Crystal McKellar is the Founder and Managing Partner of Anathem Ventures, an early-stage venture capital firm investing in companies that have developed breakthrough technology that they are pragmatically leveraging to win and own uncrowded, high-margin markets. Crystal currently serves on the board of Cooler Heads, and previously served as a board member at Siren, Neurable, and DoubleDutch (acquired by Cvent) and as a board observer at Fractyl.
Crystal is a Kauffman Fellows Mentor, and has served as a mentor to the TechStars MetLife Digital Accelerator and the Ad Astra tech incubator program. Crystal is a proud member of All Raise and is a frequent speaker on entrepreneurship and innovation at technology conferences and finance events.
In this episode, you’ll learn:
- When raising a fund, what recommendations are there for first-time fundraisers?
- What are the relationship dynamics between a Venture Capitalist and the Limited Partners (LPs)?
- The life of a VC, how is it really? What are some of the positives and negatives of the role?
- What are the advantages of keeping the fund size small?
We would like to thank Maya Tussing for making the introduction which allowed for today’s episode. Thank you for the support!
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Disclaimer to the Transcripts:
Intro 00:00
You’re listening to The Silicon Valley Podcast.
Shawn Flynn 00:03
On this week’s episode of Silicon Valley, we sit down with Crystal McKellar, who is the Founder and Managing Partner at Anathem Ventures, an early-stage venture capital firm investing in companies that have developed breakthrough technology that they are pragmatically leveraging to win and own uncrowded, high-margin markets.
On today’s episode, we talk about: When raising a fund, what recommendations are there for first-time fundraisers? What are the relationship dynamics between a Venture Capitalist (VC) and the Limited Partners (LPs)? The life of the VC, how is it really? What are the positives and the negatives of this role? And what are the advantages of keeping a fund size small? These and so much more on today’s episode of Silicon Valley. Enjoy!
Intro 00:49
Welcome to the Silicon Valley Podcast with your host Shawn Flynn who interviews famous Entrepreneurs, Venture Capitalists and Leaders in Tech. Learn their secrets and see tomorrow’s world today.
Shawn Flynn 01:12
Crystal, thank you for taking the time today to be on Silicon Valley!
Crystal McKellar 01:16
Thank you so much, Shawn! It’s a pleasure to be here.
Shawn Flynn 01:19
Now, Crystal, your background is very different than the normal VC. In my mind, every VC is this boring guy that sits down with a math book and just crunch numbers. But can you tell our listeners a little bit about your upbringing, your childhood, and the path that has led you to where you are now?
Crystal McKellar 01:38
Absolutely! First of all, I think that there are a lot of idiosyncratic paths to VC. Although, I like the mental image that you just brought up. I like the idea of sitting in my office scrolling into a physics or math book. I started out a long time ago. I was a child actor, and that’s what we were talking about right before we began here. Most famously, I played a character named Becky Slater on The Wonder Years. My older sister, who is fantastic, was a math major, and wrote math books for young girls. She is now on the Hallmark Channel, and she’s an amazing woman. She played Winnie Cooper on The Wonder Years.
So, I was on The Wonder Years for three years. I did other television and film. And then, when I was 16, in conjunction with a writer’s strike that happened in Los Angeles that significantly choked off the available new work, I also decided to pursue my love of learning. I went to Yale. I then follow that up with doing a master’s degree in Roman History at Oxford. Funny fact: I was in the Modern History department because if you’re going to be in the Ancient History department, you should be doing Greek. I was doing Roman and the Roman Empire apparently is pretty modern if you’re at Oxford. Then, I decided to go to Harvard Law School and pursued a career in the law. I clerked for a federal judge. I worked for a white-shoe Wall Street firm for five years, which is a fantastic experience. I worked for a great firm out here in California for a couple of years after that, and then entered the world of venture in 2012 and haven’t looked back.
Shawn Flynn 03:05
Now, can you talk a little bit about how the skills of being a child actor translate into the venture capital world?
Crystal McKellar 03:14
Absolutely! One of the things that even successful actors have is they have the same experience that even successful founders have, which is going on a lot of meetings, and your hit rate or success rate is very low. Even a successful actor is going to go to 20-30 auditions for every job that they book, and you have to approach every single audition with the same level of enthusiasm. Put yourself out there, really get vulnerable in the room, and give it all that you have, even though you know the person sitting across the table from you is giving you the sort of bored look. Today, they’d be on their phone. Maybe they’re engaged. Maybe they’re not. And the chances are you’re going to get rejected, if you ever hear back.
So, I think that the experience of being a child actor gives me a lot of empathy with founders, and understanding that when I’m sitting in a room with them, they are essentially revealing their heart and soul. They are telling me about their life’s work, knowing that they have given that same pitch 20 times already that month, and that they’re going to give it 20 more times. I think that it gives you a lot of empathy, and also, it gives you respect for their time and respect for how hard it is that they’re continuing to do what they’re doing.
