In episode 19 of Venture Confidential, Charles Hudson stops by the studio to talk about his journey from founding a mobile games company to becoming a partner with Uncork and most recently Precursor Ventures .

About the Guests

Charles Hudson is the Managing Partner at Precursor Ventures , a classic seed stage investment firm based out of San Francisco, CA. Prior to launching Precursor, Charles Hudson was a Partner with SoftTech VC and was also the Co-Founder and CEO of Bionic Panda Games.

Show Notes

Transcript

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Peter Chapman: All right, Charles. Welcome to Venture Confidential.

Charles Hudson: Thank you for having me.

Peter: Can you tell our audience what shoes we're both wearing right now?

Charles: We are both wearing Allbirds. Gray, but it's not the charcoal gray. It's the bluish gray.

Peter: I actually bought these from my roommate. I bring up Allbirds because my second interview on this podcast was with Anarghya Vardhana, and she talked about this really cool founding team that they had just brought on board that were making this cool new cotton-based shoe. I love that they're exploding over San Francisco now.

Charles: I found out about Allbirds from a founder that I backed.

Peter: Oh!

Charles: And he wore them every time I met with him. He had a different pair on, and I'd go, "What are those?" He's like, "They're Allbirds. You should totally check them out." Before the big Allbirds boom in San Francisco. He's the one who introduced me to them.

Peter: You got in before they were cool.

Charles: That's debatable.

Peter: I want to start with your entrance into venture. You got a couple of degrees from Stanford, you got your MBA there. You spent a bunch of time in various business development roles. And then you joined Uncork as a venture partner in 2010. What led you there?

Charles: It was an interesting story, my journey getting to Uncork, which was then called SoftTech. I had been working in games for about five years. If you go all the way back to the beginning I worked at In-Q-Tel, the CIA's venture capital group, right out of college. Really enjoyed the experience. Thought it was great. But didn't feel like I had enough operating experience, or just general business knowledge to be useful as I progressed in my venture career.

Going back to 2010, I'd been thinking about going back to investing. I hadn't committed to it, but it was becoming interesting to me again. And I talked to a handful of firms about their plans, this was in most of the seed funds then. Micro VC's, whatever you want to call them. On fund one or fund two, looking to grow.

And Jeff had funded a lot of people that I knew. I didn't actually know Jeff that well, but he'd funded Elad and Othman from Mixer labs, GeoAPI and now Color fame. Jason Shellen, who I ended up working with at Google.

I said, "This guy's overlapping with my network quite a bit." And I was contemplating joining a Micro VC fund. I was meeting a lot of people, trying to learn the model. I went to Jeff and said, "I have a lot of questions around how these micro VC models work. Particularly when it comes to the fee structure.

How do you make the math work on these small funds and low fees? And what are the returns expectations?" He was thoughtful and kind and walked me through the model, and he said, "Maybe you and I should just look at some angel deals together and maybe something will come of that."

We started looking at Angel deals together. What I learned quickly from working with Jeff at arm's length was we liked different kinds of companies. I would meet somebody and pick up on something, and he would pick up on something really different.

I felt like in a partnership what you want is two people who have complimentary skills. There were other people where I was I guess, "angel dating," for lack of a better word. I found that we either liked exactly the same companies for the same reasons, or we could never find anything to do together.

Organically at some point Jeff and I started talking and he said, "I'm thinking about expanding Uncork." At that point he didn't have an assistant. He was running the entire thing. It was him plus a back office administrator, which to me as someone who runs my own firm, is literally impossible to imagine trying to do all of that on your own. And so we started working together towards the end of 2010, and made it official in 2011.

Peter: Awesome. You said something there that I want to dive into. You said you want an explanation of how small funds make the math work, and we haven't really talked about the fee structure of a venture in this podcast yet. Could you give us a little bit on why it might be harder to make a small fund financially viable?

Charles: Absolutely. The way that venture funds work is, you might have heard this expression, "Two and twenty." A shorthand for how venture funds work. What that means is you get a 2% management fee on an annual basis and you get 20% of the proceeds known as carried interest, once you've returned all of the invested capital plus management fees.

So if you do the math, if you've got a $15-million-dollar fund, and let's say you've got a 2% management fee, that means you have $300,000 dollars a year to run the fund. Which maybe on the surface sounds like a lot, but it isn't.

