Interview with Avidan Ross, founder of Root Ventures

Watch (or listen) to the full interview here.

In today’s episode of Atoms & Bits, Avidan Ross breaks down the reasons behind current market conditions, gives some poignant and much-needed advice to start-up founders, and reiterates, hopefully for the last time, that Smart Coffee is Not Going to Happen - Stop Trying to Make Smart Coffee Happen.

Avidan is the Founding Partner of Root Ventures. Before founding the deep tech VC firm in 2013, he designed industrial robotics for the Food Network's kitchens. Before that, Avidan was the CTO of CIM Group, a $15 billion investment firm, where he focused on industrial internet investing.

Root Ventures is an early stage seed fund that invests in highly technical businesses led by technical founders. Root recently announced their third fund, bringing another $150M to bear to drive the tech industry forward.

Audio Only 👇

This interview is about an hour long, and is best consumed in video or audio. That said, if you’re looking for the Cliffs Notes, read on, and further down we’ve included a transcript of the interview.

Atoms & Bits will alternate between essays and video interviews like this one; tell us what you like and dislike as we’d love the feedback for future issues and episodes.

Key Takeaways:

• Investing in “deep tech” is about investing in technical risk. Every early stage business carries significant risk; that risk is what creates the opportunity for significant return to the investors. Businesses that take on extremely technical challenges face a set of technical risks (essentially that they might not be able to pull off the tech to make their product work) that represent opportunity for the right kind of investor that knows how to evaluate that risk and the founders’ ability to overcome those risks.

• Hardware/software businesses represent a subset of those “deep tech” businesses that carry unique challenges. Bringing a physical product to market as a start-up is challenging, and it requires the right founders who will survive the early technical challenges and the right investors who know how to help the founders navigate the challenges they will face.

• Hardware/software businesses often require unique business models that are unfamiliar to most venture capital investors. Many hardware/software businesses are not “venture backable” — they don’t have the kind of financial flywheel that generates the exponential growth required to appeal to VCs. That said, some hardware/software businesses do create exponential growth — but often through business models that may be unfamiliar to a traditional VC. Those businesses then have to educate investors to help them understand how their business model will create the kind of returns that a venture investor is looking for.

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Transcript:

Intro

Avidan (00:00): ...to hone your pitch and think through the business model. The whole way Silicon valley works is a pay it forward attitude of everybody willing to get on the phone and share whatever they think. By the way, if you just want to get on the phone with me to get advice, that's easy. If you're not asking for money, it's a much easier... And that's how everyone in Silicon valley is like. Honestly, if you saw me at a cocktail party or you saw me at a coffee shop and you wanted to come up to me and chat for a couple minutes and hear my thoughts, I'm not shy. I will tell you what I'm thinking and that's great.

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Zach (00:33): Hi, my name is Zach Supalla, and this is Atoms and Bits. We're here interviewing Avidan Ross of Root Ventures.

Avidan (00:39): Absolutely. Thanks for having me. So I'm the founder of Root Ventures. We're a[n] early stage seed fund, based here in San Francisco and we invest in engineering enablement. So what we mean by that is we think technical risk is worth taking. There are a lot of people out there who believe venture capital has always funded people taking the biggest technological risks. And the truth of the matter is over the last 10 to 15 years, there have been other opportunities to invest that aren't really about engineering risk. It's about go to market risk or it's about internationalization risk, or it's about a brand and building brand. And at the end of the day, we believe that funding deep technical risk is a risk we want to take.

So the way that we manifest it is we invest in people who are building tools for engineers, and we invest in engineers who are building companies. So the two types of companies that get created are ones where there's a lot of technical risk in getting the company started. Things like hardware, robotics applied AI, synthetic biology. And then we invest in people who are building tools to make those companies easier to build. So we end up investing in companies like electrical engineering software, mechanical engineering software, data science software, a lot of things like IOT development platform. So our relationship was that we were the first investor in Particle and we have continued to invest in this space, but it all comes down to, we believe that engineers need the funding and I'm happy to share with you that, that's a chip on my shoulder, because my background is an engineer and we can dive into that if you want. I don't know which order you want to go in.

Zach (02:14): So just for the audience's purposes, Avidan invested in Particle like a thousand years ago. What, eight years ago?

Avidan (02:20): Eight, nine years before COVID. Nine year BC. No, I'm joking. Nine years ago, 10 years ago.

Zach (02:29): Something like that. So Avidan and I have been doing this for a very long time. So all the questions I'm going to ask him, I've already asked him and we've already talked about all the stuff a thousand times.

Avidan (02:36): You're a part of half of the story and I'm part of half story.

Zach (02:39): Yeah, exactly. So like this is all going to be just like all the stuff we've been talking about for many years. But so like let's go back before that. Yes. You found your way into VC. How did you find your way into VC? What caused you to get into this?

Avidan (02:54): Yeah, I've heard of a lot of people taking a pretty direct route. People come up here and they study business and they go to business school here and they work at Google or they work at Apple and they work at Andreessen Horowitz and work their way into starting to invest in tech companies. And for me it was totally not the path.

So like everybody at Root, I have an engineering background. I studied computer science and embedded systems. And during the first dot com boom, I was writing embedded firmware and network application software at Excited Home, which was a company that basically invented high speed broadband. So we were building cable modems. But long story, short dot coms crashed, I bought a round the world plane ticket. And when I got back to the US, the dot coms were still crashed. And I found my way into building tech for a private equity firm in Los Angeles. And it was a small firm doing a lot of real estate and infrastructure investing.

And when I say infrastructure, I don't mean like data center infrastructure. I mean water, wind, solar smart grid. And I was very lucky to be in the right place at the right time. We grew tremendously quickly. And as the CTO, I was overseeing how we deploy technology, both in companies we were purchasing and how technology transformed that business, as well as looking at technology that transformed the way that we operated as investors.

And my revelation was that so many of these huge industries we were looking at could be transformed. If someone was willing to take that technical risk. If someone was willing to invest in fundamental technology that applied to pick your industry, construction, agriculture, mining, waste management. And I had this working assumption that, I was in Los Angeles at the time, and I was like, "well, in Silicon Valley, they're clearly investing in that", but this was 2009, 2010 and all the rage was, technology has been pre-built for you. You have Apple building the iPhone and iOS store and platform. You have a lot AWS basically scaffolding everything for you-

Zach (04:58): So a lot of social mobile, local time.