Shawn Flynn 04:22
As a venture capitalist, you also had to pitch and present to limited partners to raise a fund. Is that a similar experience with the presenting and giving your heart and soul out to possibly someone on the other side of the table just playing with their phone?
Crystal McKellar 04:37
Luckily, I’ve never had the experience of an LP or prospective LP on their phone on the other side. The dynamics in the VC relationship are a little bit different. But one thing is absolutely true, which is that if you’re a VC, in one of three or one out of five of the LPs that you pitch to invests, you’ve got a pretty high success rate. So, a friend of mine, who raised a fund recently said to me, “If I don’t get turned down 10 times a day, that means I’m not working hard enough.” That’s a great perspective to have. It’s an absolutely fantastic perspective to have. One that every entrepreneur should have, and one that every actor necessarily has by now.
Shawn Flynn 05:13
How does one keep that morale though? Getting rejected 10 times a day, that’s got to hurt the soul somewhere.
Crystal McKellar 05:20
Well, I suppose it depends on how it’s done. But you know, it’s grit, resilience, and perseverance, and it’s what you’ve got to have to get the job done. That’s what brokers have. It’s what realtors have. Anyone in the sales industry has that. You’ve got to make a certain number of pitches. You’ve got to make a certain number of calls as a real estate broker or as a financial advisor in order to get the customer base that you need. Everyone in sales knows that. I think it’s just grit and resilience.
Shawn Flynn 05:47
Let’s talk a little bit about the fund and the fund process. We’ve had a lot of VCs and investment bankers in the past, but we’ve never really talked about raising your own fund. Could you talk a little bit about the experience that you’ve gone through, and what that looks like, that roadmap?
Crystal McKellar 06:04
Sure! I think, first of all, a VC should have a very clear view as to why they’re raising their fund. There’s really only one reason to raise a fund, and that is because you have a strong view as to what investment criteria are going to return a multiple of your investors’ dollars, and you have a strong plan for identifying, and ideally, you’ve already identified the companies that fit those investment criteria that you believe are going to return a multiple of your investors’ dollars. That is the only reason to raise a fund if you think that it’s going to be successful, and success means returning a multiple of your investors’ dollars.
There are a lot of folks say, on Twitter, if you read their Twitter feeds, you would think that the point of being a VC is to change the world. You think that the point of being a VC is to invest in companies that are going to make a positive change in the world. And of course, we all hope that our investments will ultimately be a net positive, but when I want to support a cause that I believe in, I make a charitable donation. When I’m investing, I’m investing in businesses that I believe in. I’m investing in companies that I believe in. And I think it’s very important that before a VC goes out and commits a significant portion of their own net worth, which they absolutely should do to their fund, and ask other outside investors to commit money to their fund, to their idea, that they have a very clear view as to why it’s going to be successful. That is the only reason to raise a fund.
Shawn Flynn 07:28
So you said a VC commits their own capital. On average, what percentage of a fund is the VC’s capital? And does that change over time from Fund 1 to Fund 2 to Fund 3, and so on?
Crystal McKellar 07:41
Well, I think it does vary in the industry. In later funds, I think a VC should be committing a higher percentage of a fund to the fund, so the GP should be a higher percentage of that fund’s committed capital because, presumably, they’ve been successful and have the resources to do it. At the beginning, I mean, I think that the GP as in the venture capitalist’s own portion of the capital commitment should be at least 5%. If it’s less than 5%, you really wonder about how much skin they have in the game.
There’s also a sort of a clever thing that some VCs try to do, which is they just try to rename the management fees on a pre-tax basis, and use renamed management fees, again, on a pre-tax basis, to fund their GP commitment. This is effectively the venture capitalist saying, “I want you, my investors, to commit capital to my fund, but I’m only going to commit capital if I can do it on a tax-advantaged basis.” I think, again, incentives get out of alignment, when you start seeing these sorts of clever structures.
The reason that I decided to raise my own fund is I’d recently left my prior fund, and I had some fantastic investment opportunities ahead of me. There were some companies I had very strong conviction in, and I was telling these companies, “Gosh, you know, I’d like to give you $50,000 or $100,000 check in your next round. Can you make sure you make room for me?” And when I heard myself saying that enough, I thought, “My gosh! I should be raising a fund. I shouldn’t be putting $100,000 into this company. I should be putting $2 million to work in this company.” When I talked to friends and family, they said, “I’d like to invest alongside you.” And so, the next thing I knew was I had 10% of my target fund size committed. And I thought, “Okay, I’m going to do this. I’ve got fantastic investment opportunities ahead of me. I’ve got a very clear view as to why I want to invest in these companies.” And then, I was off to the races from there.
But if a VC is not already saying, “Gosh, I want to put my own money to work on the same terms alongside my LPs,” LPs should not invest with that VC.