Out of that management fee you have to pay for all of the fund's core operations. Any legal fees you have that aren't related to setting up the fund, rent, travel, conferences, a salary for yourself or your team. That $300K has to basically cover operations of the firm.

And particularly in a place like San Francisco or New York, when you net out the things that you have to pay for on behalf of the fund it doesn't leave a lot for current compensation for you as a manager. And what it means is that you need your fund to get into carry. That is, you need to return your invested capital plus fees so you can start making real money on the upside.

Contrast that with a much bigger fund. You've got a $500 million dollar fund, you're taking home $10 million dollars a year in fees. That's a lot more money to have a nicer office, more people, admin staff. It just gives you more flexibility operationally.

Peter: Got it. And you're running a pretty small fund yourself now, right?

Charles: I'm intimately familiar with the economics of running a small fund, yes. Our first fund was $15.3 million.

Peter: Great. So you're trying to make it work on $300K a year, you have what seems like a pretty sizable staff for a $15 million fund. How do you make it work?

Charles: I'll tell you a little bit about how we put together the math for Precursor. We have two full-time people on the payroll. There's me, and there's my associate Sydney Thomas, who joined us in early January of '17 on a full time basis, after working with me on a part time basis for a few months before that. We were able to encourage our limited partners to give us a slightly higher management fee.

So they've given us the right to call 2.5% per year as opposed to 2%. Truth be told, we still have to pay back management fees before we get into carry.

As I remind everyone, our management fees are basically a loan to ourselves. We still have to pay them back.

We had, until very recently, a cryptocurrency researcher who left to start her own cryptocurrency fund called Luna Capital. And we have an entrepreneur in residence who's working on his own idea. So the four of us wanted a very lean operation.

And to be honest, I spent about two years thinking, "In a world where I want to have more financial flexibility down the road, how would I think about my own personal spending and runway?" Both for thinking about buying a home or children, all these things I've started saving money for. This uncertain future.

While I was at Uncork and by the time I had clarity around what I wanted to do with Precursor, I accumulated some resources that said, "I can draw these down for about two years without things getting awkward." What I tell everyone, when I was setting up Precursor, fund one I planned for 18 months and budgeted for 24 months. When it came to, "When do I think we'll have the fund closed?"

Peter: Got it. I want to bookmark this and come back to you and Jeff joining forces. You like different things, and you like working together, and you become the first investment hire at Uncork while you're working on your own thing. Right?

Charles: Right. The tricky bit was when Jeff and I started talking, I had been working with a gentleman who I'd worked with before. We had worked together at a company called Serious Business. He ran engineering, I ran BD.

He and I became good personal friends and I thought we had complementary work styles. He and I had been tinkering with the idea of doing this Android games company. Mind you, this is in 2011. I would say kindly we were about seven to eight years too early to Android.

To give you a sense, the state of the art top of the line Android phone at that time was the Nexus One. Which you can maybe find in a bargain bin these days. But that was the nicest Android phone you could get. The Google Play store was a shell of itself at that time, and we had this contrarian bet that Android was going to catch up and the tonnage of handset volume would make up for the lower monetization.

We were in the middle of building that games company and I decided to join Uncork as a venture partner. I was trying to both help and support Jeff in growing Uncork, but also running a team that at peak had 12 employees, not including the founders. This is also when Uncork was primarily a Palo Alto based venture firm. Bionic Panda Games, our company, was decidedly a San Francisco based company.

Peter: Great.

Charles: So, an easy way to do things.

Peter: That sounds stressful.

Charles: It was. And I think the hardest thing was trying to figure out how to be good at two jobs. Because the rhythm of venture is, for the most part, you have control over your time. Most meetings can be scheduled at a time that is convenient for you. Until you get something that's moving quickly. And at a startup, everything is always moving quickly.

So you get these awkward tension points where you have a promising fast moving opportunity that you need to meet on behalf of your partnership, but you are also trying to ship a new version of a game. Something's got to give. Invariably when you're doing two demanding things, something's got to give.

And the question is, do you try to balance who gets the short end of the stick? Or do you just decide, "This is my priority." When push comes to shove I'm always going to choose thing A over thing B.

Peter: And you chose venture.

