Startup mania: Dave McClure on rapid-fire funding, opportunities

There's a fierce debate going on in Silicon Valley about the state of startup funding. Some are screaming that valuations are way too high. Others are arguing early stage startups are facing a cash crunch and are unable to raise their first real money, known as the Series A.

Longtime venture capitalist Bill Gurley of Benchmark Capital said recently that every day he gets five to 10 introductions to startups that need Series A money--up from one to five a year ago--but that there just isn't enough capital to invest.

Whatever the reality--and TechCrunch just crunched some numbers that support the cash-crunch argument--a big part of the startup boom is happening because of guys like Dave McClure, who sometimes sports a white t-shirt emblazened with the words, "Believe in your f**king self."

McClure, it seems, is everywhere. A PayPal alum who's been in the Valley for 20 years, McClure runs a seed fund and startup incubator program called 500Startups. He started it a year and a half ago, after a stint investing with PalPal founder Peter Thiel at Founders Fund. While MClure hasn't invested in 500 actual startups (he says it's around 220 now), he's getting close.

I caught up with McClure to pick his brain about all the fuss, what he's seeing now, and just how he invests at such a manic pace:

Q: You put small amounts into very early companies--as little as $10,000, as much as $350,000. With so many investments, how can you possibly do due diligence?
McClure: A lot of VC funds like to think they're great about figuring out a company before they write a check. But I think most people really are guessing when writing that check. We'd rather write a small initial check and assume we're wrong and be pleasantly surprised than write a check after we think we've figured out everything about the company, which is often not the case.

So what do you look for?
McClure: Our filter is fairly straight forward: We look for companies that already have a functional prototype and basic revenue models, even if there's not much revenue. We want some solid engineers on the team, and possibly a designer and possibly a customers acquisition person. Then, most important, is a kind of a passion and focus on a particular customer segment and a problem that they're trying to solve.

We invest quickly based on that filter. We write a small check, and we'll be wrong two out of three times, maybe more. But at least 25 percent to 50 percent of the time we'll find something interesting. Then we'll be a follow-on investor, and we really look at that as the due diligence process.

How hard has it been to raise money?
McClure: Well, I'm generally advised from our lawyer not to comment about fund raising. Our current fund is around $26 million right now, and we have a target of $30 million, and I think we'll get there. But it's still a little more challenging for a small fund with a pretty different strategy than most other traditional VCs out there.

VC funds have performed pretty poorly over the past 10 years, and that's quite an understatement. I think most traditional sized funds--north of a couple of $100 million--are not having tremendous success raising unless they have had really solid returns.

What about from entrepreneur's perspective?
McClure: This is the stuff I've gotten frustrated with. The popular story in the press is there's this Series A crunch that's happening. Bill Gurley is saying there are too many startups chasing too little capital. I hear that pretty much every year from a bunch of larger VCs who aren't so active in early stage. And maybe that's true from their perspective because they're looking for billion-dollar-type returns.

From my perspective, the industry has gotten steadily better and better over the last 10 years. We're not dumping millions of dollars on dumb startup ideas with no revenue models any more, at least not quite as regularly.

Some of the lean startup methodology and ideas have taught people to be way more frugal. Product development costs are just down generally because it's cheaper to build. Customer acquisition is up substantially, and it's just much easier to get customers because more of them are online. Look at the macro picture. It's dramatically improved over last 10 years. Even dramatically more so over the last five years, with the advent of Facebook and Twitter and now Apple and Android.

So anybody who's crying about the funding industry being not good enough or there being too much crap out there is full of s**t in my opinion. The industry is way more efficient than ever before--on product development, on customer acquisition and that is a good thing, period. If there's too many startups for lazy VCs on Sand Hill Road to look at or they're too picky, you know, fine.

And there are lots of opportunities even without a big VC investment.
McClure: It's just that they're not the only source of capital only more, and you don't have to grow billion-dollar businesses to be successful. There are plenty of exits, like Mint's $170 million exit and others at $25 to $50 million and people making reasonably good money on their efforts. [McClure was an angel investor in Mint].

So there are more small exit opportunities, whether tradition tech companies like Google or Microsoft and now new non-tech companies like Walmart are making acquisitions. A lot of returns south of $100 million won't fit with traditional venture funds. For seed funds and incubators and angels, those types of returns are just fine.

How about your returns?
McClure: We're going a little more for single or doubles than a home run portfolio that most venture funds go after. But we're optimistic that because of the number of investments that we will see one or two home runs in the overall portfolio based on law of averages.

What opportunities get you excited?
McClure: There's obviously a lot of new cases based on mobile platforms and tablets.

One big new category we're spending a lot of time on is family, parent, and education, which has opened up considerably based on the number of iPads in use. Previously, you would've had to go to school systems and get approval. Now you can go direct to consumers. That's a big market. And Apple has 100 million credit cards on file.

Tablets and mobile also open up a lot of opportunities to reach small businesses.

So you believe in the local mantra?
McClure: We're pretty bullish on Groupon and LivingSocial as being future platforms for local. Everyone thinks of them as buying platforms. We think of them more as small business platforms. If you think about it, in the U.S., there are millions of small businesses. These people have historically not been that easy to get to, so it's been hard to have a business focused around small businesses.

The previous platforms have been limited, like Intuit for financial or accounting, or Salesforce or LinkedIn perhaps. Now you're starting to see Groupon and LivingSocial throwing billions of dollars out there, putting sales forces on the ground, bringing small businesses online. And with the advent of mobile payment happening, we're going to see an explosion in those markets for the next two to five years.

Are you talking about so-called location-based services, because we're all carrying GPS-enabled devices in our pockets?
McClure: We've been pretty negative on location-based services, which is kind of the buzz word. In the past, we've been like where's the f'n money coming from on that sh**t? But I think now you're starting to see Yelp and Facebook and Groupon and LivingSocial are willing to say--that check-in is probably worth $1 to $5. That really becomes an enabled services and third-party application developers can start building services where they enable check in and pass that info on in exchange for economic incentives from those major platforms.

It's another version of lead generation.
McClure: Yup. We used to think an e-mail address or or a click is worth 50 cents or $5. Now we're going to say a check-in is going to be worth 50 cents to $5 bucks. It might even be worth more than that to the local merchants. Some of that's still emergent, but I do think that's now on the horizon.