Shawn Flynn 09:31
Just to give a little bit of background, LP, limited partners. Those are the people that the VCs are getting their funds or their investment for their funds from?
Crystal McKellar 09:41
Yes, the way that it works is a VC fund gets commitments from outside investors. Those investors basically sign a contract saying that when the VC calls their capital for investments, they’re committing to send a check at that point in time. So, a venture capital fund, let’s say, a $50 million fund doesn’t have $50 million sitting in the bank. They have commitments from investors that add up to $50 million. And those investors are saying, “When you’ve got an investment opportunity, and you issue what’s called a capital call, I promise, I contract that I will give you the money, and transfer the funds into the accounts that are set out in that capital call.” Typically, a venture capital fund has a five-year investment period. So, for five years, the investors are obligated to meet their capital calls for new investments. And then, there’s usually another five-year period after the investment period in which the limited partners continue to commit to fund additional capital up to their total capital commitment amount for follow-on investments in those same companies.
Shawn Flynn 10:43
Now, funds these days, I hear about it on the news, they’re getting bigger and bigger and bigger. For yourself, is your fund a smaller fund? Bigger fund? What’s a good-sized fund? And why would you not want to make as big a fund as possible?
Crystal McKellar 10:59
That is a great question. It’s interesting because we do see a trend. SoftBank started this, but we’re absolutely seeing that funds are getting bigger and bigger and bigger. I take a bit of a contrarian view. My view is that, actually, when the bigger a fund size gets, the more you end up limiting your opportunity set. So, I made a decision to raise my first fund; a target of $25 million. That’s considered a micro fund. Typically, a small fund would be a fund that’s $100 million or below. When you’re getting below $50 million, I think the new term for that is micro fund. A large fund would be $500 million and above, but we’re getting to see multibillion-dollar early-stage venture capital funds.
The reason my view is that smaller funds actually increase the opportunity set goes back to the purpose of a venture capital fund, which is to return a large multiple of its investors’ dollars. The best way to do that is to build a concentrated portfolio of very high conviction investments and by concentrated, I mean, you shouldn’t have more than 10 or 15 companies in your portfolio. When you find a company you develop high conviction around, you want to put a good amount of your capital to work in that company, so that when it does what you think it’s going to do; when it returns that 10x or 30x multiple, then it actually has a meaningful impact to your fund. If you put 1% of your fund into a company, and it returns at 20x, that’s a huge missed opportunity. If you put 10% of your fund into a company, and it returns at 20x, well, you’ve just returned 2x of your funds. That’s actually your job as a VC.
If the goal is to put 5-15% of your fund into each of your best companies, and you’re investing a $25-75 million fund at the early stage, which is, in my view, where the best opportunities are; anywhere from a seed stage, Series A or Series B. You’re going to be able to get into companies, and you’re going to be able to put that capital to work. You’re going to be able to put $2.5-7.5 million to work in an early-stage company at reasonable valuations.
If, however, you’re investing a $750 million fund or a $1 billion fund, in order to put say, $100 million to work in an early-stage company is going to be virtually impossible. You’re going to have to invest across multiple rounds. Those last couple of rounds are going to be at valuations that are high enough that you’re essentially cutting yourself off from the opportunity of a venture return on those dollars.
And so, the prototypical company that you could have put some money to work in the Series A at a $50 million valuation, and maybe they have an early off-ramp, and they get sold for $250 million. It’s a decent return for your investors. If they get sold for $500 million, it’s an even better result for your investors. If you’re putting a $1 billion fund to work, and you have to put $100 million into each company that you’re investing in, you will have never invested into that $50 million Series A. You will have never been able to put enough money, enough of your funds, to work at a reasonable valuation to provide a venture return to your investors in anything other than that very small number of companies that are going to be unicorn pluses.
So, it’s a long answer. But it describes why, in my view, you’re actually limiting your opportunity set if you’re having to put $100+ million into any one of your companies to build that concentrated book. And that’s the situation that you put yourself in, when you’re a large fund.
Shawn Flynn 14:24
So micro fund, small fund, or even a large fund, how long are we talking about to raise that fund? Is it fairly quick? Or is this a long process? Most startups, I hear them say, “It took me six months, eight months to raise that next round of funding.” What’s it like for VC raising money?
Crystal McKellar 14:43
Well, conventional wisdom is that it takes about a year to raise your first fund. I’m doing things a little bit differently, and I think the best VCs do things a little bit differently, which is you have to do a first close early, so that you can start putting that money to work. By definition, if you have decided to raise a fund because you have imminent investment opportunities right in front of you, you don’t want to wait a year to raise your fund, close your fund, and then see what opportunities there are at that point in time.
So, I think the best approach is to do a first close, when you’ve closed on maybe 10-20% of your target amount. Start putting that money to work, and then go out with what is actually better than a track record, which are actually companies that your current fund is invested in, and raise the rest of your fund because you’re able to do that as a venture capitalist. You’re able to allow later investors, who come into your fund to participate on an equal basis as your earlier investors.