Avidan (05:00): ...Yeah. Mobile, local, slow, mobile, local social time.

Zach (05:03): It was that time.

Avidan (05:05): And I started getting approached by engineers who were saying, "I want to build a company, but I need someone who's willing to take that technical risk". And so I went to my partners at the firm and they were very supportive, but they said, "look, we can't invest as a multi-billion dollar private equity firm. We're not looking to take technical risk. We should invest when they're already grown and they have scaling risk and internationalization risk. Why would we take that technical risk?" And when I heard them say that, I realized that was my unique opportunity that I could take the technical risk.

So I gave them a year of non-compete and I did all sorts of wacky stuff. I basically told them, "I'm not going to invest for a year, but that means I'm going to travel around the world. I'm going to write a book about the best coffee shops around the world. I'm going to build crazy robots for the food network," which was a fun non sequitur. Although I will tell you the show never made it to air because my cohost lost his eyebrows in the first episode, because we built a pizza oven that cooked pizza in 45 seconds using robotically, charged after burners. And we didn't build a safety switch on it.

Zach (06:18): Does that pizza oven still exist somewhere?

Avidan (06:19): It eventually got taken apart. I didn't have space to build it, so my parents offered their backyard. And my father, I remember the day we were about to film the final shot of this crazy oven. And he shows up and he looks, he said, "did you guys take out insurance on this?" And I looked at him and I said, this is the wrong time to ask that question, because we're rolling. We're in a film right now. I was like, "mom, can you get rid of dad? He's asking questions about the insurance." But it was a lot of fun and it sort of reminded me how much I love building things.

And the segue into venture capital was that I started meeting engineers who I kept on leaning into this. I want to help any technical founding team figure out how they go to market. Figure out how do they sell to customers? How do they figure out their go to market motion, but also what technology is worth de-risking, what's worth building, how do build out your business model? And for me, the chip on the shoulder was I was the technologist who was always told technology is about cutting costs. Not about driving growth and transforming your business.

And so I put my money where my mouth is and I started angel investing. But before I could write any check on my own friends of mine said, we want to invest with you. We know that technical risk is worth taking, but we're not ones who can assess that technical risk. And that transformed into a bunch of companies that I invested in minor syndicates. And now we're in our third fund, we've invested in a bunch of special purpose vehicles.

We've - we have about 350 million under management at this point. So we are very much focused on those early stages and it all came from a failed Food Network episode where my buddy lost his eyebrows. Which I'm in retrospect, thankful for the lack of safety switch on that. Because I could have just been a, no offense Guy Fieri, but I could have just been frosted tips and out there building crazy cooking robots.

Zach (08:23): I assume his eyebrows grew back.

Avidan (08:25): Oh he had plenty to lose. He was all right. I think his girlfriend at the time was like "you know? They're trim. I actually..." When they grew back, she was like, "that length, keep them that length."

Zach (08:40): So, okay. You go from the private equity world into the venture capital world after a segue out and then in, with a focus on deeply technical problems and engineer solving them. My experience, this is about when you and I meet.

Avidan (08:57): Yep.

Zach (08:58): And the thing that I will always remember is that you showed up, I gave our whole pitch to a room full of investors about what we were doing, and you showed up with holding in your hand, a pair of our competitor's products. And we hadn't built our thing yet, so of course you didn't have ours yet, that's Kickstarter campaign at the time. But you came and you said "I know what you're building. I know what the alternatives are. I know there's a problem here. This is really interesting. I want to talk."

Avidan (09:23): And the alternatives are, I think my words were, "I don't think-"

Zach (09:27): "These products suck."

Avidan (09:28): Yes. I think it was, "these products suck." I think I said, " I don't think you're the first person building this. I think you're the first person building it right." Right. And it was this idea that I had seen so many big industries that we were trying to transform with connectivity at my old private equity firm. Right. And as the CTO, I ran the R and D group to try and figure out what would work. Most of those companies I was holding are now bankrupt or sold for pennies. So I'd rather not list out the names of all the modules I was holding.

Zach (10:02): Those don't exist anymore.

Avidan (10:03): Yeah. But the idea was that those modules weren't thinking about how businesses could be transformed. They weren't treating the engineers who were developing on them as first class citizens. Instead they said, "we've got this solved. You're going to sign up for our white paper. You're going to get access to our development kit, but we don't trust you with the keys. We're not going to let you see inside. We're going to give you a command list and you may use this command list." And you were like, "no, no, your thing has a bug in it. I found the bug. Somebody listen to me, the thing is broken." And they're like, "no, no, no, we've got this." And it was just a very old guard method of building hardware. So I do remember, I think you've subsequently described it at a party or two as a fist full of microcontrollers in one hand and a fist full of cash in the other.

Zach (10:52): Right. Exactly.

Avidan (10:53): And it was more like a wire.

Zach (10:55): But yeah, this doesn't actually work with bags of money like the emoji-

Avidan (11:00): Only in crypto. Yeah.

Zach (11:02): So, okay. So your thesis, now when we met, aside from the fact that you understood the problem, which was unique. I was talking to a bunch of VCs who I had to explain the fundamentals of, well, why did anybody build an IT product? Why does somebody need a product like ours in order to be able to do that? You just knew. And I think that when it comes to investing in technical founders and technical products, just knowing and understanding those problems is a big part of what puts you in a position to make the right bets.

Zach (11:32): You also were at the time, one of the few investors who didn't run screaming from something that had a physical product associated with it. We're showing off circuit boards in a pitch deck and most investors are like, "Nope, that's not a thing that I'm interested in", you leaned in. How do you think about that? And especially that was what, 2012, 2013, something like that, that's 10 years ago. World's changed a lot and I'm sure your perspective on it has become much more refined. How do you think about why are you not scared of it? Let's frame it that way.

Avidan (12:12): I am a little bit scared of it, but it's scared in the right way. It's understanding that it is a high risk endeavor, but it's high reward. If you do it well, you build something that's far more valuable and far more difficult to recreate and far more difficult to switch out. And I kind of fall back to the roots of venture, which is you should take on the risk, right? Risks are worth taking, but you need to make sure that the upside is commensurate with the risk you take. And I think at the time IOT... I actually have a real hard time with IOT as a three letter acronym. Because I think that there was a time and place, and it wasn't long after we met, that IOT meant stuff a chip in it. Grab your toaster oven, make it an internet thing.