Charles: Eventually I did. I enjoyed being an entrepreneur. I liked the people that we worked with at Bionic Panda Games. And it's interesting, in many ways I learned a lot more from Bionic Panda than I realized even in the moment.

At the time we were done I was probably 35 or 36 years old and the end days of Bionic Panda were extremely stressful. It was hard. We couldn't raise. We were trying to keep the team together. And I just stepped back and said, "Do I want to live this way anymore?"

This is the de facto state of being a founder. It's stressful, it's difficult. It's thrilling. But you've got to be all in.

It was taking a toll on my life. And I asked myself honestly, "Do I want to do this again? Do I want to start over from scratch with a new idea and a new team? Knowing that this level of stress and anxiety is the norm?"

I said, "I just don't." I think the hardest thing for me was, I hate going out feeling like a loser. And I felt like the last thing out of my entrepreneurial track record as a founder was going to be an outcome I wasn't excited about.

Part of me said, "You don't want to go out as a loser. You've got to go do another company and go out on top." I realized that I was just at a different phase of my life. And I felt like I had given my all, financially, emotionally, time-wise, to my games company. If that was my last experience as a startup founder I was okay with that because I felt like I'd learned a lot.

I wanted to help other people be successful. I realized I liked the management part of my job more than anything else. I said, "I want to go back to a role where I spend most of my time helping and encouraging other people." And venture is a pretty good place to do that.

Peter: I'd love to hear more about those early years at Uncork. What was hard, what was fun?

Charles: It's funny. I didn't know any different. I give Jeff a lot of credit. When I got to Uncork, Uncork basically ran in Jeff's inbox. Because it was a single partner fund, all of the information was really in his inbox. And when I first met Jeff he had this little office, if you know downtown Palo Alto well. Behind Joya, it's off the university. There's a Spanish restaurant and there's a little house tucked away backed there.

He had a floor in what looked like a residential house. And he's probably one of the hardest working people I've ever met in my whole life in terms of ability to put hours on a task. I feel like in my career I've been lucky. Gilman Louie and Jeff, the two people I've worked with the most in venture, both have an incredible work ethic. That's something that I just assumed and I've internalized as necessary for success.

But it was cool when I got to Uncork. I think most people thought of Uncork/SoftTech as being The Jeff Show. And I give him a lot of credit. He tried really hard to create an environment where the industry, our peers and the market understood that this was a new chapter for the fund and that it wasn't exclusively The Jeff Show.

It was going to be our thing, with a clear understanding that he put a ton of work and effort into building the firm from scratch and getting the fund raised. And he went out of his way to try to give me space to be myself at the firm and create my own identity and be complimentary.

Also, I'd never been at a for-profit institutional investor. So there's a lot of things about the back office side of venture that I just had no visibility into. We didn't have capital calls at In-Q-Tel. We didn't have a third party administrator. We didn't have an LP committee. We didn't have any of these things. And he just threw me in.

He's like, "You're a partner at the fund now and this is what we do. You and I go do this together. We're going to go have some fundraising meetings, and you're going to get to know the portfolio, and you're going to start bringing in deals. And we're going to come up with a mechanism by which we talk about what things we're going to work on."

And it was great, and it got better when we added Ashley on the operations side. She helped rationalize a lot of the things that Jeff and I were trying to do and kept us on task and on mission. It's cool to see how much Uncork has grown since those little days in that small office.

Peter: You said those early days were partially about finding your own identity as an investor. How would you describe yourself as an investor?

Charles: I think for the first four or five years of my career as a VC, I thought there was this monolithic way to be successful as an investor. It involves some combination of technical skills, an innate sense for product, maybe people and market.

I would say in the last seven years what I've realized is, everyone has some combination of strengths and weaknesses. So there's three dimensions. There's the people piece, how much you trust your ability to judge people? There is the technology piece. Then there's the market piece.

And with technology, I really mean technology and product. What I realized is I know some people who are exceptional at judging product. Josh Elman at Greylock, exceptional at meeting product-oriented founders, evaluating the quality of what they've built and being able to extrapolate that to the future.

I don't know that I'm world-class at that. I feel like I have good instincts around markets, around whether a founder sitting across the table from me understands the structure of his or her market and why they have an opportunity.

