A version of this article previously appeared on Forbes.
There are a number of reasons why Rincon Venture Partners passed on Twilio’s Seed Round. In retrospect, our decision was both perfectly rational and completely lame.
VC's love to talk about their successes. However, they seldom acknowledge their mistakes. Exceptions exist, such as the highly self-aware Paige Craig, who recently described how he missed out becoming Airbnb's first investor. Yet most VC's bury their failures under six feet of denial.
Twilio has now raised around $235 million, including a July 2015 round totaling $130 million. This latest round valued the company in excess of a billion dollars, entering them into the overly-hyped Unicorn Club.
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What’s The Worst Mistake?
Mistakes can be categorized as “false positives” or “false negatives.” In the startup world, the former happens when a VC makes a bad investment, and the latter occurs when they miss a great opportunity. For a high-volume seed fund that adds many portfolio companies every year (such as our friends at 500 Startups who invest in over 100 distinct companies annually), the cost of a bad affirmative decision (a false positive) is quite low, since it accounts for a relatively small portion of their total fund.
In contrast, low-volume, high-conviction investors like Rincon only invests in a handful new companies each year, making it much more costly (in dollars and effort expended) to invest in a loser. For us, it’s OK if we miss a great deal once in a while, so long as the companies we DO invest in generate outstanding returns. Like fishing, it sucks when a big one gets away, but if you still catch a hefty basket of fish, it’s a good day.
Thus, while we maintain a healthy degree of optimism, we begin each funding discussion knowing that most nascent startups are not worthy of an investment, until we prove them otherwise.
There were no unicorns in sight on April 14th, 2008 when Kevin O'Connor, my Partner Jim Andelman and I met Twilio's Founder and CEO, Jeff Lawson.
We typically do not ask entrepreneurs to visit our offices in Santa Barbara, but Jeff wanted to meet with Kevin, an investor in our Fund who helped us vet opportunities and occasionally invested alongside of us. A true Internet Pioneer, by 2008, Kevin had already founded or co-founded two Unicorns in his own right, DoubleClick (sold to Google $3.1 billion) and ISS (sold to IBM $1.3 billion). He is now well on his way to scoring a billion dollar hat trick, with his latest company Graphiq (formerly FindTheBest).
I recall being impressed with Jeff, but I was concerned that he was creating a platform, which often requires a significant amount of capital, takes an extended amount of time to establish and can be subject to margin pressure as the enabling technologies become commoditized. It also wasn’t clear at the time what types of apps would be built on top of the platform, other than cheaper IVR systems.
Little did I know that it was Jeff's first pitch of Twilio to a VC, as he recently noted when I asked him for his recollections of our meeting.
Hi John - if I recall correctly, this was the very first investor meeting we had for Twilio so I bet it was interesting I considered Kevin to be a friendly to get feedback on the pitch. <Note: I edited a few comments from Jeff's email, none of which related to our meeting in 2008.>
Despite our business model reservations, we were sufficiently intrigued by Jeff and the opportunity to seek technical and market feedback from a VoIP expert.
Tech Diligence - Consider The Source
Our approach to diligence isn't the classic Sand Hill Road methodology of forcing entrepreneurs to deal with an expensive charge-by-the-hour "expert" who spends weeks performing a largely academic exercise of assessing the company's tech stack and code, all the while asking irrelevant questions intended to assure the investors that she is truly an expert that is giving the investors their money's worth.
Rather, we value entrepreneurs' time and thus our diligence generally includes introducing them to potential customers and partners. Our approach is often additive to all parties, resulting in ongoing, productive relationships. In turn, we receive unfiltered, frank feedback regarding the team, their value prop and the veracity of their assertions.
This was the approach we took in vetting Twilio, by introducing the Company to an industry expert with whom we had a long history.
Our friend and expert was gracious with his time and spoke with Jeff. Below is my email to Jim and Kevin, following my debriefing with the VoIP expert, who requested to remain anonymous.
The expert’s feedback was fair, but what I failed to adequately consider was that he and his team had previously built one of the world's most sophisticated softswitches. Thus, he naturally viewed Twilio's toolsets as rudimentary and easy to copy - easy for him and his world-class team of VoIP engineers, but not so easy for the average developer.
I spoke (with) *** (name redacted) re Twilio. *** spoke with Jeff for about 40-minutes. The net was that ***'s app is too sophisticated for the five verbs. <Note: at the time, Twilio offered users five basic actions>
*** was surprised that there were some VoIP tools that Jeff wasn't aware of, such as SIP-T (which allows you to dip into the Caller ID, even if their ID is blocked).