It's already a thing, make it now internet. And I think no one was really contemplating how industries could transform with connectivity. Because really at the end of the day, if you think about what does it mean to be a venture backed hardware business, or what does it mean to be a company that's enabled by connectivity? It is this idea that like you are doing something at the edge.

You have a piece of equipment, you have a robot, you have lighting, you have air conditioning, you have whatever it might be. And you benefit from not being alone. From not being an isolated asset from the benefits of infinite compute in the cloud. The access to worlds of information, access to information about what is the current cost of electricity at this exact moment? What is the forecast of weather in the next six hours in the next six days? What are the other devices on the network doing? And then most importantly, it's that you can impart change. So it's not just reporting out information, it's then getting that information back.

And I think that there was a moment in time when people said, "no, we need to just take every thing, and think, can we sell it more if it's connected?" And it destroyed the industry. I mean, the IoT industry spent these years where everyone was banging their head against the wall because everyone just assumed "oh, add compute and intelligence, and now it's a venture backable thing."

And we think about it totally differently. So we think about it as, does connectivity make this business sticky, scalable, generates a larger TAM, grows the overall market. Make something possible that was never otherwise possible. And for any listener out there, who's trying to understand what does it mean to be venture backable, what it means to be venture backable is venture capitalists are actually pretty terrible at investing. Most of our deals go to zero. And we don't know which of the deals is going to succeed.

But when it succeeds, it needs to make up for all those losses. And so what we look for is only companies that have the potential of becoming extremely big and extremely quick. And so you might look at a venture backed deal and be like, "that's a dumb idea." But the question you have to ask yourself is what if it works? What if it works? And if it works, can it become so big? And the reality is venture is not the core investment method for most successful businesses.

When we think about, what does it mean to be a successful business, you can walk down the aisles of target and Walmart and any retailer, or even on Amazon for that matter, there are successful businesses and there are successful products, and most of them weren't venture backed. At the end of the day, they're building product. And that product is great.

So we're not scared of companies that are building something that's technically complex, or has a high risk. But what we make sure of is that the upside and the exit of, what if it works, what if this hardware works? How big is the potential upside? Is the market even more massive than we could have ever imagined? And that's how we make those assessments. I'm happy to go into, if you want to talk about individual detailed ones, but I think that at the end of the day, a lot of investors are looking for risks they understand.

And hardware risk is one that there are very few VCs who can understand the risk of, what will it take from get to get from point A to point B. And I think I'm sitting here, but the reality is our secret weapon at Root Ventures is that there are five of us. And one of whom is Chrissy Meyer. And she was the EPM on the iPod, on the Apple Watch, she ran hardware at Square, she was the founder of actually an IOT-

... hardware at Square. She was the founder of actually an IOT accessory business called Pearl. So when the two of us work on things, she's able to really understand the risk of supply chain, chips, chip shortages, how the hardwares get manufactured. And I'm thinking about the customer base and how does the customer base's business change and all of those things. And unfortunately, it's a risk that most VC firms don't have the stomach for.

Zach (17:25): So that I think is... I mean, one of my theories of venture capital and hardware is that there is a framework for what a good business... Like a sort of hardware, software combo business. Right? I mean, I'll start with by saying I think most businesses that are just pure hardware products, that are like a physical widget that you sell, by default are probably actually not venture backable.

Avidan (17:46): I agree.

Zach (17:47): Right? There are going to be exceptions to that, but the fundamental economics of selling a product that way do not match well with VC. So therefore, we're really just talking about hardware, software businesses. Businesses that have, yes, a physical product, but also software and create value through that combined effort. And that the hardware software businesses can be venture backable or cannot be just like a pure software business can or cannot be. Not just because you make a software product doesn't mean it's venture backable either.

And so then it's a framework and you say, what is venture backable? What isn't? And I think most VCs have a framework for a SaaS product. They know what to look for. They know what questions to ask, what metrics to look at, to be able to say this is a good one, or this is a bad one. Most investors who don't do any hardware, software investing just don't have that framework for hardware, software. So everything looks the same. And you are one of the few who has done enough of these things to actually have an opinion on what good or bad looks like. So actually before we get into that, because I want to understand what your framework is, but before-

Avidan (18:55): Oh no, I was like the framework, it's the golden rule of seven, but no follow up question.

Zach (19:01): Yeah. It's like, where's the white board? We need a whiteboard. Okay. Before we get there, I'm curious actually in the last decade you have become one of the relatively finite number of early stage investors that like... If you're starting a business that has a physical product and you're like, "What VCs are not going to like run screaming from this?" There's probably like a half a dozen and you're one of them.

Avidan (19:27): Yep.

Zach (19:27): Which, my guess means that you get a lot of phone calls from people who make widgets.

Avidan (19:31): Yes.

Zach (19:31): Right? I mean, first off, like how do you feel about that? Are those good phone calls? Is that good pipeline or is that-

Avidan (19:41): I mean, from like a personal perspective, I love it because I still love product. My wife hates it because our house is filled with me purchasing all those widgets because I can't tell you how many times I say absolutely customer, not an investor. I love what you're building and I want to have it in my home or in my office or part of my life. Because to be honest, everyone who's building hardware, whether it's hardware plus software, the moment you're building hardware, you have to have a certain passion about what you're working on because it's so difficult. You have to care so much and it becomes so clear so quickly that you are climbing up a serious hill. It is not a weekend project. It's not a quick wire frame or an app that is just like a quick proof of concept that might be a lottery ticket.

There is no quick and dirty hacker camp of just like, well let's build the product that we're going to now go sell. You have to care a lot about it. And so the people who come and share with me what they've built, they come along with a passion. They come along with a care and a belief in it. And I try every time to make it abundantly clear that whether I invest or not is not an indication of whether or not what you've built is awesome. Because there are a lot of products I love in my life that are not built for a venture investment.

And so I think what it comes down to is I love hearing those pitches because I genuinely get excited for the people who are attached to those. And then I try my best to just help them, even if it doesn't mean investing, which I know is really hard. Come for money, get advice. But I try my best and I try to be really helpful. And what I will say is like every once in a while we get pitched a really interesting product and the person surprises me pretty massively when they say, "Oh, this is a Trojan horse for something huge." This is a hardware product. And on the surface you might think, oh, that's just a hardware product. And they say, " No, but it's a hardware enabled blank." And that's where things start to get interesting.

