On Wednesday, I published a summary of 10 candid questions that “super angel” Dave McClure of venture capital fund 500 Startups answered during his presentation at King Abdulaziz City for Science and Technology‘s BADIR incubator. So, if you haven’t done so already, please read 20 Questions with Dave McClure of 500 Startups: Part I.
In this article, I will summarize 10 more of Dave’s frank and often funny responses. Keep reading to find out why risk-averse Dave is interested in Saudi Arabia in the first place, what 500 Startups’ biggest international challenge has been, and whether Dave shoots the incubator participants that fail to transform into shiny and perfect Mark Zuckerbergs.
1. Will U.S. and European investors only be interested in Middle Eastern companies if they offer fraud protection?
While Dave agreed that fraud protection is important, he added that “having worked at PayPal, fraud is just a feature.”
According to Dave, PayPal tolerated a certain level of fraud, then lowered their tolerance when the time came to decrease that volume.
“Yes, you need to keep fraud coming under 2 percent, but you could probably dial it between 0.1 to 2 percent, depending on the parameters of your business, particularly if you want to be competitive,” he explained. “So, these days, PayPal is not particularly friendly or loose on fraud, and it’s actually created the opportunity for other payment competitors to jump into the market who have a higher fraud tolerance.”
2. What happens to accelerator program participants who don’t find investors?
“We hold a wake for them,” quipped Dave. “We take them out, we shoot them in the leg, and we carry them out.”
After laughter from the audience quieted down, he explained that sometimes participants who don’t find investors weren’t cut out to be entrepreneurs, but sometimes, they just had trouble making everything work and needed to try again.
“We have a lot of companies who didn’t figure it out the first time, but we thought that they were exhibiting learning behavior,” said Dave. “In those cases, those people join other companies where they become individual contributors or managers of a department, and they’ve learned something.”
3. Does 500 Startups bring in external investors to pick among the graduates?
“We definitely bring a lot of downstream investors,” emphasized Dave. “In fact, one of our primary things that we pitch to the companies that we’re investing in is that we’re helpful in connecting them with other downstream investors.”
4. What about the entrepreneurs who no one wants?
“It’s not binary,” said Dave. “It’s not like these people are shiny and perfect Mark Zuckerbergs and these people are failures.”
It’s common for 500 Startups entrepreneurs to have handled some parts of their business well, but have struggled with others. He said that the old-school approach is to go to an MBA program and learn to be a businessperson, but today, success requires you to quickly react to changing variables.
He then quipped that failing to build a start-up is a learning experience that costs less than an MBA.
“Do you want to pay a business school $100,000 to read about somebody else’s success, or how about I give you $100,000 and you go fail, but you learn something about building your own business?” asked Dave.
However, entrepreneurs can also learn from working for large companies, he added. Dave’s example was his time at PayPal, where he learned about e-mail marketing from running an e-mail campaign that reached hundreds of thousands of customers.
5. What happens when you have to make the hard decision to remove someone?
Dave said that he recently had to fire and replace a CEO for a company where he served as a board member, and it was painful.
However, he again emphasized that the most successful start-ups have been those with which he has little involvement, as a board member or otherwise.
“Investors tend to spend a lot of time with companies that are either failing or not succeeding a lot,” said Dave. “The best companies I’ve been investing in, I don’t teach them things—they teach me things and I get to brag about the fact that I’m involved with them, but they don’t really need me.”
“The ones that are really great don’t need you,” he added.
6. What are the most important things you’ve learned from your mistakes?
According to Dave, the main lesson he learned was to make a wide array of small investments, then make additional small investments in successful companies.
When he first became involved in angel investing around 2004, he spent half of his budget within the first 6 months by investing large chunks into a few companies. Fairly soon, he had to sell his car just to make small investments.
Dave described himself during this period as “the dumbest.”
As his money ran out, Dave realized that he had to make a wide range of small investments instead. That would allow him to continue making quarterly investments over a period of about 3 years in companies that were actually succeeding.
“And I would have probably doubled my money if I had just done that,” he said.
In terms of what he had done right, Dave said that investing alongside smart angels helped him avoid making stupid decisions back when he didn’t understand the legal documents behind the companies he was investing in.
7. What opportunities available in the Middle East should entrepreneurs focus on?
“So, I think that most of what we’re doing in developing markets is not very complicated,” said Dave. “So, we’re not looking for the next Facebook or Twitter. We are investing in a fair number of e-commerce businesses, subscription services, in SaaS, education products, jobs, real estate, travel—things that are very straightforward problems to solve.”