Shawn Flynn 15:38
What recommendations do you have for raising a fund for first time fundraisers other than what you just mentioned?
Crystal McKellar 15:45
Well, number one, I think, is having a very clear view as to what your investment criteria are and figuring out how to articulate those investment criteria. Number two is to have tangible examples of companies that embody that investment criteria. Ideally, these are companies that you are in the process of investing in or that you’ve already invested in. And number three is the earliest prospective investors one should start with are people who know you and who trust you and who trust your judgment. You don’t want to raise your first $5 million from large institutions that are going to put you through a 6-9-month process.
It is much better, in my view, if you’re raising a small fund, to talk to high net worth individuals, who know you and trust you, and who’ve decided that they can make a decision. They’ve got autonomy to make that decision, and they’re investing in you. Maybe they’re writing you smaller checks, but those smaller checks add up quickly.
Shawn Flynn 16:36
How did those relations look when you have high net worth individuals and LPs or institutional investors all invested in your fund? What are the dynamics like there?
Crystal McKellar 16:46
Well, everyone’s busy. So, your ultra-high net worth individuals are busy. They’re more likely to talk to you on the weekends because you’re a personal investment of theirs. Institutional investors are also extremely busy. They’re more likely to talk to you during the week. That’s one dynamic that’s a little bit different. But fundamentally, the dynamic is the same. I was given some very good advice early on, which is: “Reach out to your LPs, when you have an update for them, and have updates at least once a quarter.” So, you don’t just reach out to your LPs, and say, “Hey, I want to touch base and tell you everything’s going great.” You’d want to reach out, and say, “Here are the three things that we’ve done this quarter. Here’s what we’ve invested in. Here’s the progress these companies have made. Here’s why we continue to have a conviction here.” People talk about the relationship, being of trust. And of course, that’s important. But trust is generated over time by doing what you say you’re going to do, then telling your investors what you’re going to do next, and then doing that.
Shawn Flynn 17:40
This relationship, or more or less the actions, the job of a venture capitalist, has it stayed pretty constant over the years? Or has it evolved and changed?
Crystal McKellar 17:51
So, fundamentally, the job of a venture capitalist is to find and fund companies that are going to return a multiple of your investors’ capital. That is number one, the most important, and really the only job is to find and fund great companies, put your investors’ capital to work, and return a multiple of it. So that has stayed constant. I think one thing that has changed a little bit is I think there’s an increased expectation that VCs, particularly the early-stage VCs, are going to be helpful in the company’s own operations. That maybe we’ll make customer introductions; that we’ll serve on their boards; that will provide sage advice. And I think that those expectations are well-founded, but I think that they’re secondary. Because even at the seed stage, when I’m investing in a company, I’m investing because I believe, and I’ve already had it proven to me, that the founding team knows how to execute, knows how to get it done. And so, any help that I can give is sort of gravy. It’s interesting because, as a VC, you do find yourself in situations where you can make helpful introductions.
JP Morgan holds a big healthcare conference that happens every year here in San Francisco. As a venture capitalist, you get invited to a lot of events and a lot of parties, and so I happened to talk to a family office that just bought a 70-clinic, does medical practice, and that has direct relevance to one of my portfolio companies. I was telling them about this portfolio company, and the next thing I know I’m connecting the two of them on email, and a potential customer relationship has been built.
Now, when I invested in this portfolio company, I did not say, “Hey! By the way, I get invited to great parties with important people, so I can make introductions.” No, that’s not my pitch. My pitch is: “I’m going to be aligned money. And more importantly, I’m going to invest in you because I believe in you; and then, therefore, you’ll have someone on your cap table who believes in you.” That’s my pitch to them. Their pitch to me is why I should believe in them. But it’s sort of a nice side benefit that VCs are often in a position to be helpful on the operation side.
And I think that we should be helpful, but we shouldn’t overstate the role that that plays. When I talk to my LPs, I’m very clear with them. They should invest in me if they believe in my investment criteria, if they believe in my strategy, if they think my strategy is going to make them money, and if they think I’ve got the capacity and the network to find the companies that meet my investment criteria. That is why they should invest in me, not because I may be operationally helpful to the companies after I invest.
Shawn Flynn 20:20
Crystal, you’d mentioned a little bit about VCs sitting on boards. What’s the VC role when they’re on these boards? How can they help? What are they supposed to do?
Crystal McKellar 20:28
Sure! That’s a great question. There are two different ways in which VCs will often sit on boards. One is as an actual voting board member. Fundamentally, their job is all about corporate governance. It’s all about ensuring and complying with their obligations, which are typically set by Delaware law, to oversee management and ensure that the company is being well-run for the benefit of all shareholders.