Similar to VoiceXML, the standard for the past 5-yrs. Seems to be the biggest competitor. The difference is that VoiceXML does not leverage customers' knowledge of web development. *** is concerned that anyone familiar with VoIP will be confused with Twilio and VoiceXML.
*** agrees that Ribbet's strategy is bizarre since they are client-centric. They have no solution for a call that comes in while your browser is not open (it goes to Voicemail).
*** thinks his product is probably much easier to (use than) VoiceXML, but he is not sure that the ease of use will offset the market confusion.
*** reinforced our reservation regarding trying to sell tools rather than apps.
Clearly not a ringing endorsement. *** asked that his feedback be kept in confidence and NOT be passed along to Twilio.
Although the expert’s startup and Twilio never formed a partnership, our collaborative approach to diligence did benefit Jeff and his team. Per the email below, Jeff leveraged his discussion with the industry expert to enlist his help with future investors. Notice how Jeff first offered value to the expert, before asking for a favor – perfect execution by a true Mensch.
Notice how Jeff first offered value to the expert, before asking for a favor -- perfect execution.
Greetings from Twilio! I wanted to check in and see how your app progress is going. Also, you mentioned an interesting rails session that you attended last month about security, and we've been studying Google's web app security guidelines... thought you might be interested as well:
Also, I'm curious if you could help us out a little. A potential investor would like to speak with somebody familiar with the telecom industry to help him gauge where Twilio fits in. I thought of you, since you've been in telecom aa (sic) long time and really impressed me with your knowledge of the space. I think that making contact with this particular investor would benefit you as well, as they're probably good people to have in your rolodex. Let me know if this sounds like something that interests you.
It's Me, Not You
Entrepreneurs should realize that VCs’ decisions often involve factors that have nothing to do with their startup. In the case of Twilio, there were a number of such issues that influenced our decision to pass on the deal, including:
Potential Portfolio Conflict – At the time we met with Jeff, we were also prosecuting a potential investment in RingRevenue, another VoIP opportunity. We had known and worked with the RingRevenue team for years, they were located in our hometown and the pain they were alleviating was validated by several large, early-adopters.
We certainly could have invested in two VoIP deals simultaneously, but we were concerned that the two companies might ultimately compete. Although larger VC firms routinely invest in competitive offerings, it is less prudent for a small firm to do so, as it can be difficult to avoid inadvertent information transfers within an intimate partnership. Most importantly, it just doesn't feel right to us to hold positions in competitive companies.
Too Early – Twilio secured a $1M seed round during the first half of 2009, nearly one year after we met with Jeff. At the time he pitched us, he had no paying customers and was only offering five basic "verbs" of functionality to his users.
Also in 2008, SMS was not pervasively used by businesses. The iPhone had been launched about 10-months earlier (tying users to an exclusive carrier with a crappy network) and most of the smartphone apps that had reached scale were games. As such, it was difficult to envision the ultimate size of Twilio’s market.
This is a common situation in early-stage stage investing. It is often challenging to extrapolate the future from a sparse dataset. As noted in What Does VC Traction Really Mean?, if an entrepreneur doesn’t have prior history with a professional investor, it is highly unlikely they will be successful in their fundraising efforts unless they have third-party validation of their venture’s value prop. Without knowing Jeff first-hand and absent market validation, we weren’t comfortable placing a bet on his opportunity.
Geography - Rincon is now very active in the Bay Area. However, in 2008 we were focused almost exclusively within Southern California. Without insights into the Northern California startup ecosystem, our thesis was, "Why are these guys seeking capital in SoCal? What do Silicon Valley investors know that we are missing?"
Painful Past - We are all also victims of our past. By 2008, I was only a couple years away from the brain damage I suffered at CallWave, after the executive team turned down acquisition overtures from Google and Yahoo (I'll write about this colossal mistake in a future confessional article).
Other than the fact that both Twilio and CallWave utilized similar telephony technology, they were otherwise unrelated. The former is a developer platform, while the latter was a consumer subscription service. Thus, it was not rational to allow my negative experiences at CallWave to influence my thoughts about Twilio, but it happened, nonetheless.
Billion Dollar Consolation Prize?
Fortunately, after turning down Jeff, we co-led the first priced round in RingRevenue (now known as Invoca), along with Mark Suster of Upfront Ventures. The company has been a resounding success and we believe is well on its way to a billion dollar exit. We "missed" one Unicorn opportunity, but at least we didn't miss two. Well, we actually did pass on a seed investment in Uber... but that's another confession, altogether. Doh!
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Image: Courtesy of Twilio, all rights reserved