All posts tagged with VC

Is This VC a Good Girlfriend or a Good Wife?

I’ve been using this slightly chauvinistic metaphor a fair bit recently, so please forgive me :)

It’s always interesting to me to watch how entrepreneurs evaluate VC investors.  If you are in the luxurious position to be able to choose your investors, I really recommend going through the extra couple days of work that that would entail.  In a world of highly competitive financings, entrepreneurs are sometimes presented with the “opportunity” to “get a deal done” quickly.  What they don’t realize is that on the VC’s side, they are being encouraged by their partners to “lock it up” quickly, which, when you put it that way, actually doesn’t sound too great at all.

Some investors are what I’d call bad girlfriends but great wives.  They may be hard to get a hold of initially, tough to schedule with, deliberate with their process, ask really blunt and hard questions, etc.  This can be off-putting, and I don’t advocate for this, but I think the entrepreneur should keep in mind that pre-investment behavior is not always indicative of post investment behavior.  I know some investors that are pretty tough on entrepreneurs as they go through the fundraising process, but go to enormous lengths for the entrepreneurs after an investment as been made.  

Conversely, there are other investors that are sweethearts in the dating phase, but not great after the investment.  I’ve seen this myself - some investors are very charming and easy to work with during the fundraising stage, but don’t contribute much after the investment is made.  Entrepreneurs quickly realize that the friendliness of the investor during the partner meeting doesn’t really mean squat when you can’t get him or her to hustle for you. 

Ideally, you want an investor who is both a good girlfriend and a good wife.  Some of the best do behave this way.  But you can always catch a great investor in an “off” period.  Much of VC is about managing your time so that you can be as helpful as possible to the entrepreneurs that you are in business with.  So sometimes that means some annoying encounters early on.  Also, at the seed stage, some investors might do very little due diligence and be very easy to deal with to get a very small check that they view as a option for the future. On the flip side, an investor that takes a seed investment very seriously and will devote their full efforts towards a company will probably be more methodical and rigorous in the evaluation process.  One of these hypothetical investors may be considered a better girlfriend, but who will be the better wife?

All this can be addressed with a little bit of VC due diligence.  Some specific thoughts:

1. Call some of the entrepreneurs that this VC has backed before.  Most VC’s will say “feel free to talk to any of the CEO’s of my portfolio companies”.  Take them up on it.  You don’t need to go overboard - find a cross section of a) CEO’s that seem similar to you or lead a company that is in a similar stage as yours b) The CEO of a company that is not doing so well or where the person was replaced.

2. Use LinkedIN to accomplish #1 if asking directly might be challenging (which may be a negative signal in and of itself).  I find that raving fans love talking about people that they are enthusiastic about, so don’t feel like you are disturbing them of it’s out of place to ask.  Also, no answer is a datapoint (although take it with a grain of salt in case your email bounced or the entrepreneur is crazily busy).  For the sake of all entrepreneurs and investors, only do this is you are very very serious and the VC has indicated very strong interest in investing in your company.  

3. Ask for specifics. “What did they do specifically to add value in x, y, z situations” (when x, y, or z are the most critical areas that you need help).  ”How did this investor behave during your follow on round of financing?”.  If the entrepreneur has a couple investors, ask “what does investor X bring that investor Y did not?”.  

For additional thoughts on this, check out my partner Dave’s blog post on doing due diligence. Also, read the book "Who" that has some great tips on conducting diligence calls. 

The Evolution of Angels into VC’s

evolution of man

We’ve been witnessing an institutionalizing of angel investing in recent years.  For the most part, it’s good. There continues to be a gap in the market for stage appropriate seed investors, especially in the East Coast.  But it’s interesting to watch some of these funds pursue a predictable path of evolution. 

It’s goes something like this.  An angel investor writes a lot of checks and has some level of success.  It’s amazing how right out of the gate, and individual angel can get into many good deals with a bit of hustle and a willingness to deploy capital in small chunks.  They find themselves coinvestig with many great funds and getting a bunch of write-ups and some small wins.  ”Man, this is easy!”, they think. Those big funds are dinosaurs. I’m in way more interesting deals than many of them.  And I bet I could do even better with more money.

Some LPs agree, and the angel becomes a small VC (aka a super angel).  Maybe managing $7M-$25M. They continue to pursue their strategy of writing many small checks. But they quickly realize that this doesn’t work well. That $50K they have in the next hot company may yield a 20x, but it doesn’t move the needle on the fund. The logical strategy evolution is: “Ok, I must invest more per deal, and I must focus only on companies that have the potential to move the needle in my fund.”