The second kind of board membership is something called a board observer. This is something we’re seeing increasingly popular at venture funds. A board observer is sitting in the boardroom, provides the advice, the feedback, the judgments that a board member provides, but they don’t actually have a vote, and they don’t have all those obligations that come under Delaware law. So it’s actually increasingly popular among venture capital firms that want the insight that comes from board membership, but doesn’t want the potential liability that comes under Delaware law from actually being a voting board member.
Something else with the increased numbers of corporate VCs, is we’re seeing these large corporations that will place people as board observers when their venture arms invest on the boards of these portfolio companies because, again, they don’t want the liability. Because of course, as a board member, you’ve got an absolute duty of loyalty to all shareholders, not just the preferred shareholders. And then, you’ve got a duty of care, which basically means you have to do the homework. You have an obligation. You’ve got true oversight obligations. You need to read the board deck; you need to understand it; you need to provide follow up; and if you see a red flag, you need to pick it up.
A board observer has a much lower-key role in a board meeting. It’s actually an important distinction that not a lot of people spend much time thinking about. It ends up being very critical. One other thing I’ll mention, and this is something that I’m constantly telling young VCs, who want to get on a lot of boards because they think that that’s going to help them, that’s going to help their resume, that’s going to help show that they’re senior in their industry is: When you’re on a board, in your capacity as a board member, you are not allowed to think first and foremost of the interest of your fund and your LPs. When you’re wearing your VC hat, your first duty, your obligation, is to your LPs, to the investors in your fund.
When you’re sitting on that board, your fund is one of many shareholders, and you’re actually a preferred shareholder. You’re not what’s called a common shareholder. And when you’re wearing your board member hat, you are obligated to take actions that are to the benefit of all shareholders. If there is a conflict between the interests of your fund and the interests of all shareholders, you have to take the action that is in the interest of all shareholders. That is something that is not that well-appreciated among venture funds; although, it is very well-appreciated among the general counsels of these venture funds. But it’s something that I think is a very important consideration for VCs, when they’re joining boards, particularly if they’re investing in companies that may be competitive with each other.
Shawn Flynn 23:27
It sounds like, right off the bat, there’s a conflict of interest. Has there been any actual issue where the VC sitting on the board, it was clear to everyone, he was not doing what was best for the company, and maybe some lawsuit or something resulted from it?
Crystal McKellar 23:44
Well, there certainly have been lawsuits out there that you can find on Google, where Delaware courts have slammed board members either in the private equity world or in the venture capital world because there are two different kinds of stock. I’ll just go into that very briefly for the listeners, who don’t know. Most employees of startups own what’s called common stock. That means they have a proportional share of the company. If you have 1% of the company, and it’s all common stock. In a successful exit, you’re going to get 1% of the proceeds. VCs invest in what’s called preferred stock. What that means is if there’s not enough money to go around after a bunch of VCs invest, and the company exits in a suboptimal way, the VCs get paid first.
This creates a potential conflict where, for example, let’s say some VCs, put $50 million into a company. The company’s maybe not doing all that well, but there’s a chance it’s going to turn around. There’s a buyer out there who’s willing to buy the company for $50 million. This will wipe out the common, but the VCs will get their money back. If the board votes to go for that acquisition, they know that they’re voting for an acquisition that will wipe out the common stock, where all the common will get absolutely zero at the end of the day, but they’ll get their money back. That is a situation in which you can imagine there’s a real conflict because the VC funds are potentially looking out for themselves. And if they are a majority of the board, there could be a real issue there.
Shawn Flynn 25:13
So with all these liabilities, having that witness seat to the table, you have all the information, but you don’t have a vote, correct?
Crystal McKellar 25:24
Correct. The benefit of being a board observer is that you get access to all the information that the board has, so you’re learning about, in real-time, the challenges and the opportunities facing the company. You’re getting a granular view about the finances and the budget, but at the end of the day, you don’t have the liability of having to vote on difficult decisions. The other thing that I always remind my founders is the number one job of a board is to potentially fire the CEO, so think carefully about who you want on that board.
Shawn Flynn 25:53
So say a CEO was not doing his job, or maybe there is something in the news like a scandal, and the board wanted to come together to replace a CEO. What does that meeting look like?
Crystal McKellar 26:05
Well, luckily, knock on wood, I’ve never been involved in a meeting that would look like that. And again, I’ll put my lawyer hat on. The board would typically hire what’s called independent counsel to give them advice on how to handle the situation. And so, the independent non-management members of the board would be represented by counsel, and then they would be guided by counsels to how to best fulfill their fiduciary duty. But again, that would be a very difficult situation to be in as a board member. And a board observer, who likes to think of themselves as founder-friendly, would be exempt from that entire difficult situation.
Shawn Flynn 26:38
Fascinating. Now let’s go back to raising a fund and the conversation earlier. In a lot of situations, startups and VCs have term sheets, where they negotiate many things. Is that similar between VCs and LPs? Are there term sheets where terms are negotiated?