I trust my instincts on founder ability independent of previous success. What I realized was I should probably discount whatever feelings I have about the product sitting in front of me, positive or negative, as long as the product works. And probably trust my gut on people and markets, because those are the areas where I think I have better instincts.

It took me a while to realize that there is no monolithic way to be a good investor, but a good way to be a bad investor is to overweight the things that you don't have good instincts on just because you're supposed to.

Peter: That's comforting to hear. How did you figure out that these were your two strengths?

Charles: It's interesting. I had a limited partner, someone who invests in a venture fund, ask me, "What was the common thread of the four or five companies that I'd been a part of as an investor that had done particularly well?" I said, "I always had an overwhelming positive feeling about the founder and his or her ability to do great things from the beginning." And it was always some combination of presence, story telling, understanding of the market and the problem they were going after.

I think about a couple of companies, like Laura at Shippo, I think about Mike at Top Hat. I think about a handful of other folks that we backed at Uncork who even in a first meeting had this energy and clarity around what they wanted to build, that was infectious. Also importantly, had a good sense for why the market they were going after was amenable to the product they were building, and why it would be difficult for other people to compete with them.

And the areas I made my worst decisions were all companies that had some element of market traction and data, but where the data and the progress with the business caused me to not ask good, difficult questions about the ultimate scale and what they'd actually achieved.

Peter: You eventually left SoftTech to build your own, we'll call it an early seed fund. What prompted that move?

Charles: It was hard. I enjoyed working with Jeff, and as the team grew to be me, and Jeff and Steph and Andy. We had a very nice dynamic as a group. When I joined, SoftTech had $15 million under management across one institutional fund, and then a little bit of Jeff's personal money that he'd invested is what we called fund one. But it was his aggregate angel portfolio. In the year that I left they crossed the $330 million dollars in assets under management mark, and it had become a different place.

And when I joined SoftTech/Uncork, I remember meeting Bastian from Postmates and him telling us about this crazy idea he had for a delivery service. It was painfully early, and he was raising a fairly modest amount of money at the time. And we were able to invest in companies like that because we wrote small checks, the companies were raising small rounds, and there was no expectation that they would have much in the way of proof.

That's how I left. My guess is our average check was maybe $1 million into companies that had somewhere between $5 and $20k in monthly recurring revenue, if they were a B2B business, or certainly almost always had launched product unless they were coming out of a top tier accelerator, or they were a founder that we knew.

And what I noticed was increasingly the founders that we would have funded five years ago would e-mail me, and tell me, "I'm raising a new round. I need to put together a run of $750." I would just tell him, "I have nothing to offer you. I need you to be farther along for you to fit our on-model check."

People would say, "I get it. You've changed your model. Where should I go?" And I would say, "Gosh, I don't know. Everyone else like us who's been reasonably successful has also radically increased their fund size and moved upstream. I don't have a good set of mini SoftTech, or mini Freestyle, or mini Floodgate funds to send you to because those firms have all gotten larger."

I realized that there was a gap. And when I thought about what made me happiest about investing. It was having a model where people were the principal input and where you're not trying to forecast based on current monthly growth rates and churn. You're trying to say, at a fundamental level, "Is this person onto something? Yes or no?"

There wasn't an easy way to do that work in the context of a $100 million dollar seed fund and still be a part of the firm's real action. And if I'm honest with myself I think all of my colleagues had internalized our new reality, and they had accepted and I think embraced the fact we were going to write bigger checks and we were not going to do the stuff that was too early. And I couldn't let it go.

I just couldn't let it go. I said, "I miss the days of betting on people 15 times a year as a group, and trusting our judgment. And the new thing we do is harder but fulfilling in a different way." Finding people who were early, and coaching and nurturing them to the next phase is just different work. And I said, "I think I like the old work we used to do more than the new work that we do. And there isn't room in a four partner partnership to have one person who's out of step with the group."

Peter: What's behind this movement towards larger funds? Why did all these guys get bigger?

Charles: The whole increase in fund size piece, I think venture is a funny business. In the beginning for most people, unless you're remarkably talented or you're spinning out of a well-known existing fund. raising your first fund is hard. It's a grind. Took me almost two years to raise Precursor fund one. It was not easy.