Then, they realize something. Hey, it’s tougher to get into great deals now!  It used to be easy for investors to let me in for $50-$100K.  But now that I’m writing a bigger check, there isn’t enough room because I’m actually eating into another investor’s target ownership.  I need to work harder to encounter companies earlier, and I need to spend more time on each company to develop a reputation of being an excellent, value-added investor. 

To make matters worse, the Super Angel is not in a great position to lead many deals. They quickly realize there is a big difference in tagging along on another investor’s deals and leading one.  There is usually only room for one or two leads, and you usually need to write a meaningfully sized check to do it. 

The super angel also realizes that they need a follow on strategy.  "Guess what, investing heavily into your winners makes a lot of sense" they say. "I knew company X was going to be a winner, I should have put way more capital behind it!" . The funny thing is that this conclusion is made with incomplete data.  The angel only responds to the regret of the good companies that they wish they had invested more in.  They look back and say “it was obvious that this was the winner!”.  But it’s more difficult to know this prospectively than one would think, and the super angel does not have the scar tissue of throwing good money after bad that many VCs have seen happen themselves.

At this point, the portfolio is starting to get pretty hefty.  So the super angel starts thinking of scaling their team. More people means more mouths to feed.

So, here are all the motivators that have arised to raise a bigger fund:

1. Wanting to put more into each deal to make them meaningful

2. Wanting to be able to lead deals and get ball control

3. Wanting to reserve more to invest big in the winners

4. Having more mouths to feed and needing more fees.

So, what happens next? Viola! The next fund is a traditional VC fund with $50M/partner or more. Meanwhile, the VC is annoyed by the new crop of seed investors that somehow keep on getting into good deals with their small checks.

Parting Thoughts:

1. This isn’t immediately obvious, but as an individual angel, there is actually an advantage in terms of deal flow. You can invest at a scale where most investors will let you in, especially if you see an investment early and have a reputation for helping.

2. Institutionalizing is harder than it looks.  There are some terrific firms that have had the opportunity to raise much larger funds but have resisted in order to stick to their strategy.  But this is hard to do and many end up raising larger and larger funds or pursuing new strategies like growth or international expansion. 

3. Super Angels are VC’s. They are governed by the same incentives or anyone else managing money.  And have a tendency to look and behave more like VCs over time, unless they start out with a completely different strategy from the beginning and are very disciplined about sticking with that strategy (ie: Ron Conway, Paul Graham).

What Is The Ideal Seed Round Composition?

I’ve been having this conversation quite a few times over the last several weeks, so I thought it would be important to do a post on this.The question that I often get asked is “how should I think about the composition of my seed round?”  

This is related to my prior post on how to think about VC’s in seed rounds, but I’ll try to be more specific.  By way of background, of our 12 investments at NextView, 4 were with only angels, 3 were only with seed funds, and 5 were with some combination of VCs, angels, and seed funds.

It seems like a high-class problem for an entrepreneur to be able to influence round composition, and it is.  But I find that once a company has investor interest, many other folks tend to want to pile on.  How should an entrepreneur think about the different options on the table?  Here are a few of the typical configurations and the pros and cons of each.

The One VC Led Seed

  • Definition: This is the case when a large (ie: greater than $200M fund size) VC takes a significant portion of a seed round, and maybe leaves 50% or less of the round available for angels or seed funds.  In this case, the VC will typically take a board seat, be very active in the company, and the entrepreneur has basically gone through the standard investment process of the firm. 
  • Pros: High degree of VC commitment, easier to attract good value-added folks to fill out the round. More dry powder in case there is a need for an extension and the VC feels supportive of the company. 
  • Cons: Locked in to the incentives of the VC around outcome size, portfolio strategy, etc.
  • Series A Dynamics: This is a middle-of-the-road outcome in terms of optimizing your next round of financing.  If the company is doing really well, the VC will have an incentive to try to do more of the next round at perhaps not the highest possible valuation.  Their aggressiveness sends a signal to the market.  But, it’s very typical for a VC to say “we are committed to half the series A, go find an outside lead” and be helpful in making that happen.  That’s probably what would happen if the company is doing well and is a fine outcome IMHO. This is what happened with Gemvara (FKA Paragon Lake).  We saw the series A at my prior firm, Highland was committed for half the series A, which we took as a positive signal of support.  But if the VC is not participating in the follow-on round for any reason, you’ll be in a pretty difficult spot. 