We are a hardware enabled services business. We are a hardware enabled software business. We are a hardware enabled platform business. We are a hardware enabled recurring revenue business. We are a hardware enabled data business. And when people start digging into that, that's when I really lean forward. And I say, okay, okay, let's talk about the what if this is successful. And the fun part about these businesses is that there are multiple stops of revenue along the way, but we always know what the biggest version of that business is. And that's when I really get excited, when people are able to describe how does this become a multibillion dollar business or even larger.

Zach (22:50): Okay. As you describe what you're looking for, it sounds like you're very much focused on the end state which is like, what will this become? There is a higher degree of idiosyncratic risk associated with hardware businesses than the equivalent software business just because it is harder. Right. I think we'd `all agree, like the whole hardware thing, like it is true. How do you think about that? Because your thesis is we're focused on technically challenging problems, is that just part of the game or is there an exercise that you have to go through to validate, well, yes. Okay. Big vision. It's going to be hard. Are you still going to say no to some of these deals because it's going to be too hard?

Avidan (23:30): Yeah. It's a great question. We've talked about this a bunch and I think we can't delude ourselves to believe that there are people who think like us at every stage. So the really hard thing is like you listed off that there are six early stage folks, and it's probably more like four who are willing to take on that really-

Zach (23:51): These days, it's probably four.

Avidan (23:52): Right.

Zach (23:56): It was once six.

Avidan (23:56): Yeah. And then the last-

Zach (23:56): It was once like 15 and then it was six and then it was four.

Avidan (23:58): Yeah. And it's totally fair that that number has dropped. But the bigger question is how many people in the series A and the series B want to take on a level of risk where it's still a triple black diamond deal. So what we look at is we say, okay, each round you get two. Eventually, you're like, well, there are very few... Let's go to all the way to the end, the public markets.

Zach (24:31): Yeah.

Avidan (24:31): Right? The hypothetical full end. Are they willing to take on a company that says we still have a lot of technical risk to de-risk. We have a lot of technology we still need a de-risk. And it there's like zero, nearly zero companies out there. Elon Musk is the only person who can sell technical risk on an ongoing basis. And otherwise you saw what happened to the specs. The specs tried to sell that vision. And it was a very short lived experience in the public markets. And what I believe is that you have to realize that your goal as a deep tech company is to eventually just become a tech company. You want to take on the risk that you know you can retire. What you want to do is say, okay, if this company can... We like to look at it as a J curve, right?

You drop under and you're making no money. You're building technology. You're doing the really hard stuff. And you might not ship a product for two years. But after two years, when you start shipping, you're going to be generating revenue. You're going to have a customer acquisition cost. You're going to have a sales team. You're going to do all these things. And sometimes it's two years, sometimes it's three years.

But our take on it is how much money will you need to raise before you can be a company that starts to pattern match in a way that a broader universe of investors can assess the opportunity? And so that's what we love to do as a firm. What we love to do is invest a couple million dollars in the early stages. And we have a couple friends that like to do a little bit after us or with us. And we know that a company can spend anywhere from two to seven or $8 million and then emerge as a company that starts to look like a venture backable business to a very broad audience.

Zach (26:23): Yeah. That's interesting. So as a seed investor, you have to think about you're not going to be the last money in.

Avidan (26:30): That's right.

Zach (26:30): Or if you were, that's probably not what the intent was. If you's trying to build businesses that are going to be multibillion dollar businesses, then the seed is going to be the first of five stages investment before you get there. And so that company has to be viable through each stage and then lead to some kind of exit, whatever. And so you have to evaluate a business for its viability for later stage venture funding. I mean, I imagine every early stage investor has to do that. Do you think you have to think about that more and differently because you're investing in deeply technical products than the equivalent early stage investor who's investing in traditional enterprise SAAS products?

Avidan (27:09): Yeah. Yeah. I think it's different because the risk truly goes away. There is a binary switch when you say the hardware functions. It passes, it turns green. The light turns green. The hardware has shipped. The robot functions. The robot is harvesting the strawberries, the robot is making the pizza. The machine in biotech went through a clinical trial. And in the clinical trial, the performance was amazing. That is a switch. That is a moment when you say the largest and most pronounced technical risk is complete. The rocket launched. The rocket landed. These are big milestones that in a lot of other investment worlds, it is many, many, many small steps.

Zach (28:01): Yeah.

Avidan (28:02): And the person who's not doing seed rounds of FinTech, they'd be like, well, it's actually all along the way. It's minorly decreasing risk throughout the entire thing. It's not a big moment. There's not a shipping moment. There's not a delivery moment. And I think that for a lot of those companies, that's why they love investing multi-stage because there are all these different entry points for them. There are all these different times and they just assess the risk at each juncture. But with deep tech there oftentimes is the like does this thing do what we hoped and dreamed it would be able to do? And that doesn't mean it's the only risk of the business.

This is why it's so difficult is even after you've de-risked that part, you still have these other risks you have to figure out. You got a branding risk. You got to go to market. Does your software work? Do you brick all your devices with a bad over the air upgrade and realize that we thought it worked, but they picked the wrong platform to develop on. They picked the wrong chips. They built it in house when they should have partnered. And those are the things that you start to figure out.

Zach (29:09): Yeah. We see this at Particle with our customers where in a lot of ways, our business operates like the Twilios, the Stripes of the world where you say like, okay, we're building a platform upon which our products are going to build products. Our success is tied to their success. If they expand their roll out of their product, we expand with it and their success is our success. And that's true of a business like ours. It's true of a business like Twilio or Stripe, or a bunch of companies that sell like dev tools into software products.

The difference that I see in our business is that our customers don't grow along a curve. They grow in stairsteps. And so somebody will be little and they might be little and then disappear, or they are little and then they go from being little to big and it almost happens overnight. And it doesn't happen in this very smooth way. It has that sort of binary, stair step pacing to it. Now, is that true? Because you do a bunch of deep tech stuff that's not hardware, right? Like CAD software, things like that. Is that dynamic also true for software deeply technical products or is that really just kind of a hardware thing?

Avidan (30:16): Oh, it's totally different for software. For software, you do start to see these people are picking it up. I mean, the graph can still look very hockey stick. But it's not like in hardware where you have a, well, we just got a huge contract or we are now able to step up to a new contract manufacturer where minimum order quantities are this high.