Crystal McKellar 26:54
They’re not the same kind of negotiations because, of course, one of the things that you’re negotiating with a founder is the valuation of the company. So, that is probably the number one thing that ends up getting negotiated. Something else would be whether or not the VC has a board seat; if they want vetoes over certain company actions. Those issues just don’t arise in the venture setting. The one situation in which you will have potentially different terms unnegotiated is if you have what’s called an anchor investor, who’s maybe 30-40% of a fund. And sometimes, those anchor investors want to get a piece of the GP. It’s more common in the private equity, in the hedge fund context, but we’re beginning to see it a little bit in the venture world. But venture terms are pretty plain vanilla, and they’re pretty standard. So, they tend not to be negotiated as much.
Shawn Flynn 27:43
And then, I guess it’s a simple question, but why tech? Why do VCs only invest in the tech sector?
Crystal McKellar 27:50
I’m going to disagree with the premise of your question because I’d say there are a lot of VCs who invest in companies that have nothing to do with technology that we’re seeing increasingly. But I can give you my answer as to why I invest in tech. I don’t invest in tech because it’s exciting or cool or fun to think about; although, it is all three of those things. I invest in technology. We invest in technology, and the best VCs should be investing in technology because, fundamentally, technology translates to enhanced capabilities. The ability to do more with less; the ability to do something that wasn’t possible before; or the ability to do something that was possible before but for 1/100 of the cost, 1/10 of the time, and maybe 3x or 5x the capabilities.
Technology provides the ability to dominate an industry by doing whatever that important task is better. And fundamentally, those enhanced capabilities that will allow a company start-up to win and own a market. And that is why you invest in tech. Not because you want to be invested in technology companies. Because, of course, companies that looked very high tech 50 years ago seem pretty commodity today. Our definition of technology necessarily evolves over time as additional innovation follows additional innovation. The difference is, does a company have a capability that didn’t exist before? Do they own it? And are they applying it to a market that has high margin, that is relatively uncrowded, and that is wide open for them with their enhanced capability to take over?
Shawn Flynn 29:25
And the companies that you like, what’s their secret sauce? What attracts you to them?
Crystal McKellar 29:30
The central and most important ingredient in any company I invest in is it has to be fundamentally animated by breakthrough technology. I am not interested in yet another on-demand dog-walking company or another on-demand food delivery company or an on-demand dry cleaning company. These are companies that are using commodity technology to potentially innovate in a slightly different way in a market that they think is overdue for change. My view is I’m only investing in companies that have actually, themselves, developed breakthrough technology that they own, that’s protected either by patents or trade secrets, and where they have identified a market that is right for ownership; where they have identified a market that they are uniquely positioned to win and own.
The characteristics of the market are important. For example, what are the customer relations look like? Is there an intermediary between the start-up and the end-user, whose incentives may actually not be progress? So, the structure of the market is extremely important. A good example is utilities. The utility is different from the end-user, which is different from the green tech start-up. We’ve seen these intermediaries in industries like utilities create all sorts of obstacles for a start-up that is potentially offering a great solution to that end user.
Start-up capital costs are also something that I look at. So I’m looking for companies that have identified, and that have developed breakthrough technology that they’re uniquely applying to a market that has high margin, and that they have a plan to win and own it, and where they’re able to do it with capital efficiency. Because if someone has done that, and they’ve spent $300 million to get to $10 million in IRR, that’s probably not an attractive investment opportunity for me.
Shawn Flynn 31:13
Tell me a story of one of the portfolio companies you’ve invested in.
Crystal McKellar 31:17
Sure! And actually, this goes to the name of my fund. So, my fund is called Anathem Ventures. I was inspired by this actual very story. Anathem is a fictional word from a Neal Stephenson novel. Any Neal Stephenson fans out there, I’m giving you a shout out right now. I’m a huge one. So, Anathem referred to the exile of very smart people from these sort of cloistered environments, called “maths,” when a very smart person had an extremely intelligent, but dangerous idea. The analogy in Silicon Valley is, you know, every Silicon Valley founder, who’s ever had a truly novel idea how to do something different and better, gets thrown out of a room. This is actually something that we hear from founder after founder after founder.
So, one of my founders, she innovated a very smart fabric technology: the ability to embed sensors into thread, where you can then insulate that thread and load that thread onto standard mass-production textile manufacturing equipment, so you can make truly smart fabrics at-scale inexpensively. Her first product is a temperature-monitoring sock for people with Type II diabetes, who were at risk for diabetic foot ulcers. The gold standard for identifying whether or not diabetic foot ulcers are beginning to form is temperature.