The Two VC Led Seed

  • Definition: This is a the case where two large VC’s partner to take a significant portion of the round together, often leaving only a small piece for value added angels or seed investors. In this case, the VC’s really consider this a true investment of both time and reputation. This tends to be more common on the East Coast where there is more of a history of firms buddying up with the intention of doing the next couple rounds of financing together. Often, the VC partners have worked together before and both have deep domain experience that is very relevant to the company. This is distinguished from a round with multiple VC’s that are not leading.  
  • Pros: Lots of help from the VC’s. Potential for very quick and easy series A and even series B if things go well. Lots of credibility at even a very early stage. 
  • Cons: Not much space for new investors in future rounds.  Locked in to the incentives of the VCs. Limited options for series A. 
  • Series A Dynamics: When a seed round like this happens, you are banking on the VC’s to lead your series A round together.  It’s harder to go outside and create competition for the round unless you are absolutely knocking the cover off the ball.  But, if you were able to get the right investors to participate together in the seed, it can work out well.  We did this quite a bit at Spark with Tumblr (Spark & USV) and Admeld (Spark & Foundry). 

Angel Round Led By A Micro VC or Seed Fund

  • Definition: This is a the case where there are no large VC’s investing in a round but a dedicated seed fund or Micro VC is acting as the lead.  Often, a member of the seed fund’s team will take a board seat and be actively involved.  Sometimes, there will be multiple seed funds participating, or there will just be one and a number of angels. 
  • Pros: Good incentive alignment. Round can come together quickly. Lots of optionality and less signaling in future rounds. Strong credibility in the market if the round is led by a respected seed fund. 
  • Cons: Will need to attract outside capital for subsequent rounds. Varying degrees of willingness to do an inside round or bridge. 
  • Series A Dynamics: Your seed investors are well aligned to help you raise your series A from the best parter at the highest price that makes sense for the company.  The potential for competition is high.  The downside is that some funds are very reluctant to do inside rounds or extensions, so it is up to the entrepreneur to gain external validation from the market. 

Individual Angels Only 

  • Definition: This is a round comprised only of individual angels.  In the best case, a very sophisticated angel acts as the lead for the round that others can participate in.  In the worst case, there is no angel that emerges as a true lead. 
  • Pros: Good incentive alignment. Can get some support/help from multiple angels
  • Cons: If there is no lead, it’s much harder to actually pull the round together. Also hard to raise a larger amount of capital (ie: >$500K) since most angels are writing modest sized checks. There may be a lack of credibility from the perspective of partners, customers, or potential series A investors unless the angels are very well known and respected. 
  • Series A Dynamics: This really depends on who the angels are.  In theory, most angels should be well aligned to help you raise your series A.  If you have well known angels, they can be a strong asset.  The downside is that angels usually have limited capacity and interest in following on. 

The Large VC Chip-In

  • Definition: This is an angel round of many different potential compositions, but includes at least one or more large VC chipping in a small % of the round. 
  • Pros: Good to get another very smart person around the table who can help the company.
  • Cons: Usually won’t get that VC’s full time or attention.  The investment is explicitly an option to keep tabs on the company and potentially participate in the series A if things are looking good. 
  • Series A Dynamics: Others have talked quite a bit about this. I’ve heard the argument that investor signaling is reduced if there are more VC’s in the round, but I’m not sure if that is necessarily true.  I do think that entrepreneurs have become savvier at navigating these situations and maximizing their outcomes if things are going well (such as our investment in RentJuice that had Highland as a small investor prior them leading their first true VC round).  Of all the scenarios, this is the trickiest and most idiosyncratic.  It’s possible that the VC’s participation can exert a lot of negative influence in the future round, and it’s also possible that that VC’s gets very aggressive and catalyzes a pre-emptive series A.  In any case, it’s important for entrepreneurs to have their eyes wide open if they enter into a round with this composition. 

How VC’s Win

VC’s grill entrepreneurs all the time about how they will win vs. their competitors.  What’s your “secret sauce”?  How do you have an “unfair advantage”? How do you “get to first base” in light of many other competitors?

What entrepreneurs probably don’t think about is that VC’s face the exact same questions from their own investors.  Venture is a competitive market with many players selling similar “products”.  So every VC firm needs to justify how they win vs. their competition.

Reflecting on this a bit, I’ve come to realize that there are a few different strategies to winning in venture.  Some firms pursue many of these simultaneously.  Some don’t really do any of these, hence the lemming-like behavior that is sometimes observed that leads to pretty lackluster results.