And we have this huge seasonal purchase.

With software, what you see is momentum. With software, so a lot of our companies in the electrical engineering world or some companies like anthropology and mechanical engineering. What happens there is a lot of users are using anthropology software to design their mechanical parts. And it becomes viral internally. So you see the part and you say that... I mean, so for, for context, anthropology does implicit modeling. So generative design, oftentimes for advanced manufacturing, like 3D printing or advanced CNC milling. So the parts look wacky. They clearly were not designed with like pen and paper and they were not designed using traditional CAD drafting tools.

Zach (31:22): Right. I'm reading the expanse right now. And I imagine the things that come out of anthropology look like the spaceships in the expanse.

Avidan (31:30): That's right.

Zach (31:30): When I'm reading the book.

Avidan (31:31): That's right.

Zach (31:32): I haven't seen the TV show. So I assume that they actually-

Avidan (31:34): And I don't know, I could see it in your eyes that you get it. I have no idea what you're-

Zach (31:40): It looks like alien stuff.

Avidan (31:41): Exactly, exactly. Because there's an algorithm that's generating the ideal design for light-weighting, for performance, for tensile strength, for whatever your parameters are. And as software users, as users in an organization are using it, their output is seen by others. They say, well, how do you design that? Then they get a training on it. And you get more and more licenses. And people are just adding licenses within an organization because they've seen the value of it. And so with a lot of software, you just see the adoption and you can see companies that are doing product led growth. But at the end of the day, most of those companies are one off until you get to enterprise sales. At which point, it starts to look a little bit like stair stepping, because there's a big enterprise contract that comes in.

But even then, it's not the same as hardware companies that live and die by Black Friday or seasonal spending or their factories that stand up a certain amount or the minimum order quantities that they have to hit. And then we also see companies that are building hardware that look nothing like that stair step. And oftentimes those are companies that are hardware enabled, but they're hardware enabling a verticalized business. So I'll give you an example. We have an investment in a company. It's called Oma Fertility and they run fertility clinics. But that's not the core technology. The core technology is their equipment is machine learning enabled to select the ideal sperm candidate in a fertility treatment. Now that is a piece of hardware that unlocks in a totally new type of business that is extreme.

The idea is that if you can improve outcomes by a very, very large percentage, and I won't talk about those percentages because that's part of their... What's amazing about that business is how big of an unlock it is. Now all of a sudden you're offering... You look to the world like a fertility clinic. But at the end of the day, you are hardware enabled. You have built a piece of technology that is connected, is intelligent. It's actually robotics at the end of the day. There's articulation that's occurring. And at what we made, we go back to that, like what is that big risk that we had taken on? The big risk was does machine learning improve the selection and outcomes in fertility treatments?

Election and outcomes in fertility treatments. Let me tell you, when we saw the numbers, we knew we had flipped a switch. That's unique in that type of business. That's what I think is unique in deep tech, but the growth there is going to come down to something that you would've never guessed is a problem, which is real estate, the construction of fertility clinics, what it takes to build these clinics out. Then, there's only a certain number of people that go in for fertility treatment at any given time. It's not like everybody gets the new iPhone at the same time and. There's a release of a phone and you see that ladder step. At the end of the day, there's a certain number of people who are looking for treatment in any given geography.

Zach (34:45): Right. It just turns into sort of a services business that grows in a different kind of way than that stair step.

Avidan (34:53): That's right.

Zach (34:53): Right.

Avidan (34:54): That's right.

Zach (34:54): Right. But you have to get over that initial milestone, delivering the product, proving that the product works, so there's a stairstep at the beginning.

Avidan (35:00): That's right.

Zach (35:01): You're coming in at the beginning, so you are always seeing a stairstep. That's the technical risk that you're taking on. You're then thinking about what does the next investor want to see. You're painting a picture where you're saying there's some milestone that has to be hit in order for this ... This is currently a seed stage investment, this is not a series A investment. I imagine if you're doing this in pure software world, you're thinking about it as, "Well. I want to see the metrics develop," but at the end of the day, if you have a 140% net revenue retention at series A, then in order to have a good series B, you just need to not lose that. You need to maintain 140% net revenue retention at series B, which if you keep that up ...

Avidan (35:44): Is that easy?

Zach (35:45): I'm not saying it's hard, but I'm just saying keeping up those numbers as hit higher stages is very hard.

Avidan (35:52): Yes.

Zach (35:53): You're fighting forces that are going to draw those numbers down, but you're trying to keep them as high as you can decline a little bit maybe, try and keep those figures up. But you're talking about it's a totally different staging, it's a totally different way you match the stages of VC.

Avidan (36:08): Yeah. Absolutely.

Zach (36:10): Then you're thinking, what milestone do they have to hit for the next person to be interested in investing in this business? Do the entrepreneurs that are pitching you, are they thinking about that way too? Or are you working with them to figure out let's think about how we would get you ready.

Avidan (36:25): Yeah. I think it's more that we work with them to help them understand, look, you're going to spend two years down in the fox hole building technology. You'll get no credit with revenue. You'll get no credit with metrics. It is okay for you to go down into deep R and D land to de-risk something majorly. Then, what we will do is help you message that to the next stage investor so that they understand that that big risk, that risk, was de-risked and that is the major risk. Because now what happens is, the business you have has an unbelievable competitive advantage. Not just a two year head start, but a two year head start where you were funded to work on really difficult technology, something that maybe you're the only team in the world that can do.

Now, if you are correct in your assumptions about the market, you might be an N of one company. You are category defining, category creating or category killing. The idea that you can come out with a technology enablement that allows you to charge half of what anyone else can do, and because of your automation, you're in a situation where you're saying, "I can charge half of what everyone else charges. I get the same margin." Therefore, all the people who are doing this without the hardware, without the robotics, without the AI, without whatever it is that you've built, what you spent the two years building, that whole business disappears and possibly your ability to charge less means that the total market size is huge.

You step into an investor who usually is taking pitches about X million ARR net revenue retention. Now, instead, they're looking at it saying, "You are the only company I've ever been pitched that can do this. What I need to believe is that that risk that has been de-risked leads to a business that moves faster and is safer or more protected or has a larger potential outcome than these other software companies, where the first two years, they figured out a way to get to 2 million ARR. Next year they're going to do 6 million in ARR. Then who knows what happens after that?" The difficulty of getting started is a feature, not a bug, in that situation. Right. The difficulty of getting started and someone having funded you to work on the most technical challenges means you become a different type of company when it's time for you to get revenue and scale.