I think it's so hard to raise, by the time you get to fund two or fund three and it's working, in the mind of the people who back venture funds, you go from being this very risky thing to this very proven thing. Or, this very low risk enterprise to back. And suddenly when you were struggling to get $15 or $20 million for a fund you have capacity to raise $50 or $75.

It feels good. It feels validating. I assume it does, it hasn't happened to us at Precursor yet. But I assume it feels validating. I was there at Uncork when we went from fund two to fund three to fund four. And it feels good to be recognized by investors who say, "The things you said you would do, you did them and they worked out well, and you're doing a good job."

The other thing is management fee. As we talked about earlier, you get 2% of what you raise in a given fund as fee, and you're allowed to stack management fees on top of each other. So as you can imagine, let's say you had a fund one that was $40 million and you had a 2% management fee, and you had a second fund that was $60 million. You get that 2% on that whole $100 million pool.

So with more management fees you can do things like, get a bigger office and maybe have space for your portfolio companies to work alongside you. You can hire a full time assistant, you can hire talent partner, you can hire an operations team. You can have better portfolio company events at nicer venues. You just have more levers that you can pull to try to make your firm successful. And for a lot of people I think that's attractive.

And also, if you run a small fund on low management fees and made some financial sacrifices of your own, the idea of having more day to day comfort is appealing. The challenge is I've always believed that fund size is destiny. If you tell me how large your fund is, I can probably predict the size check that you like to write and where you like to get involved. Fund models are elastic to a point.

I think the difference between a $10 million fund and a $25 million fund is fairly trivial. Twenty-five to $50, it's a difference in scale but not in substance. You go from $50 to $100, you're doing different work.

Peter: I'd love to get explicit there. What changes between $25 and $50?

Charles: At $25 a lot of VCs think about it as, "What if I write this check and this company is wildly successful? What percentage of my fund will that return?" We'll just do a little thought experiment. Let's say you write a check of $250K into a company and you buy 10% of that company. So it's a $2.5 million dollar post, that company raises no more money, and sells for $100 million dollars. You're psyched. Your little fund just got $10 million dollars back. Life is good.

Imagine you're a $100 million dollar fund that wrote that same $250k check, got that same 10%, company sells for $100 million dollars. You get $10 million dollars back, which is also great, but not great in the context of a $100 million dollar fund. You have to run that experiment 10 times over in order to get back to even.

And so I think the natural tendency for a larger fund is you tell yourself, "If my goal is to return multiples of the capital that I raised, the check that I write has to be big enough such that a $30, $40, $50x, a huge home run multiple at least returns my fund."

And so you start talking yourself out of writing small checks at low prices because you say, "If it's a good company it'll come around again. There'll be an opportunity to invest more money and we'll write a bigger check later." And you get out of the business of writing small speculative checks and you start writing bigger checks to companies that are farther along.

Peter: And now, as you said, you're working with founders in a different way and you're evaluating them in a different way. It's less about people and idea, and more about metrics and a trend.

Charles: And I think the hard thing with metrics is you can't ignore them. Once they exist you have to deal with them.

Peter: Sure.

Charles: So here's a thought experiment. You find a company that's at $10 thousand a month in revenue. Low churn, good growth. That's great. The real question is still the same as it was a year ago when it was getting started, "Are they on to something?"

And my fear at Uncork was always I would find a company that was doing $10 thousand a month in revenue, but that would top out at $250k a month. They were just going after something small and they had just made good progress in finding early customers in what was ultimately a small market.

I was like, "This is not a good outcome for me to optimize for. This is not what I'm looking for. I'm looking for companies that are going after something big." What I realized for me was if there is no data it frees my mind to do the thought experiment of, "How big could this actually be? Is there a world where this company could actually become a big company?" It allows me to focus on the fundamentals and not get distracted by early data.

And in a world where you're looking for a company that can ultimately do $1 to $200 million dollars in annual revenue, the difference between zero and $10k in monthly revenues is actually just noise. It doesn't matter. And so I learned about myself. I actually find it's easier for me to analyze companies from scratch than it is once they have even a little bit of data.

Peter: So what does a good exit look like for Precursor?

Charles: I tell founders all the time, "We have the same enemy, and it's dilution." We're a small fund. I'm always looking for, "How can I keep my ownership as high as possible and stay in line with the founder?" The nice thing for me is founders don't like dilution, Precursor doesn't like dilution because we're a small fund.