Strategy #1: See Better Companies

This is the most straightforward.  VC’s talk about “proprietary deal flow” to their LP’s all the time.  Different VC partners also have an advantaged position to see better investments based on their prior relationships with entrepreneurs.  You can bet that a VC that has had success by backing or working at one company will have an advantage in backing the alumni of those companies.  See Matt Cohler at Benchmark and his investments in Facebook alumni. 

Truly “proprietary” deal flow doesn’t really exist in most cases.  Most good entrepreneurs know that they have a better chance of securing favorable terms if they get interest from multiple investors.  I do think that semi-proprietary deal flow occurs in tiers.  IE: there are certain tiers of firms that see more or less the same quality deal flow. 

Strategy #2: Win More Competitive Deals

Also pretty straightforward.  Is the VC able to win in competitive situations? Can they convince an entrepreneur to take their capital vs. another VC based on brand, personality, promise of help, better strategy fit, etc.  Personally, I have found that three things usually drive victory in competitive situations.  One is brand.  It’s very hard to turn down an offer from a top tier investor vs. an offer from an investor with a less stellar reputation.  Second is determination.  Does the investor do whatever it takes to win - introduce the company to potential customers, start recruiting for them before a deal is inked, etc?  Mike Moritz at Sequoia is famous for being amazingly determined and persistent then it comes to trying to win competitive deals.  The third is personality/chemistry.  Entrepreneurs need to believe that they get along with their investor, can trust them when the going gets tough, and can count on them to help in meaningful ways. 

Strategy #3: Say “Yes” When Others Say “No”

Or perhaps a better way to put it is: “being willing to do what others are not.”

Not surprisingly, no one markets this. But it’s actually my favorite strategy, and it’s true in more cases than one would think.  Some people think back to the big winners and think that success was obvious from the beginning, but that is almost never true. LinkedIn looks like a sure thing in retrospect, but more than 10 investors said “no” before Sequoia ended up leading their series A (to be fair, they did have multiple offers as well).  

Of course, every early stage company has their naysayers.  What’s more interesting is when an investor is willing to employ a strategy around assumptions that few others in their industry share.  That’s also “being willing to do what others are not”.  Union Square started investing heavily in the NYC consumer internet scene before it was cool to do so.  DST started investing in super late stage winners when everyone thought they were crazy, before everyone started to try to copy them.  But usually, pioneers of a new model or space end up building sustainable advantage because they are structured for the opportunity from the beginning (both in terms of fund size and personell) and enjoy the reputational benefits of being perceived as the market leader. 

Strategy #4: Adding More Value

Again, almost all VC’s will claim that they can add more value than their counterparts.  It’s very difficult to discern the differences - some investors will demonstrate deep market knowledge, some will lean on experience as CEO’s or long-time investors, some will talk about their level of hustle.  But the truth is that almost all VC’s are smart and hard working, so it’s very difficult to differentiate.  More recently, firms have tried to be programmatic about the ways they help entrepreneurs.  First Round Capital and SV Angel try to create leverage from their portfolio and community. Andreesen Horowitz hires specialists to assist portfolio companies in areas like PR and Recruiting.  I like the programmatic approach because it actually provides something for entrepreneurs to evaluate and reference. 

So, those are the most straightforward winning strategies for VC’s.  I may be missing one or two broadly, I’ll admit.  But in the true Charlie Sheen spirit of #Winning, it should be noted that another strategy is: Raise as much money as possible and milk fees.  Usually, one needs to do something remarkable to get into a position to do this, but seriously - it’s a pretty good strategy to continued wealth, especially in an industry with a very long time horizon.  Fortunately, the best investors out there do not do this - they are incredibly thoughtful, hard working, and competitive.  Most could just coast along and play golf at Pebble Beach everyday.  But they are willing to do what others are not. 

Hi, I’m a tech VC on Twitter

Hi, I’m a tech VC on Twitter. I’m @xyzvc

My icon is cool.  It’s a painting/cartoon/wacky photo.  Shows that I’m hip and approachable.  But when I meet with you, I’ll still crush your dreams. 

I tweet about technology, but occassionaly post personal stuff.  Important to show I have a sensitive side and care about more than just making tons of dough. 

I use # tags, sometimes as a funny form of emphasis.  Kind of like a wink and a smile ;) #donttakethisposttooseriously

I love Twitter because I can broadcast my blog posts.  Otherwise, no one would read them!  I blog at xyzvc.com!