Zach (38:49): You are one of the few investors who does this stuff with regularity. You have expertise in being able to separate good hardware, software businesses from bad ones. There's a small handful of investors who do that. The rest of the VC world still occasionally makes investments in things that have hardware with them, but they don't have the experience and knowledge necessarily to have a good framework of like what to invest in, what not to invest in. Where do you see the typical VC investor making bad bets? What are their false positives? Where do you see them not making bets they should be? Where are the false negatives for the typical VC against these kinds of businesses?

Avidan (39:25): I mean, it's a great question because literally the industry is piled with failures. If you think about it, the number of people who are currently investing in hardware, it's a much smaller number, and for good reason. Most of the VCs who dabbled in hardware and most of the hardware companies that even existed, don't exist anymore.

The hardware investors, the people who are okay with a little hardware are like, "I don't want to touch hardware again." How do you bundle up all the failures, all the mistakes made? A lot of it was this belief that you could sell a consumer on a piece of connected electronics, and you didn't have to think about the business model change. You're like, "Oh, they need smart lighting." You're like, "Great. And then what?" They're like, "Well, then it's the full ecosystem and platform for all their connected devices in their life. You will have smart lighting that leads to smart buildings that leads to smart cultures. The world changes because my light bulb can turn off at sunset." You're like, "Wait, what?" That's not a whole business.

Zach (40:37): Yeah. But that's interesting because, I think there's the consumer story.

Avidan (40:40): Totally.

Zach (40:41): I think there have been a lot of failed venture back businesses that started from a premise of we're building nest for X and nest ended up being a great exit, but most of those other businesses didn't do well, don't exist anymore, had small exits. You do have other cases where, Peloton for instance being an example. Now, Peloton's had all sorts of troubles in the sort of post public world. But as far as just being a venture backable business, I mean, they went and had a great IPO. I would expect that the folks who backed Peloton did well.

Avidan (41:19): Yes.

Zach (41:19): Is that a business model thing? Is it just that Peloton was a business with a subscription model and you consumer smart home product X that didn't make it or had a crappy acquisition, they didn't?

Avidan (41:31): Well, they, I mean, that's a perfect example. What is the value proposition? What are you replacing? Is there a willingness to spend? There is no world of cycling gym trainer where people don't pay on an ongoing basis.

Zach (41:48): [inaudible 00:41:48]

Avidan (41:48): Some pay monthly, some pay once per session. You had Flywheel. There was just so many things going on where there was a trend of, I take a group class, I pay 10 bucks a session or 20 bucks a session. I pay a hundred bucks a month or 200 bucks a month. Whatever it was. But there was something systemic about that. There was something about that setup that technology could unlock. Technology unlocked your ability to move to the suburbs and continue to do the thing you did when you lived in the city. When you were a young urbanite, you and your girlfriends could go spin together and it was a group experience, you had a trainer. Peloton really was just recreating that experience.

They needed to build great hardware to do it. They needed to build great hardware, but most importantly, they needed to build great content. The hardware was delivery of an experience that people were already paying for. It was a time and place that was perfectly done. It was not just about COVID. It was about the trend line of group fitness specifically around cycling ...

Zach (42:59): There was Soul Cycle.

Avidan (42:59): Right.

Zach (43:02): Right. You're taking an example where you're saying there was a business being displaced, Peloton was not displacing the at home bike. They were displacing the gym or the class. Those have ongoing revenue associated with them. You're not forcing a business model change. You're jus taking something from one place and putting it another, whereas, a more classic consumer product, if you're making a smart toaster ...

Avidan (43:31): That's exactly what I was thinking too.

Zach (43:34):

You're a coffee guy. How many times have you been pitched a smart coffee?

Avidan (43:37): Oh my God.

Zach (43:39): Actually, how many do you think?

Avidan (43:43): 40, maybe 60. Yes. Probably in the 60 range. That doesn't include the ones where I just got the pitch and wrote a very nice email to say, "Unfortunately, this is not [inaudible 00:44:05] to me."

Zach (44:04): If you include just the pitches, how many?

Avidan (44:08): You mean including the emails?

Zach (44:09): How many times has someone sent you an email and say, "I'm making a smart coffee maker."

Avidan (44:14): Yes. A hundred plus. A hundred plus easily. The reality is, in a lot of those situations, I think it comes down to the nest of X, then got replaced with Keurig of Y. People really telegraph the Keurig of X they're like, "Well, I'm just going to build the modern Keurig. We're going to build the Keurig of high quality coffee." At the end of the day, people then took this Keurig of something model, I mean Juicera was a great example and people weren't thinking about the value proposition of the connected device. Keurig itself made a bunch of missteps around what they believed the next generation of Keurig was.

For example, I don't know if you ever saw this device called the Keurig Kold. It's cold with a K, because Keurig. It was a Coca-Cola machine. They partnered with Coca-Cola and you had a pod, you'd press the button, it would chill the water, carbonate the water, and then pump it through the Coca-Cola. An undisclosed amount of time later, maybe six minutes later, you had a fresh Coca-Cola. When was the last time you said, "Wow. This Coca-Cola is so fresh." Think about the value proposition. Think about what you're displacing. The Coca-Cola in my refrigerator right now, that is probably canned a year and a half ago, when I crack it open it's fresh. In juice, yes, to a certain degree, you were like, "This juice is super fresh," but what's the difference between juice that was pressed 30 minutes ago, three minutes ago, or three days ago. We have technologically made those pretty fungible and like the consumer doesn't realize the difference.

I think it's about the value proposition. Making sure that there's a willingness to spend in a way that's ongoing, or that your technology is able to generate a true reason for being a service delivery mechanism, a platform for connectivity or something more than that. I think so many times people were just like, "I'm going to do this of X or I'm just going to stuff a chip in it. People will pay because well now it connects to wifi and therefore it's more valuable."

