thought through that is, or if not, how well can they kind of get through new thinking about it. I find that to be really, really revealing about the future trajectory of the company just the kind of quality and depth of insight vision that the founders bring into the table, whether they can draw people, whether they can lead, whether they have the ambition, that's a huge part of it.
It takes a lot of ambition to do a startup and it's not natural for the typical person, honestly.
[00:08:38] Gopi Rangan: Maybe you could give an example of a startup. How did you meet the company? What kind of questions did you ask them and what helped you form the conviction?
[00:08:48] Paul Arnold: Yeah, one of my first investments was you're an insurance guy, so I know you appreciate it, was in Policy Genius when they were first starting in 2012, 2013. And Policy Genius is a life insurance marketplace and it's expanded into other verticals of insurance. That's a marketplace model where you receive a quote from lots of underwriters and you choose which insurance company you want to go with.
Uh, and, and they've done really well, but when I first invested in the company, Jen and Francois were, were both at McKinsey and we had known each other at the firm. Jen was kind of on the fast track to the partnership and insurance practice and, and more than that, kind of in the insurance and marketing.
And she had clear insight about what was missing. It was just this white space for a company that needed to exist that didn't exist, which is what, you know, became PolicyGenius, originally called Know It All. And I had a lot of respect for her individually as a person, character, um, and leader, but then also for just the quality of insight she developed. We were on calls all the time through kind of thinking and development for the company. And I just knew that I believed her and that what she was saying was right. And it was right because it's intuitive to me. It was right because of the depth of her understanding of what she was getting into.
And I made that without any hesitation, first as an angel, later as a venture investor and all the way through every financing that the company's ever had. And it's been just a thrill to see them grow.
[00:10:22] Gopi Rangan: Yeah, I met Jen many years ago when she was raising her first seed round of funding. I wish I invested.
[00:10:28] Paul Arnold: Oh yeah, you should have. But is that
[00:10:31] Gopi Rangan: the typical stage where you get involved, uh, when entrepreneurs are just building their business, they have an idea, they may not have a lot of traction in the market? What's a typical opportunity that you look at?
[00:10:44] Paul Arnold: I would say somewhere between day one and year two, that that's sort of the window of when I'll get involved.
[00:10:50] Gopi Rangan: The first 650 days of the business.
[00:10:53] Paul Arnold: Yeah, exactly. I stay involved with the companies as they, as they mature, but that's when I want to get involved is in those early stages and some companies are off to a faster start than others, but it's in that time.
[00:11:04] Gopi Rangan: Are there things that entrepreneurs do that makes it easier for you to have those conversations that you mentioned earlier, that deep thought on how they're going to build a business, their ideas on how they want to market?
Are there things that they can do to make it easy for you to have those conversations?
[00:11:22] Paul Arnold: Yes. So the worst thing you can do is not prepare a VC for the conversation. If you send me your deck, if you send me a white paper you wrote on your industry a week before we talk, I'm going to use the time to develop a thesis before we even talk.
And the conversation is going to be far more productive than the one where you're kind of telling me for the first time in person, you kept it a secret up until then. You didn't want to share your deck. All these things where there's, I've been kept blind until this moment of conversation. And so the conversation part ends up being just a waste.
It's just this information transmission of the basics. And I could have used that time to actually come in two levels in on thinking, and we really could have got somewhere interesting for myself and for you and, and a lot further down the line of potential investment cause I'm gonna have to get there anyways, but the founders that didn't kind of give me enough to really dig into and to be ready for that conversation. We were just off to a slow start.
And it's kind of a waste in my opinion. I tend to think it's a, it's a mistake.
[00:12:23] Gopi Rangan: Yeah, I see what you mean. When an entrepreneur sends you information, you invest the time to prepare, you research. We're all geeks in some form. So we geek out on those topics. We come with an informed mind, with some questions that we want to ask when nothing is available, uh, when the entrepreneur is very cagey and it's, it's not their fault because they might have shared information with another VC who probably pass that deck onto the Internet, and that's not the right thing to do. So therefore, the entrepreneur withholds everything, and then they want to talk about it in the first meeting. That doesn't help us because we don't have prior knowledge on what's really happening with the business. We have to recalibrate and steer the discussion in a direction that gets to more meaningful conversations.
That's hard.
[00:13:05] Paul Arnold: Yeah, exactly. What it means is that first meeting is just superficial. And I have to ask the first 50 questions to just paint the picture before you can kind of click into level two. I really started thinking about what that all means. And so it's just a blown opportunity that that's my take on it.
[00:13:24] Gopi Rangan: What about stealth mode startups? What do you do in those situations?
[00:13:28] Paul Arnold: I think that if I were a founder, what I would do is be stealth mode selectively. I mean, I would still share what I'm doing with investors that I'm trying to get money from and employees that I'm trying to hire and partnerships that I'm trying to build.
There's all sorts of sensitivity and tactics to that. I think a lot of times sometimes stealth is more justified than other times. So a lot of times it's just kind of silly. In fact, I would say most time it's silly, but sometimes it's justified. And when it really is justified, because you've got some hot secret, which is almost never true, but when it is true, there's a lot of tactical things to do, and you can imagine in that scenario taking a bunch of extra precautions.
I would say it's almost never the case that there was some state CIA secret that couldn't be revealed. I just rarely see that. I see the perception of that a lot of the time founders often think that a lot of times it's just the silliest thing in the world. The secret. There's something to the old adage that it's 99 percent perspiration.
It's, you know, that people aren't going to steal the 1%, which is your idea. It's whether you're just going to get the idea going and you're going to win.
[00:14:35] Gopi Rangan: Yeah. Stealth mode is sometimes a marketing gimmick. It creates a kind of an aura, a mystery around this startup. So that's sometimes good for a startup.
Maybe they use that as a tool for marketing. But I agree with you that with investors who entrepreneurs want to establish a long term relationship, there has to be some level of trust and openness. The information needs to be shared. That's the risk that entrepreneurs have to take. Well, this is fascinating.
I want to ask you about your involvement in any community leadership roles, a nonprofit organization that you're passionate about.
[00:15:09] Paul Arnold: Where I've been spending a lot more time locally in San Francisco is with the Commonwealth Club. The Commonwealth Club is a very old San Francisco institution that was originally just a civic organization for people to come together and have conversations.
You know, a large bias towards issues around government, society, and a range of topics and, and originally a local body. People in person coming to listen to their local senator and have a conversation about topic of the day, the Vietnam War, whatever it was. And that, that's grown over time. It is that, but it's also the radio programs, the 450 affiliate radio stations that the Commonwealth Club has played on and has been played on for quite a long time all around the country. The YouTubes and the podcasts and everything that people listen to. It's around having conversations that matter for society and they do a fantastic job facilitating and brokering those conversations that are important.
I've enjoyed being involved. I try to help them think about digital distribution stuff and adapting for the new ways that media is shared, the social media and tech environment.
But it's, it's a great organization. I'm happy to be a part of it.
[00:16:13] Gopi Rangan: I'm glad to hear that you're a podcast listener. What role do you play with Commonwealth Club?
[00:16:18] Paul Arnold: I lead a digital distribution effort.
[00:16:22] Gopi Rangan: Ah, okay, great. Well, thanks so much for sharing your insights on the startup world. And it's great to hear about your community involvement through Commonwealth Club.
Thanks a lot for spending time with me today. It's always great talking to you. I look forward to sharing your insights with the world.
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