I tweet blog posts with advice on fundraising, customer acquisition, and company building.  Usually, someone really smart has said it before and said it better.  But I haven’t been in Hacker News for a while, so I figured there is no harm reinventing the wheel. 

Retweeting is fun.  It’s like a virtual high-five.  I retweet the posts of my partners, coinvestors, and entrepreneurs I’ve backed.  Oh, I also retweet posts from guys whose butts I’m currently kissing so that they will like me.  I really hope @fredwilson retweets this… I’d get so many new followers!

My portfolio companies are the best.  I will share so much of their good news with you it will make you want to unfollow me (unless you are a co-investor, in which case you will probably RT and add a #)

If a portfolio company is doing bad, no Twitter love.  It’s like going to Disneyworld and trying to find Hercules or Mulan.  It’s like they never existed.

I also tweet about the cool places I’ve been (via Foursquare and Gowalla), things I buy (via Swipely and Blippy), and the cool places I’m going to go (via Plancast).   

Wow, that’s a lot of tweeting! That’s why I also tweet about how busy I’ve been and how little I’ve slept. It’s a tough life. 

Full disclosure, I’ve been a tech VC and I’ve done most of these things. 

Good vs. Bad VC Due Diligence

I remember early on in my VC career, I chatted with an entrepreneur turned VC who remarked “as an entrepreneur, time is your enemy.  As a VC, time is your friend.”

What I think some VC’s mean when they say this is that investors typically have limited incentive to move quickly.  Unless there is a forcing function like a competing term sheet, it’s usually preferred to spend more time doing diligence on an investment mainly to get to know the founder better, watching the company make more progress (or eliminate risks), and getting buy-in from others in one’s firm.

One of my current partners calls this “hanging around the hoop”.  It’s a good strategy in basketball, but I think it’s pretty lame as an early stage investor, and specifically at the seed stage. 

I was chatting with another successful entrepreneur today who is also an active angel investor.  He emphasized the high value he places on speed of decision-making, and remarked that being known for speed will lead to positive selection bias.

This is particularly true for repeat entrepreneurs.  Often, successful founders can fund the early stages of their company themselves.  But if they are going to raise outside money (to provide feedback, help, and leverage on their dollars), they are more likely to go to folks they know will move fast and make decisions on rational dimensions that will actually help the company.  They will avoid investors who hang around the hoop, or send entrepreneurs on assignments that aren’t truly productive.  The truth is all VC’s can make fast decisions if they need to, they just need pressure to be applied properly. 

It’s hard to force an investor to move quickly unless you create competition.  But what you can do is try to tell whether the VC is doing good vs. bad due diligence.  ”Good” due diligence doesn’t take up entrepreneur time, burn the time of their valuable references, and are usually productive towards the goals of the company.  They include:

1. VC’s doing backchannel due diligence on the team.  This is good practice as an investor, and doesn’t burn a lot of cycles for the entrepreneur.  Usually if the VC is reaching out to their own networks, it means that they care enough to burn the time of their own contacts. 

2. Introducing the entrepreneur to real prospective customers and partners and seeing if they can close.  This is very informative for the investor and entrepreneurs want to sell to good customers.

3. Introducing the entrepreneur to executives with deep domain knowledge in the space.  This is a real opportunity for the entrepreneur to learn and the person may end up being a valuable advisor or even a member of the team. 

4. Meetings with a purpose.  The investor and entrepreneur want to get to know each other better.  But these interactions should be structured and constructive.  Debate business models, discuss product priorities, interview the founders to understand their strengths and weaknesses… these are all good, but definitely have a purpose and prepare to dig in deep at a level that the entrepreneur finds beneficial. 

5. Quick “no’s”.  It’s counter-intuitive.  But if a VC gives a quick “no” but with a very clear reason that seems addressable, there is no better due diligence than seeing if the entrepreneur responds and comes back having addressed the issue.  It happens rarely, but if the feedback was genuine, responding to the feedback will create genuine interest.  

Bad due diligence looks like:

1. Calling all an entrepreneurs references just to go through the motions or for selfish gain.  This does happen a lot.  The investor may know they are very unlikely to invest, but they think person x,y,or z on the reference list is interesting, so they’d love to talk to them. 