I think actually one thing that's even crazier is the wifi cellular thing. Speaking of getting pitches. I got pitched by a bunch of home security companies. For the longest time, I couldn't wrap my head around why a company like Simply Safe was doing so well. We didn't invest in any of these security companies because at the end of the day, we kept on talking to them and they kept on putting more and more chips in things. They were like, "It's got wifi. It's got Bluetooth. It's got cellular." We ended up doing a really interesting analysis of why did Simply Safe have an amazing attach rate to their recurring revenue and somebody who had wifi in their product did not? It was because the consumer knew that they had to pay for something when it had a cellular chip inside of it. But if it was wifi, they said, "Well, I'm bringing the internet to this thing. You're using my wifi."

The revelation we had was the attach rates for adding remote monitoring for Simply Safe, where it was a cellular only option ... They said, we will turn on an ATNT connection or whatever it was and it's going to be 10 bucks a month. That attach rate was significantly higher than the people who said, "Well, when you turn on our device, it has wifi and immediately is connected to the internet." There's a consumer expectation that they get certain services. If you walked up to somebody who's building IOT and said, "Hey, by putting less radios in your device, you will make more money." That's counterintuitive.

Zach (47:53): I mean, a lot of that comes down to a business's ability to activate a subscription model, at some point in its future. Which doesn't necessarily have to be out of the gate. Transitioning from not having a subscription model to having one is challenging. There's a bunch of ways to make that happen. There's a bunch of businesses where you just can't. If consumers look at a wifi connected product and say, "I don't feel like I'm supposed to be paying a monthly fee," then they won't, where if it's cellular, they might.

Regardless, if you come down to it, is it as simple as saying that the false positives are places where people thought that a product would be very successful, but it didn't have a subscription revenue associated with it. At the end of the day, that made it a good product, potentially, but not a venture backable product. That's where the core false positives have lived for the last decade.

Avidan (48:44): Those are the most visible false positives. Because you see the product in market, you see it out there. It is successful. People have bought it. People are using it.

Zach (48:51): People love it.

Avidan (48:51): It still went bankrupt, because they predicated their entire business model on continuing to raise venture capital dollars. The venture capitalists were like, " Well, where is your recurring revenue?" Because going back to that venture model, is you need recurring revenue because it's stacks. If you sell a million widgets, next year to double your revenue you have to sell 2 million widgets and then 4 million widgets. Whereas, if you get recurring revenue, you can count on the revenue. I think that recurring revenue is as simple as saying continue to provide value, ongoing value, to the customer means you can charge them for it.

I think a lot of times people just took for granted that, well, because it's connected, you're going to have this ongoing value or a dependency on ongoing support and somehow people would pay for it. I think that most companies didn't really wrap their head around how do I provide ongoing value to my customer? What ongoing value is unlocked by this connectivity? That is the holy grail. That is the holy grail. I think people have started to figure out things above and beyond just the willingness to pay to keep the connectivity going, and instead saying, "Okay. What is the ongoing value I could provide the customer? Or, what can I continue to sell the customer in consumables?" This is why everyone was obsessed with Keurig. Can I pull something off my connectivity to say, "Oh, by the way, I can sell you a subscription to supplies."

You see that with a lot of companies where there's a consumable attached to it. The reality is the consumer doesn't do a great job of keeping up to date on their consumables, or better yet, wants it to be turnkey. Just says like, "Hey, when there's a problem, just send me the thing that I need." Then, there are other people who are unlocking even wider opportunities where they say, "I'm going to put connectivity in. I'm going to sell better insurance policies. Or, I'm going to connect into people who are trading derivatives on how much grain is in a silo. Let me put a piece of hardware to like look into that silo." I think the most interesting versions of it are people who are truly transforming industries from top to ...

Who are truly transforming industries from top to bottom through hardware enabled transformation. So when you think about things like robotics, and I don't mean robots that are like R2-D2, C-3PO. I mean, people who have built fully autonomous connected systems that change the world and can react to changes in the world.

So we have companies like Tortuga, they build a robot that harvests strawberries. They're not just harvesting strawberries. They're also harvesting other fruits, but monitoring how much will this vine yield in the next three days, three weeks? Because I could see how many little green strawberries there are. Big green strawberries, half green, half red. That's not just the value of what the robot is doing when you initially decide to pay for it. Or other companies like Dusty Robotics that's painting layout on construction sites. They're able to take the digital world of your BIM model and lay it out on a construction site. But that unlocks all sorts of amazing opportunities where the people who come into the construction site are no longer interacting with the plans. They're interacting with what is painted on the floor, if it's a QR code or information about which subcontractor on what day is doing work.

I think that's the next step of building connected hardware is thinking about not just how do I charge somebody to keep the lights on? But how do I transform the way they do business because I've brought intelligence to the edge.

Zach (52:40): Yeah. Yeah. What's your advice... Actually, hold on. Before I get to that question, false negatives. So what are the areas where you've seen these are the companies, people are not investing in these, they should be and there's something about this kind of business that makes it really hard to raise venture capital for, even though it should be... This should be venture backable. It has all this stuff that leads to good returns for a PC fund.

Avidan (53:08): Yeah. That's a great question. Where are all the misses? I think this is probably a dig on the entire venture community, but people really have a hard time imagining industries they're unfamiliar with. The reason why there's so much enterprise SaaS, and networking, and security, and social media investments being done is because when you look at the history of so many venture capitalists, it's where they worked. It's where they were product managers and project managers and finance people and sales people. Those are the industries they know.

The industries that are getting missed are the industries that don't run in California on the 101 Freeway between San Francisco and San Jose. If you drive that freeway, you will see the industries that are getting funded. The amazing thing about connectivity, and connected devices and IoT and hardware is that they're oftentimes disrupting offline industries. Those offline industries are massive. It's agriculture, it's mining, it's construction, it's waste management. It's all of these huge industries and people will come up with all sorts of reasons why they don't think that industry is venture backable.

The funniest is when they say well, the TAM isn't big enough on that and you just sort of... It's hard. You can't undo the way they think about an industry, but then when you tell them it's a multi-trillion dollar industry, they kind of can't wrap their head around it because they can't empathize with the problems of the people in that industry and how transformational this solution can be. So you end up in a world where there's a very small audience. Now, there are a bunch of VCs who have found a way to reach into networks of people to learn about the industries they're not familiar with. But at the end of the day, it's a small group and the Venn diagram overlap of people who are willing to invest in hardware or deep tech companies and willing to look at those big out of sight industries is very small. I think that there are a lot of misses happening.

