Mike Smerklo, Next Coast Ventures

This article is a part of the “Navigating The 2023 VC Landscape,” which previously featured Greg Baker of Alumni Ventures, Bascom Ventures, and Towerview Ventures. Click here to view the previous installment, and follow Brian Penick on Forbes.com for more expert interviews with top investors and entrepreneurs.

For the next installment, Brian Penick interviews Mike Smerklo of Next Coast Ventures in Austin, TX. While Next Coast primarily focuses on Series A and B funding for startups, with checks typically ranging from $5 to $15 million, they have participated in some Seed stage investing where the intent is to follow on with future funding. Next Coast’s portfolio includes Everly Health, Alert Media, Icon Technology, Galileo Health, and many others. Before co-founding Next Coast, Mike worked in Silicon Valley with Marc Andreessen and Ben Horowitz at LoudCloud, scaled the ticketing company ServiceSource from 35 employees to IPO, worked as an investment banker, and earned his CPA. Mike is also the author of the book Mr. Monkey and Me: A Real Survival Guide for Entrepreneurs, a noted favorite among the startup community.

Brian Penick: There are a variety of perspectives on the current market. Has your firm adapted your strategy?

Mike Smerklo: All of our partners experienced the Dot Com Bubble of the late 1990s and the Great Recession of 2008, so we’ve seen the cycles before and have a good perspective. As a result, we’ve had a more fundamental view of areas like gross margin, contribution margin, cost of acquisition, and similar points. The narrative that others were pushing over the past few years and through COVID was that that mattered less, but we never really bought into that and just kept our focus.

The one thing we’re spending more time on with our current portfolio and looking at new investments is the future financing risk, which should be a real part of everyone’s consideration. For the last four or five years, entrepreneurs didn’t have to worry all that much about future financing risks––there was so much capital, and there was such a forgiving mindset that as long as you were doing your top line, you were virtually assured of getting follow-on capital. But that has changed, and I think entrepreneurs have to re-examine that fact, and we, as investors, are doing the same.

Penick: Can you speak about your due diligence process and whether it has changed in recent years?

Smerklo: We’re a relatively smaller firm of thematic investors, so being focused matters on our core areas and industries of interest matters. We’re looking at differentiation and solution. Financial metrics have always been a cornerstone of our analysis. At the end of the day, the bulk of our returns have been by backing amazing talent, which sounds simplistic, but a lot of our diligence has always been around the tenacity, focus and experience of the entrepreneur. That has served us well, so we’re currently reinforcing our principles.

I’m not smart enough to figure out what will happen with ChatGPT, but there are a lot of really smart entrepreneurs who will, and we want to support them as best as we can. I know that sounds a little cliche, but I’ve read where venture investors take way too much credit for the success their portfolio generates, and I think it’s very accurate. We help strategically, we give capital, and we are supportive as much as we can be, but success comes from the entrepreneur at the end of the day.

Penick: With a fund spanning the occasional Seed round to more historic Series A and B, do you fund first time founders, and has that strategy changed in recent years?

Smerklo: I would say the bulk of our investment is made in first-time entrepreneurs. My joke is you can do it once if you do it right. Michael Dell [of Dell, Inc.] only started one company, which is a great example. I certainly think being successful is more of a mental aspect, which my book discusses. What is the mindset of the entrepreneur? Do they have some experience in the industry that shows their tenacity? Candidly, you can tell a lot about someone fairly quickly when you meet them, and some qualities come off, like perfume, which is where I focus. Things like market size, core economics, disruption, and nature of the solution, can all be tested and measured, but the bulk of our diligence on the entrepreneur is in these other areas.

Penick: What best advice can you offer startups in this current climate?

Smerklo: One of the most important things is to research your investors before you pitch. Make sure they have capital to deploy and are not a zombie fund. Secondly, don’t assume you are completely unique––it’s a competitive world, and some people may not be as different as they believe. It’s simple advice, but go into a pitch and play devil’s advocate. Ask, ‘why won’t this work? What is the competitive landscape? How will I fight inertia?’ I find too many entrepreneurs talk about how great they are without recognizing the challenges that they may face. I would rather you tell me why it’s hard, what you’re worried about, and why you’re scared that this may not reach escape velocity. Oddly enough, that actually shows me more about your acumen as an entrepreneur than telling me how big the market is.

Penick: I was told early on in my fundraising experience that every investor is looking for a reason to say “No,” and you have to convince them otherwise. Do you agree with that statement?

Smerklo: Well, yes and no. I’m looking for a reason to say no, that’s true. But telling me some of the reasons I should say ‘no’ is actually helpful. It shows me you have experience. I had an entrepreneur two days ago that I felt was solving a really complex problem. I said, ‘this seems like it’s really hard,’ and they replied, ‘no, it’s going to be easy.’ Either you’re not as different as I thought, or you don’t understand the struggles you will face. Tell me a business where some founder’s story starts with, ‘Yeah, and it was easy––I just came up with this, and it was successful.’ Maybe Beanie Babies 30 years ago?

Penick: What best advice can you offer any VCs/LPs in this current climate?

Smerklo: Future financing risk is real. If you look back over the last four or five years, it was pretty easy to be sitting around an angel investor dinner where somebody would invest money, and then it’s off to the races. That scenario can still potentially happen, but the risk of a company shutting down is much higher and should be considered. Thinking about future plans and risk is really, really important right now.

Penick: Based on your expert opinion, what will happen this year? Do you believe a recession is coming? What does your prediction mean for both entrepreneurs and investors?

Smerklo: I think it will be a slog and will take a long time to recover. I liken it to a housing market shift where it takes three years to reset and trade or lock the jump and come back in the market. I think we’re in the early stages of something similar. If you’re an existing company, it will be really challenging to function, and you will have to work through a lot of pressure. Investors are super cautious right now, the exact opposite of where they were 18 months ago. I think we’re just in the middle of a rebound, which I kind of like, by the way. The view two years ago was that you can’t lose money, so you would be crazy not putting money to work. Now the view is that you can lose capital, but the intensity to not lose is what drives investors ahead.

Thank you to Mike Smerklo from Next Coast Ventures for his time and perspective. Please stay tuned for more articles from my “Navigating The 2023 VC Landscape” series by following me on Forbes.com.

Legal Disclaimer: I am a partner at the venture capital firms LOUD Capital and Legacy Entertainment Ventures. For journalistic integrity, I have not included my perspective within my colleagues’ responses for this article to remain unbiased.

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