2. Multiple meetings rehashing the same information.  Lame.  It’s part of the difficulty pitching to large partnerships, but you’d hope that an investor would sufficiently brief his team so that conversations go deeper each time into the critical levers of the business.  Not rehashing generic stuff.  Also, this is a signal that the entrepreneur is hanging around the hoop.  They are waiting to hear an update and aren’t prepared and focused towards driving to a decision. 

3. Making entrepreneurs fly to partner meetings when they aren’t extremely enthusiastic about the investment (particularly a danger for junior VC’s).  Total waste of time and money. The investor in this case is not only hanging around the hoop, they are trying to take the temperature of their partnerships to see if they should spend more time with you. Remember, junior VC’s get “credit” for perceived activity, so they are more likely to do this so their partners know they “saw” the investment even if they know it won’t get through the partnership. 

4. Doing due diligence to inform an investment in a competitor (obvious and happens a lot, surprisingly).

5. Lame introductions to irrelevant people.  Of course, VC’s can’t always assess what kinds of customer/partner/executive intros would be fruitful, but their ability to get close is a) a signal that the investor “gets it” and b) really will be able to help.  But when there is a generational/industry gap between an entrepreneur and an investor, you are more likely to get intros to random or ill-suited people.  For example, there has been more than one example of Boston consumer internet companies in need of technical leadership talent that got directed to really old-school enterprise software executives.  Those types of cases are a waste of time at best, and truly harmful to the business at worst. 

As an entrepreneur, it’s not always easy to tell whether the VC is doing good or bad due diligence.  Hopefully these signals help.  But I would say that overall, speed is a great indicator.  If they are making progress quickly, that’s great.  If it’s taking a long time, it means they are hanging around the hoop.  And this is what should happen to people who hang around the hoop. 

How VC’s Value Early Stage Companies

Valuations in venture backed companies seem to be a mystery to most.
Even in the past 18 months, when it was close to impossible to raise
money, we’ve seen valuations in early stage companies that caused a
lot of headscratching (Square, Foursquare, Groupon, etc).

It begs the question of where these valuations come ffrom.  B-school
students are trained to believe that valuations are driven by the
present value of future cash flows, which is a f(cash flow, growth,
risk, and capital structure).

But how does this hold when there are no cash flows (in fact, when
there is no business model)?

The answer is that vc rounds are priced by the market - by supply and
demand. I once met an experienced VC who admitted to me that he didn’t
actually know how to do a DCF.  But he did know where a deal would
likely close at based on pattern recognition.

Ultimately, the right way to think about VC valuation is not a finance
exercise but a negotiations one.   On the investor side, the goal is
to acquire as large a position in the company and exert as much
control as possible while keeping the entrepreneur sufficiently
motivated.  On the entrepreneur side, the goal is to maintain a much
ownership and control as possible while bringing in a helpful and
motivated investor. The bounds between sufficient entrepreneur
motivation and the potential to create an attractive return to an
investor is a very wide ZOPA (Zone of possible agreement).  Where the
deal closes is a function of the relative bargaining power of the
constituents.  In other words, are there many other Investors
clamouring to invest in the company (rarely)?  Do the Investors have
lots of options for where to put their capital (often).  To steal
another negotiations term - it comes down to having a good BATNA (Best
Alternative to a Negotiated Agreement).

Remember also that it’s not only about valuation, but a lot of other
terms that have value.  Liquidation preference, option pool, founder
liquidity, BOD seats, etc.  There are a lot of posts out there that
describe some of the levers Investors use to make up for higher
valuations.  Entrepreneurs should definitely read them.

Sorry for the typos, this was written on my iPhone.

Why VC is Like Poker and Stinks for New Entrants

I wrote a post on Sunday about Why the VC Business is like a big game of Texas Hold’Em. As folks pointed out, it’s not a perfect analogy, but there are major similarities because of the interplay of skill and luck and the advantage derived from early successes.

But here’s the reason this structure makes it difficult for new entrants in the business: Skill beats luck over time, but most new VC’s only have a few shots to prove themselves.  VC’s typically make only 2 investments each year, and newer VC’s (including both new GP’s and Principles) aren’t that productive early on.  At the same time, these investments carry a lot of weight early in one’s career.  ”You only have a couple bullets, so use them wisely” is the common advice.

This doesn’t really jive with the dynamics of the industry and kind of encourages risk averse, mainstream behavior.  Also, because success begets success, it sometimes allows folks who aren’t necessarily very good at the business to get out ahead quickly with a lucky win, and then ride the coattails of that success for a while.