Years before she founded her company, she was doing wound healing, wound care in Northwestern with a Wounded Warrior Project. She had identified diabetic foot ulcers as one of the most expensive and difficult wounds to heal. She was at a conference of podiatrists, who were focused on the problem of diabetic foot ulcers. They were talking about temperature monitoring and the difficulties of healing these wounds. And she just said, “Well, why don’t we just create a temperature-monitoring sock that sends temperature signals every 10 seconds to your smartphone, to your clinician, your adult child, and to your insurance company. Why don’t we just create something smart like that?”
And you’d think these medical professionals would have said, “Great idea. Let’s fix this problem once and for all.” But, of course, they didn’t, because people, when they encounter truly new and truly novel ideas, react in fear and anger. She said she was practically thrown out of the room. “Well, no, that’s a dumb idea. If someone could do that, if that capability were possible, someone else would have already done it,” was their response. Or, “Someone tried that years ago, and it costs $60,000. So, therefore, there’s no way it could be done at scale. There’s no way it could be done in a reasonable way.” And luckily, she did not listen to the naysayers. She went and she developed her technology. She’s actually off to the races, and it’s a fantastic company.
Fred Moe, who is a very gifted founder. I’ve had the pleasure of spending a lot of time with him. My former fund was invested in his company or surgical robotics. He’s the co-founder of Intuitive Surgical. He likes to say that pretty much any good idea he’s ever had, when he brings it up, he’s thrown out of the room. This is something that we see in human nature. When people are faced with something new and different, they tend to close themselves off to it. And I think the gift and the benefit that VCs and entrepreneurs can bring, is when you hear an idea that just sounds so crazy, there’s no way it could work, is you lean into it. And you think, “Well, let me think about it. Let’s assume for the sake of argument that this was going to work. How could it work? And can we figure this out, rather than closing ourselves off to the new?” So, it’s an exciting new world, but when you’re the harbingers of new ideas, you should not expect those new ideas to be received graciously.
Shawn Flynn 34:40
Crystal, the life of a VC, in my mind, is all glitz and glamour. You’re partying with all these high net worth individuals, these family funds. What’s really the life of a VC?
Crystal McKellar 34:51
Well, I wouldn’t say that. If I made those parties sound glamorous, that probably was not my intention. I’ve got two small children, so I get up very early in the morning. Let’s just say I do not have super late nights. The life of VC is you’re taking meetings with as many start-ups as you can take meetings with, and keep them all straight in your mind. And the reason for that is two-fold.
Number one, again, your one job as a VC is to find and fund great companies. And so, not only do you have to meet those great companies, but you also need to really understand everything that’s out there. So you should be talking to the companies that were, initially, you thought, “Gosh! This sort of sounds like something I’ve heard elsewhere.” Listen to that company’s pitch. It may be different, or it may be the same, and then that’ll give you additional insight when you meet with the next company.
So, in order to not be naive, you need to be talking to companies constantly. You need to be on top of where the money is being invested, who’s growing, and what problems they’re solving. And so, a typical VC should be meeting with at least 5 or 10 companies a week. In addition to that, you’re meeting with early-stage investors, who you know and trust. Find out from them, “What are the five best companies in your portfolio, who are going to be raising these next year?”
So you’re having a lot of meetings, where you’re talking about your investment strategy, and you’re hoping to find matches. And then you’re taking in a ton of data from founders out there; what they’re doing; what they’re building, to ensure that you’re a smart investor, when you do think you’re getting to a conviction that you’ve got a real basis for understanding why you’re reaching conviction with a company.
But fundamentally, everything you’re doing as a VC requires self-starting. You don’t wake up in the morning and have an assistant provide you with your calendar for the day, with 18 meetings that have been set up internally with various departments of your 20,000-person company. You’re self-starting every single day, and you are getting out there, and continuing. As the child actor analogy that we talked about earlier, you are setting yourself up for learning, for successful meetings, for unsuccessful meetings, and you’re doing it every single day. And you’re sticking with it because, again, your job is to find the hidden gem. And it’s to continue going out there looking for it every single day.
Shawn Flynn 37:19
You had mentioned sitting down with VCs that you don’t trust and talking about what companies in their portfolio might be raising their next round. How does a VC, in their first fund, how do they create their deal flow? How do they find out about companies to use that first capital for?
Crystal McKellar 37:21
Well, typically, a VC raising their first fund will not be new to the venture industry. If someone’s truly that new, they may be better off going to work for a different fund. So typically, I would certainly fit in this category, someone starting their first fund has worked in the industry for a long time and has already built out a network of early-stage funds, of other VCs, of angels, of founders. Some of my best companies had been recommended to me by other founders, including some whom I’ve turned down. That’s always a huge compliment, when I turned down a founder, and then that founder introduces me to another CEO with the introduction of, “Well, Crystal didn’t invest in my company, but she asked good questions. And she’s really thoughtful, and she’s respectful of your time. So you might get a lot out of sitting down with her, even if she doesn’t end up investing.” So, you do need to build a network, and you do need a network in place before you raise your own fund. That’s an important criterion.
