Zillow Co-Founder Shares a 'Misunderstood' Truth About Starting, Funding and Selling Your Company Now that he runs a venture fund himself, Spencer Rascoff is sitting on the other side of the table, and he sees what founders get wrong when pitching investors.

Want to start, fund, and sell a major company? Spencer Rascoff has some advice on that — because he's seen it from all sides.

As a founder, he first cofounded the travel-booking site Hotwire, which he sold to Expedia. He then cofounded Zillow, which helped reshape nothing smaller than the real-estate market, and served as its CEO for nearly a decade. Now he's a serial board member, an investor (including as general partner at the venture fund 75 & Sunny), and a continual startup founder — including building social platforms for sharing intel on food (Recon Food, which he started with his teenage daughter) or what's best to binge-watch (Queue), saving creatives from the endless emails they face as they chase down business leads (heyLibby.ai), and simplifying the market for co-owning a second home (Pacaso).

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"I find problems that I have in my life and feel passionate about, and I try to solve them by starting companies," he says. But actually funding, growing, and selling those companies? That's about great ideas — and also cold, hard numbers. Here, he explains.

You've said that Zillow didn't start with the idea — it started with the team. Can you tell that story?

Actually, this is true of a couple of my startups. I had sold my company Hotwire to Expedia. I had been at Expedia for about a year, and decided it was time to do something more entrepreneurial. So I left with two other folks, who were actually the founders of Expedia; then we added one or two more folks. And we sat in a conference room for, gosh, maybe three months or more — just talking and kind of shooting the shit about: What's important to you? What services do you love? What are you doing in your life right now? And all three of us were buying houses, all at the same time. We quickly realized that here we were in 2005, and the internet was more than 10 years old, and there still was no category-defining company that empowered the real-estate consumer, not the industry. So Zillow was born.

You often tell startup founders to look for businesses with a big TAM, low NPS. Can you break down those terms?

"TAM" is a Total Addressable Market. A big TAM means there's lots of money spent in the category. "NPS" is Net Promoter Score. It's a measure of how much people like a product or an industry. Generally speaking, it's calculated by asking people, "Would you refer this service to a friend?" A low NPS means people are dissatisfied.

Real estate has a big TAM: something like 15% of the economy is in real estate. And it has a low NPS. Everybody finds it to be a pain in the neck. Nobody likes their real-estate agent. Nobody likes home-shopping. Definitely nobody likes home-selling. It's just, it's a very unpleasant thing. So that makes it ripe for startups. But entrepreneurs also need to know the difference between TAM and "SAM": the Serviceable Addressable Market.

Because every investor pitch starts with something like, "This is a trillion-dollar opportunity," right? How do you feel about those claims?

They create skepticism for a good investor. So I think it's useful for founder pitches to cop to the SAM. Basically, say, "Look, I understand that this market's massive" — TAM — "but realistically, this is how much of it I, and my startup, and my idea, and my team, can truly go after" — which is SAM. And even if that's a much smaller number, at least it's more realistic and therefore credible.

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What about exits? What should that look like?

So, if you're raising institutional venture capital, you should not be focused on an M&A (mergers and acquisitions) exit. You should believe that the idea and opportunity is big enough that it could be a publicly traded company, which means it could be worth over $1 billion. Generally, that's a threshold above which you can go public. So to get to a $1 billion-plus valuation, you probably need at least $100 million of revenue.

Now, there are plenty of great ideas and plenty of good companies that should be started — and will be successful — that have a smaller opportunity than that. Just realize that you're not going to be able to raise institutional venture capital, because the VC business model is predicated on spreading a lot of chips out on the roulette table: They will accept a lot of zeros, but two or three of their roulette bets are going to pay off big — 100x, 1,000x, 10,000x. So they're only going to invest in companies that they think do have that potential.

If you have an idea that's smaller than that, then bootstrap it or raise "friends-and-family" capital from noninstitutional investors, because VCs are not going to fund you.

Institutional investors are kind of like a nesting doll, right? They have investors themselves.

I'm glad you brought that up. I think this is misunderstood or just not well known among founders: When you get a check from a VC firm, where is that money coming from? The fact is, it's not sitting there in their checking account.

Let's say a VC has a billion-dollar fund, and they put $10 million into your startup. They're not going to their checking account and taking $10 million out of the $1 billion. Instead, the general partner — the person who founders meet with to try to convince them to invest in their company — issues a "capital call" to the VC's limited partners (LPs).

LPs are, say, a university endowment fund or a firefighters' pension fund or a high-net-worth individual. They'll each have a commitment to the VC's fund, and they'll get a capital call that says, "OK, we just invested $10 million in this new startup. Send us your piece." And then the VC passes it on to you as a startup. And those limited partners have a lot to say about how the general partners invest.

Everyone has a boss. Even when you're raising money.

I'll tell you a quick story. Maveron is a top venture capital firm that has invested in a couple of my companies. I'm also an LP there. They had a couple of their LPs attend a meeting a few months ago where they spoke to the CEOs of Maveron's portfolio companies. The LPs were a children's hospital and a university endowment and, I think, an environmental organization — so, these huge nonprofits that each have $5 million, $10 million, $25 million in the Maveron fund as limited partners.

It was so interesting to hear them talk. They were like, "Look, if this fund that has invested in all of your startups is a 5x fund, then I, at the hospital, will be able to add another 25 beds to our intensive care unit." And then the environmental organization LP says, "You know, if this is a 5x fund versus a 3x fund, that's the difference between us protecting another million acres of the rainforest in South America versus only a hundred thousand acres." It was eye-opening for the portfolio company CEOs to understand what actually happens when we create an exit for the VCs.

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