Now, I don’t think there is really a realistic solution to this.  Startups take a long time to develop, and so it would be unrealistic to give a young VC tons to time to see if they are good over the life of a portfolio of investments.  Also, senior GP’s take a lot of other subjective signals into account when thinking about elevating a new VC to a more prominent position.

Still, something doesn’t quite sit right with me with the status quo.  In any case, it’s the reality and new entrants need to deal with it.  Having said that, I have observed some good strategies that seem to work for some of the up and coming investors I know.  Here are three that come to mind:

1. Make a lot of investments. This is a pretty smart strategy I think.  Since there is a lot of chance in this business, and it takes a long time for investments to mature, it behooves a new VC to get as many shots on the board as possible in a short amount of time.  This allows the benefits of a portfolio to take hold, and provides a decent possibility of a quick win.  The downside is that if a number of investments go sideways, it’s easy for your colleagues to make the case that you have no idea what you are doing.  Also, you could hit a really bad moment in the economic cycle that could crater a bunch of your companies.  

2. Be Different.  This is my favorite.  The reality that I haven’t mentioned yet is that not all VC’s have access to the same deals.  So it’s really not like Poker, where every player has equal chance to draw the same cards.  New VC’s have the deck stacked against them because most great entrepreneurs would rather go with a proven success than a new up-and-comer.  So, one strategy for a new VC to take is to be radically different from one’s peers in terms of the stage they invest in, sector, evaluation criteria, or some other meaningful vector.  It’s a difficult bet to make, and one that’s really hard in a partnership unless others buy-in to your contrarian approach.  But I think this can work. Take Y-Combinator.  When it started, a lot of VC’s scoffed and said that Paul Graham was investing in dinky little companies and buying tiny ownership.  But his approach was radically different, he attracted a completely different kind of entrepreneur, and seems to be doing pretty well.  Oh, but remember - Paul did this himself, he didn’t have to content with a partnership of VC’s with a different mindset, which gave him a lot of freedom to pursue his strategy. 

3. Get access to hot deals.  Easier said than done, but it’s the typical approach to success, I think.  One way to do this is to have the right professional background.  If you’ve held leadership roles in Google, Facebook, or DoubleClick, it’s more likely that you’ll be able to invest in a buddy of yours who is starting a company. Even if it’s hotly contested, your friend may give you an allocation, or you can make the case that you have something unique to offer because of your experience.  Another approach is to do series B or C deals and pay up for great entrepreneurs.  This is a viable strategy as well, and funny enough, was the advice I got when I started in the venture business (advice that I ignored because it didn’t seem very fun). Another is to closely track an up-and-coming VC or angel investor and find a way to be their go-to investing partner.  In each of these cases, it’s easier to get these deals through a partnership because there’s nothing like a competitive deal to get people’s juices flowing. 

All of these strategies (and others not mentioned) work - since new hot VC’s do emerge and do just fine.  But I do wonder if some potential great talent gets lost because of the dynamics I described in the beginning of this post. 

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Is It A Waste Of Time Talking to VC Associates?

There has been some chatter on Twitter about the value of pitching to VC associates. Thought I’d lob in my 2 cents on the shuttle to NYC. Full disclosure - I am a senior associate at Spark Capital.

  1. Roles have blurred between associates, principals, EIR’s, and VP’s. Regardless of title, different roles have different levels of influence within a partnership. Over the years, I think we’ve seen some title inflation at some firms. It comes down to whether a person can lead an investment. In some firms, senior associates can do this in certain cases (I am able to lead seed investments at Spark). Charlie O’Donnel is an EIR at First Round (and a pretty young guy), but just led their most recent investment in Backupify. But in many cases, associates can’t lead investments, and even principles or young partners will get unusually high scrutiny through the deal process.

  2. High quality intros to GP’s > talking to associates > low quality intros. I generally agree with Keith Rabois that you want to get to a decision-maker. It’s common sense, even if it hurts. If I were an entrepreur, I’d try to talk to GP’s I know personally or can get a high quality intro into. But the emphasis is on high quality. A low quality intro is sometimes not much better than a cold call. Also, if you don’t have a quality connection to a firm, getting an associate excited about your company works. An associate pushing for a deal is almost as good as a high quality intro. If not, that VC firm is wasting it’s $ paying that associate. There are many examples of great companies that met their VC’s through associates.