Zach (55:24): Yeah. That makes sense. If you're selling into agriculture, in order to understand whether a farm would buy this product, you have to be able to empathize with the farm, which you might not be able to. The farm and the farmers and the people who own that business, which you might not be able to do because you've never done any business with them before. So you can't figure out whether this product has product market fit or is going to have product market fit.

Avidan (55:47): Calling your buddies in Napa to find out about their hobby vineyard, that's not calling a farmer. You're like I got a place in Napa and I'm going to call a friend of mine 'cause he's next door selling $200 bottles of cab. You're like, that's not American farming. So it skews people's perceptions of these markets.

Zach (56:07): Yeah. Yeah. That makes sense. Okay. So now wrapping up advice. If you are a founder who's thinking about creating a business that has hardware and software, you're thinking about... Let's just assume, I mean, aside from the fact that there's a lot of good businesses that aren't venture backable. If you are trying to build a business that is venture backable, or you believe you have one and you want to engage with the venture capital community and you haven't done so yet, or you're just trying to figure out how to. What's your advice to a founder to first A, guide their business towards being a good fit with this kind of capital and B, how to actually engage and talk to investors about these kinds of businesses?

Avidan (56:53): It's always hard to give advice because at the end of the day, each entrepreneur is taking a different path. But what I would say is that first question is a great first question. Do I actually want to build a venture backable business? Or do I just want venture dollars or do I just want venture validation? Do all my friends here in Silicon Valley or in New York or wherever you are, does it make you feel like your company is worthy?

I think that's a bad reason to go down the venture capital route. If you feel like you will not be able to sleep at night if the problem is not solved and it requires significant dollars and venture capital is the solution, I think there are a couple steps you should think through about. First understanding what about your business becomes venture appealing? I think that that is allow yourself the ability to think of the biggest version of the business.

Think about everything going right. Think about if I get this, and then I do this and then I sell to these people. Then question all of it and say, okay, how much of that is plausible? Can I really sell this far? Would people pay this much? How do I go to confirm that conclusion I've already made? I think you spend time getting out there and talking to people who are in the industry who would buy. Now, you can't take them at face value because a lot of people will say yes to a problem being solved or can't imagine a solution to their problem because it's self validating. It validates that they are important in their job or that they would say yes to anything that makes their life easier.

But you just have to really ask that question of what is the biggest possible vision of this business? How big can it become and do I see myself working insane hours and literally making my life dedicated to that vision of the world I want to see? Do I care so much about that end that I'm willing to take all these risks to get there?

Then in terms of reaching out to VCs, I would just say, it's don't be impatient. People in venture are trying to make decisions with very minimal amounts of information and they take a lot of credence into who makes the intro. So you'll have to work your way in to getting introduced to someone who might be one layer away from that VC and use that opportunity to get advice on how to hone your pitch. Because as that pitch is getting better and you've built a relationship, then the person has an incentive to then introduce you.

The warm introduction is so much better, but also the process you went through in order to get the introduction is making your pitch that much better because to be really blunt about it, you get one chance to make that first impression and talk about your business. Don't just DM the full pitch. Yes, I'll read it but you didn't get the opportunity to talk to me about it. You didn't get the opportunity for someone to warm it up and give you their insight and their perspective because the person making an introduction might say, "Hey, this is a really smart person. The idea's almost there, but I really think this industry's great because my cousin works in it."

You get more information and I think that that's what VCs are looking for at the earliest stages. So yeah, I'll read your DM. If you tweet at me, I'll read it. If you send me a cold email, I'll read it. But your odds of being able to get a conversation going will improve when you've spent time starting conversations with other people and it becomes a group conversation. 'Cause even after we've taken a pitch, what we immediately lean into is who else can we speak to about this company, this problem? Oftentimes it is the person that you chose to pitch first who then is making that warm introduction. I know people don't love that and they would love to just be able to email directly when they can, but odds improve.

Zach (01:01:17): So if you were to get a pitch for a smart coffee maker and it came in through a warm introduction versus a cold email, how much more likely are you to get on the phone with that person?

Avidan (01:01:28): Oh, infinitely. I mean, it's night and day because the person who sent the intro has spent some social capital. They've spent some social capital saying hey, I know you always read my emails. You always respond to my emails and I care about your time and I think this is worth looking at. If I get a warm email intro, I almost always, there are occasionally times when we say hey, this is too competitive, possibly close to another company we're looking at. But warm introductions from people we respect are significantly higher.

Avidan (01:02:15): We just did two deals where they came in through cold inbound. So it's not to say that we don't do cold inbound. There's plenty of deals that come in that we end up investing in via cold inbound. I would just say that there's a far larger number that don't get done and your odds of getting that first meeting are really about getting to know people who honestly forget about improving the odds of getting to meet with me. It's a great excuse to get on the phone with somebody and try to hone your pitch and think through the business model.

Avidan (01:02:49): The whole way Silicon Valley works is a pay it forward attitude of everybody willing to get on the phone and share whatever they think. By the way, if you just want to get on the phone with me to get advice, that's easy. If you're not asking for money, it's a much easier and that's how everyone in Silicon Valley is. Honestly, if you saw me at a cocktail party or you saw me at a coffee shop and you wanted to come up to me and chat for a couple minutes and hear my thoughts, I'm not shy. I will tell you what I'm thinking and that's great. But in order to get the full pitch and to lean in to do the diligence, it is a group effort. It's not just, if I can only get a conversation with that one person, I can get money. It's not how it works. It really is a lot. There are a lot of people involved.

Zach (01:03:32): Cool. Well, thank you Avidan for joining us today. Hope this has been helpful and if you have any other questions for Avidan or for myself, shoot us a note, reply to this in atoms and bits with the newsletter and yeah, thanks for joining us.

Avidan (01:03:45): Yeah. If you want, I'm @Avidan on Twitter.

Zach (01:03:49): Can you spell Avidan for those who...

Avidan (01:03:50): Oh, Bond. James Bond. I'm just kidding. It's A-V-I-D-A-N.

Zach (01:03:58): Also Root Ventures can be found at Root.vc.

Avidan (01:04:01): Root.vc. Have fun on the website.

Zach (01:04:03): If you like their website, then you're going to like Root Ventures. If you don't like their website, then you're not going to like Root Ventures.

Avidan (01:04:08): That's very fair. It is the ultimate... We actually thought about saying that. Who do you invest in? And we said, people who like our website. Root.vc, Have fun.

Zach (01:04:19): All right. Thanks folks.