Dave gave the following reasons for this focus on straightforward problems:
• 500 Startups is risk-averse
• Emerging markets have fewer competitors
• Emerging markets are developing much faster
He encouraged entrepreneurs to actually write a risk-averse business model rather than copying a U.S. company’s growth model.
“Copy the stuff that provides direct value and is likely to be paid for: real estate, financial services, travel, education, health care, security, business productivity tools,” said Dave.
8. Has 500 Startups faced regulation issues internationally?
Regulation has been an issue, according to Dave, particularly in India, Brazil, and China. 500 Startups has responded to those challenges by moving slowly and cautiously in those countries. Although he said he didn’t have enough experience to speak about regulation in the Middle East, Dave said that Dubai seemed like a good area of incorporation.
However, he also said that the real problem for 500 Startups has not been regulation, but lack of access to downstream capital.
“Most companies that you invest in are not going to get to sustainability on the check that we’d invest, and so, it’s absolutely critical that there’s access to other seed investors, preferably other Series A investors,” explained Dave. “The capital gap that we see most often is 250,000 to $2 million; it’s the big gap.”
“In Brazil, there’s 4 Series A investors. In Mexico, there’s 4 Series A investors. In Turkey, there’s now 4 or 3 investors. In the Middle East region, there’s probably 1 or 2. In some cases I’m not even sure there’s one, but I can figure that out. In India, there’s 5 or 6, but they’re all sitting on their hands right now because they’re concerned about market conditions.”
9. If you’re risk-averse, why did you come to Saudi Arabia?
After laughter from the audience died down, Dave responded that he was attracted to the demographics of Saudi Arabia. Saudis are major consumers of online video and mobile content.
Dave added that he is also fundraising for 500 Startups in Saudi Arabia, but more importantly, the organization is treating involvement in the developing world as a chance to learn.
“We can probably afford to deploy half a million to a million dollars per year in each of 5 to 7 markets, probably for 3 to 5 years, and not get any returns out of that. That’s probably great research and development and marketing for us,” he explained. “At the end of that 3 to 5 years, I’ve made 20 to 50 investments in each of those markets, I know who to co-invest with, I know which investors and entrepreneurs have their act together, and I understand what the opportunities are.”
He also mentioned the following advantages of coming to the region:
• Interesting and fun experience
• No competition
• Global brand building
• Sense of fulfillment from what Dave described as “doing God’s work”
• New friends all over the world
“I think I can actually solve a lot of these [problems] through entrepreneurship,” added Dave, inspiring applause from the audience. “Clap for me after I’ve done that, but it’s really not me that’s doing it—it’s the entrepreneur that is doing the work.”
10. What are your predictions for the mergers and acquisitions market and IPO market in the Middle East?
“I don’t expect IPOs,” said Dave. “I think there’s M&A opportunities. Particularly, I think there’s M&A opportunities for offline companies to buy their online counterparts.”
These offline acquirers could be domestic or foreign, though he predicted there would be more European than U.S. investors.
“The real changes in the last 10 years are not technology changes, they’re actually social and behavioral changes related to online services,” said Dave. “The traditional battle is not going to be one tech company start-up trying to beat another tech company, it’s going to be a company, an existing offline brick-and-mortar company that’s got a decent business competing with its online counterpart… Every business is going to have to be an online business because 30 to 80 percent of my sales are moving online.”
According to Dave, over the next 5 to 10 years, smart regional brick-and-mortar companies will solve this problem by acquiring companies that excel at online distribution and marketing.
“If they’re not smart, they’re going to get bought by their online equivalents or destroyed by them,” he added.
Finally, Dave wrapped up by reminding the audience of major recent success stories, such as Pinterest’s valuation at 3.5 billion, and Tumblr and Instagram’s billion-dollar exits.
“So, I just want to leave you with this one point which is, a lot of the economics, a lot of the cost structure, a lot of the distribution things, are just continuing to get better,” said Dave.
“With the widespread adoption of mobile phones, tablets, other types of online services, YouTube, Facebook, Twitter, et cetera, whatever you want—there’s just a lot more people who are online than ever before and the things that are remaining friction elements are going to get removed in the next 3 to 5 years.”
I hope you have enjoyed this look into 500 Startups’ practices and Dave McClure’s mindset and as much as I have.