But our typical entry point is low to mid single digit millions of dollars, in terms of pre-money valuation. Anything north of $50 for us is a big deal and anything north of $20 is a multiple for us in many cases. The thing I didn't want to do was construct a fund model where I needed multiple decacorns to make the model work.

One way to think about it is to reason backwards. We'll just do a quick thought experiment again. Let's say you have a $50 million fund, your goal is to return three times your money to your investors on a net basis. So you need to turn that $50 million into $200 million.

You need $200 million in proceeds to you. If you own 10% of a company on average at the time that it goes public or gets acquired, you need $2 billion dollars in exits to get you back to your $200 million.

But the odds are pretty low that in a $50 million dollar fund you're going to own 10% in exit. If you cut that in half and let's assume you own 5%, now you need $4 billion in exits. So you need a Nest plus a Dropcam plus something else, just to get you to 3x.

The math gets scary and daunting as your fund gets bigger, but what you realize too is the easiest lever to change is to try to own more. Because it means the scale of the outcome that you need is smaller.

Peter: Wait. I feel like you were saying bigger funds require more total exit valuation, and the way to get there is to buy more ownership which comes from plowing more capitalized companies.

Charles: That's right.

Peter: And you're in this cool niche. I'm reminded strongly of a conversation I had with Jody a couple of weeks ago where she said, "There's a whole bunch of founders who aren't looking to create capital intensive businesses and are under served by these more traditional venture funds that can only write checks above a certain size and needs you to go after billion dollar businesses. I'm doing pretty well talking to founders with moderate ambitions who are willing to take moderate amounts of money at reasonable valuations."

Charles: I tell founders all the time, "I want them to own as much of that business as they possibly can." I want this to be a life changing wealth event for them.

I think one of the biggest differences I've noticed probably in the last five to seven years is there's just a lot more transparency and visibility around fundraising.

And I think in the common narrative, raising more money is a sign of success. The more you raise the better the perception of your company. The challenge with that though is that it's not actually good for you as a founder. Maybe you're getting to participate in a secondary transaction and sell a portion of your ownership, and you're getting some short term liquidity, but in many cases that's not what happens. It's great to have a high valuation but ultimately I think as a founder it's, what's your exit valuation times the amount of the company that you own.

And there isn't as much celebration for companies that are truly capital efficient in terms of the amount of money they raise before the exit. And I think it's because it's a counter narrative. The thinking is, "Getting the $100 million Series C from a famous growth fund that in theory sees everything out there and anoints you as a winner," or "Getting $4 or $5 hundred million from the VisionFund anointing you as a winner," surely is a validation. But it's dilutive to you as the founder.

So we don't lower the ambition bar at Precursor, I still want people who want to build big businesses and who have a lot of ambition. But I do look for people who think really hard about, "How much money do I actually need to make this happen?" Who are unafraid to be the lower capitalized company in a battle if capital isn't what decides the winner.

Peter: I want to shift topics here. In an interview with TechCrunch when you were starting Precursor, you laid out some fairly audacious goals about portfolio composition. You said you wanted a quarter of your founders to be women. A quarter to be African American and a quarter to be Latinx. How are you doing against those?

Charles: We're doing okay. We look at the data on two dimensions, we'll look at the data on a company level which is how many of our companies have an African American or Latinx founder. And we look at the founder population level, too. That's looking at the entirety of the people as a group. One is we have 80 some odd companies in the portfolio at the moment, and that's about 160 founders. So we look at it through two dimensions.

And I feel good about how we've done with female founders. A little bit north of 30, probably 35%. I need to run the numbers again we've added a few companies lately. But call it 35% of the companies that we've backed have a female founder on the team. We're very focused on, not management team, but founding team. Because I think founding team has a disproportionate impact on culture. And we're at about 25% black and Latinx.

So we're a little ahead of schedule on women, and about where we need to be in terms of people of color. I believe 27 % of our portfolio companies have a female CEO. The interesting thing to me is the majority of the female founders in our portfolio are the CEO, or the person who's in charge of running the business. Which I think is a good sign. Where I'm disappointed is we have not done as well with black women or Latina entrepreneurs.