Shawn Flynn 38:17
Crystal, what’s going to happen with you in the next 2-3 years? What are you looking forward to?
Crystal McKellar 38:22
One of the things I’m really excited about, and I think is inevitable, is people’s expectations about increased transparency and control of themselves and of their surroundings. So, technologies that give people better transparency, better visibility into, and better control over, say, their privacy, their online presence, and importantly, their own bodies. So something that we’re seeing is, and I’m not a healthcare investor, but something that I think is extremely exciting is companies that are leveraging breakthroughs in technology, and building on those breakthroughs to provide individuals with the ability to understand their own ailments and self-help.
We’re seeing this in digital health and connected health. All the ingredients are there. And there are tremendous opportunities. We’re seeing, for example, Medicare is extremely enthusiastic about encouraging remote monitoring. We don’t want the person to have a heart attack at home, and then have to deal with a situation later on in the hospital, which is expensive, and not to mention all the human misery. If we can have remote monitoring that tells us 30 minutes an hour beforehand that there’s some warning signs, and stave things off at the outset.
The company that I was talking about earlier on smart fabrics provides a tremendous opportunity. If fluctuations in temperature on the surface of the skin denote sepsis or denote that maybe there is a problem arising in post-surgical care, and if the patient themselves is alerted to this, while they’re going about their day at home or the office, or if their doctor can be alerted to this in real time because of the breakthroughs in connected materials, this would be a tremendously helpful thing both for our healthcare system and, of course, for the individuals.
So I think that we’re seeing individuals with increased expectations around their ability to have insight into their bodies, their data, their online presence, and then, of course, the ability to control the outcomes. So I think that we’re going to be seeing more and more companies that are serving those needs and that are responding to those expectations. And that’s extremely exciting.
Shawn Flynn 40:28
Crystal, one last question for you. Is there any more information you want to give to first-time VCs raising their fund?
Crystal McKellar 40:35
Sure! My advice is to talk to early investors, who actually have the ability to say yes. Also, talk to investors, who have the ability to say no. Many institutional investors actually don’t have the authority to give you either a yes or a no. And so, you can spend a tremendous amount of time in meetings and endless calls and diligence sessions with another institution that doesn’t actually have the ability to say yes for maybe 6-9 months. Have all of your early meetings with, to extent that you know them, high net worth individuals, who after a two-hour-long conversation, to make a commitment of $50,000 – $250,000. Those numbers add up quickly. And having those conversations will also give you tremendous insight into your own pitch, into what’s going well, what’s not going well, and will give you the clarity on the back end to know if this is the right path for you. You’ll never get that clarity talking to a large institution because they won’t give you the same kind of honest feedback, because they frankly don’t have the ability to or the authority to.
Shawn Flynn 41:37
Crystal, thank you so much for taking the time today to be on Silicon Valley.
I also want to thank Maya Tussing, who made the introduction to Crystal that allowed today’s interview to happen. I also want to thank Sharon Vosmek at Astia Angels, who was interviewed earlier on the show, and who was another intro of Maya Tussing. Maya, you’ve been a great supporter of the show, so I want to thank you. Say hi to Sharon. And, Crystal, once again, thank you for your time today. If anyone wants to find out more information about you, your fund, and what you’re working on, what’s the best way to go about it?
Crystal McKellar 42:05
I and my fund are both on Crunchbase. You can also go to my fund’s website, which is anathemventures.com. There is a contact tab. There’s an e-mail address you can contact. It’s just hello@anathemventures.com. I encourage inquiries, particularly if you’re a founder, and you think that you have developed a really interesting technology that fits my criteria. I’d love to hear from you.
Shawn Flynn 42:35
And Crystal, is there any offer or any special that you can give our listeners if they write an amazing review on iTunes or any other podcast platform for this episode?
Crystal McKellar 42:46
Absolutely! I would be happy to have a 30-minute call with you, whether you’re a founder, who would like to try out your pitch or whether you’re an aspiring VC, and you think you might want to raise a fund someday, I can give you advice, tell you some more stories, and provide my insights that will hopefully be helpful. So I’d be happy to do that.
Shawn Flynn 43:04
So as proof of the review, please take a screenshot and attach that to an email and send it to me at shawn@theinvestorspodcast.com or attach it and send it to Crystal, when you set up the time for a call. Crystal, how does that sound?
Crystal McKellar 43:21
That sounds great!
Shawn Flynn 43:23
So Crystal, once again, thank you for your time today on Silicon Valley.
Crystal McKellar 43:26
Thank you so much.
Outro 43:28
Thank you for listening to The Silicon Valley Podcast. To access our resources, visit us at TheSiliconValleyPodcast.com and follow our host on Twitter, Facebook, and LinkedIn @ShawnFlynnSV. This show is for entertainment purposes only and is licensed by The Investors Podcast Network. Before making any decisions, consult a professional.