We have not hit my internal benchmarks there and I think it's important to have some rough sense for where you want to end up. Otherwise you'll just end up where you end up. And so we set those benchmarks out at Precursor to keep ourselves honest.

And my view is if you're a Series B or Series C investor, you're dealing with companies that were funded years ago when the climate might have been different and it's harder for you to impact your pipeline. At Precursor, we're in the judgment business. We're dealing with people that are pre-traction pre-revenue, pre-data. This is our subjective judgment on their capacity as founders.

And if every team we back, if one out of four doesn't have a woman on the team, or a person of color, it would cause me to pause. Towards the end of last year we looked at our pipeline and I said, "We are below my comfort zone when it comes to the proportion of our companies that have an African-American woman in particular on the team." And we are not going to force a fit. We're not going to go out and say, "No new investments until we find one." But we are going to let our network know that we want to see more here.

On average, the default for taking a meeting with an African-American female founder is going to tilt more towards a "Yes." And we're going to be thoughtful and introspective about maybe why we don't see as many African-American or Latina entrepreneurs. It's interesting, we've done really well with black men in our portfolio. Part of me says, "That's because that's who I am, and I have a natural affinity for them. It's very easy and comfortable for me to meet a black male entrepreneur in any context and have an almost immediate cultural and gender based bond."

And we've talked about this. "Are there things that we're doing that we're not aware of as a firm, that are discouraging African-American women or Latina entrepreneurs apply?" I don't think so. One other change we made strategically is I notice there were quite a few entrepreneurs of color in categories that we didn't play. Historically we have not done consumer products or physical goods, and I would meet people who were working on products in those categories. And we changed that rule this year.

I'm happy to say that in Q1 of 2018 the pendulum is swinging back. We're seeing more of the kinds of entrepreneurs that we want to see in the proportions that we want to see. And I'm not sure whether we're just paying more attention to our funnel and being intentional, or whether we just went through a dry spell. But I know if we didn't have some sense of where we wanted to end up we might not have noticed and stopped and said, "Are we doing everything we could be doing to get the people we want to come see us?"

Peter: You listed a couple of concrete strategies there. You said, "We gave ourselves a target. We let our network know who we're looking for, and we thought about domains to invest in," in relation to founder demographics. Are there other strategies that we venture capitalists should be engaging in to make sure we're sourcing from a diverse group of founders?

Charles: A lot of people ask me about, "How can we change our funnel and our sourcing strategy?" A couple of things on that.

One part of it is you can't go to the same places and see the same people and expect to magically change your funnel.

I think part of this is being intentional and deliberate about going to places, conferences, geographies that you haven't gone before. Because if those people are already in your network and were easy to find you would have already found them. Part of this requires a behavior change on the part of investors, and candidly, not everybody wants to do that.

Some people say, "I live in the peninsula and I like my life. I don't want to go to San Francisco on Thursday at 8 p.m. to meet a bunch of founders. I want to go to that meet up, that happy hour." So be it.

But I think if you don't change or context you're unlikely to change your funnel. One other thing that we were intentional about at the beginning of Precursor was I wanted our website to showcase the founders that we've backed, not really me or Sydney. So we spent a lot of time and money taking professional headshots of the founders that we backed. And I wanted everyone who landed on our website to see at least two people that looked like them.

To send the signal that, "Anyone can be part of our founder community. This is not exclusively only for people of color, or only not for people of color. It's not only for men and it's also not for men." And so we wanted to have the clear visual signal to people that this is for everyone, and that we're open.

I get a lot of feedback from founders that has an impact on them. That they landed on our homepage and they see the people over products, and they see the faces, and they say "This is a firm where I could envision myself being part of that collage."

I think the other thing is founders today are more empowered and vocal about the saying-doing gap. And I think in venture maybe five, seven years ago you could have said, "Our firm is very focused on diversifying our pipeline, it's really important to us, and that's why we only have white male founders on our home page."

I think today's founder will call B.S. on that and will just say, "If it's that important to you, show me the proof. Show me the evidence. And in the absence of evidence, I'm going to take the people that you've funded and the decisions you've made, and put more weight on that than I will on what you tell me."

And I don't blame them. In every other domain of life, if someone told you one thing and showed you something else with their actions you'd probably default to believing what they do, not what they say. And I think that's created a real conundrum for some people who don't have good ways to access these communities. And the last thing I would say is part of this is, what posture do you want your firm to have?

We try to be open at Precursor. We answer cold e-mails, we respond to open DM's on Twitter. We try to be accessible. Doesn't mean everyone's going to get a meeting. Doesn't mean everyone's going to get money. But it means everyone has a shot at pitching us and approaching us and getting a response.

There's lots of other firms that I think are fairly closed, and they're up front about it. That they want to meet people that get referred to them through people that they know and trust. And in some cases, by multiple people that they know and trust.

That is going to always tilt your network towards referrals from people that you know. And the people that you know are like you and have similar network, you're not going to easily diversify your portfolio. So I would encourage some firms to take a look at your own website, your own social media presence, and just the way that the firm conducts itself and say, "If I were a person who didn't know this firm would I think it's open or closed?"

Peter: It's so refreshing to hear you say that because something that's been said a lot on this podcast is how important referrals are to a lot of venture capitalists. We've heard VC after VCs say, "My portfolio is my biggest source of referrals." I appreciate you calling out that when we rely on our networks to source for us, we get homogenous portfolios. I think that's all I got on sourcing. Anything else you want to say on the topic?

Charles: It's funny. One of the questions I get all the time is, "What's your best source?" And we make 15 to 20, occasionally more than that, investments a year. And every time I think I've found a trend something comes out of left field that completely shatters the trend. So I would say our portfolio companies as the source, those referrals get priority because they're already in the family. And if I can't treat the people I've backed, if I can't treat the referrals that they send with time, attention and care, then they'll stop sending them to me and I don't want that to happen.

One of our top performing companies is a referral from a founder that we invested in at Uncork who I was not particularly close to, but liked. He said, "There's a guy that went to college with me. He's got this interesting idea. I don't know much about it, you should meet him." And that's how our investment in The Athletic happened. Alex and Adam have done a great job, but that came from a founder from the SoftTech/Uncork network who I knew but didn't know super well.

And I've had companies that I've met through accelerator programs where I didn't like them on demo day, but they've come back later. I've had referrals from founders that I passed on who sent them. So I've just become much more sanguine about the fact that I will treat referrals from founders that we back and from my limited partners with an extra level of care because they've earned the right to expect that.

And beyond that I have no idea where our next great company is going to come from. It could come from a conference, it could come from a dinner party, it could come from anywhere. So we're not quite as rigid.

I'll be honest, there's a slightly higher bar for people who come in cold, they have to write a better e-mail, make a stronger case and be a little bit more persistent. But they will get on the calendar if they have a good idea.

I just think it's hard to know at the stage where I invest where the next great company is going to come from.

Peter: Awesome. I ask all my guests the same question in closing, which is, what do you wish you knew going into this?

Charles: I've thought about it a lot, but I wish I knew. I'm going to answer your question in a weird way. I'm glad I didn't actually know how hard it was to start venture capital fund. Because I think if I had known all of the challenges that you face as a first time fund manager, in terms of recruiting new limited partners, figuring out your own strategy, building a brand, building relationships with people that you knew in one context at your old firm.

I didn't realize how difficult and challenging it is. It's very rewarding though. But I think if I had known, I don't know if I would've done it. And I think that's true of a lot of entrepreneurial endeavors. That if you really knew what you were signing up for, you might not do it. So I'm glad I was blissfully naive and thought that this will be difficult but straightforward. Otherwise there'd be no Precursor.

Peter: Where can listeners find you?

Charles: I'm on Twitter, probably too much. I'm just @CHudson and @PrecursorVC and I actually read and respond to almost every well written cold email I get. I'm just Charles@PrecursorVC.com. If people have things to send to me, I don't think getting in touch with us should be a barrier to getting things reviewed.

Peter: And you've got your own podcast.

Charles: We do. I do a lot of podcasting on my own, but I want to put in a plug for my associate Sydney's podcast.

Peter: Oh yeah. Tell us about that.

Charles: It's awesome. It's called Be About It. She interviews people that she thinks are building products that appeal to the wide swath of the economy, and not just the 1% at the very top. And does really good interviews with entrepreneurs that are building cool businesses that address a wide set of people's concerns. So I'm a huge podcast junkie. I'm really glad to be here.