  3. Careers are long and Venture is a young person’s game. In many cases, the associates of today are the GP’s or corp Dev execs of tomorrow. It doesn’t hurt to meet them early in their career as you never know where things will go. There are many good GP’s and angel Investors that were former associates: David Cowen and Alex Ferrara at Bessemer, many of the Battery GP’s, Alex Finkelstein at Spark, Chris Dixon, Jeff Fagnan, Larry Cheng, etc (sorry for the east coast bias, but this is off the top of my head). I wouldn’t burn a lot of time with fruitless meetings, but I’d certainly be respectful and get to know the guys I like. Some of these folks will be decision-makers soon enough.

So, those are my thoughts on whether to talk to Associates. Here are two tips if you are talking to them.

  1. Be mindful of associates at transition points. Usually, these guys have been associates for at least 1 year, more likely 2. They are either rising stars that will be tested by leading a few investments or guys just trying to survive. If they are the former, they can be great assets. These associates will hussle harder than other VC’s to prove themselves and usually have champions within the VC firm who will give them a lot of support. The latter are dangerous because you might spend a lot of cycles with them and get nowhere. Even worse, they may advocate for a decision, get you funded, but leave the firm in 6 months. Be mindful of the risk of becoming an orphan and make sure you establish a strong relationship with the partner on the deal early.

  2. Favor associates with clear domain expertise or a strong thesis. This can be based on their operating experience, blog, or just clear evidence that they know what they are talking about. Meeting these associates can at least be helpful, and typically have a higher liklihood of culminating in serious consideration by partners. It also helps you figure out which firms “get it” in your sector or do not. Typically, I’d be more wary of associates that are clearly chasing momentum. These meetings are less likely to be valuable and could also mean that you are part of competitive due diligence for another deal.

Sorry for typos, this was written on my iPhone.

Top VC Website vs. Blog Traffic

Larry Cheng at Volition Capital has put together some excellent lists of top VC bloggers and top VC websites by traffic.

Obviously, these measurement methods aren’t perfect (he uses a rolling 3 month average of unique visitors from Compete), but they are directionally correct.  What I found interesting is the correlation (or lack of correlation) between website traffic and aggregate blog traffic from all firm bloggers.  I took Larry’s two more recent lists and did this comparison.  The results are below ordered by website traffic:

Fund Name – (Website Traffic / Total Blog Traffic)

1. First Round Capital – (31,632 / 28,039)

2. Sequoia Capital – (22,441 / 0)

3. Bessemer Venture Partners – (14,825 / 8,262)

4. Highland Capital Partners – (12,704 / 0)

5. Garage Technology Ventures  - (12,375 / 82,838)

6. Draper Fisher Jurvetson – (11,823 / 12,010)

7. New Enterprise Associates – (11,762 / 0)

8. Kleiner Perkins Caufield Byers – (10,924 / 0)

9. Polaris Venture Partners  - (10,217 / 16,991)

10. Benchmark Capital – (10,162 / 23,084)

11. Battery Ventures  - (10,034 / 1,744)

12. Founders Fund  - (9,654 / 21,462)

13. Accel Partners  - (9,604 / 0)

14. Greylock Partners  - (9,445 , 0)

15. Centennial Ventures – (9,224 / 0)

16. General Catalyst Partners  - (9,086 / 0)

17. Summit Partners - (8,270 / 0)

18. Norwest Venture Partners - (8,198 / 0)

19. Founder Collective - (8,189 / 42,937)

20. Spark Capital – (7,834 / 15,487)

21. Foundry Group – (7,787 / 71,547)

22. Technology Crossover Ventures  - (7,503 / 0)

23. Matrix Partners  - (7,309 / 0)

24. Lightspeed Venture Partners  - (6,475 / 15,199)

25. Union Square Ventures  - (6,333 / 132,936)

Some interesting observations:

1. There are a lot of zeros.  It was surprising to me to see how many top firms don’t appear to be blogging at any scale.  Again, Compete may fail to report the traffic of some of these folks, but that probably means that scale is minimal. That said, most of the excellent firms like Sequoia, Accel, Kleiner, etc have good reach with their websites regardless of whether or not their partners blog.  I also know that at least one zero will go away with the next version of the list since David Skok started what looks like will be an excellent blog.

2. Blogging puts firms on the radar.  It’s interesting to see some relatively new firms come on the scene in recent years and build very broad awareness.  For better or worse, brands do matter somewhat in venture, and it’s always a tricky thing for a new fund to figure out how to create awareness. I think expressing your thinking openly and engaging the tech community in a dialog is a great way to do that.  It’s impressive to see Founders Fund and Founder Collective gain mind share very quickly.  And part of it has to do with one or two very vocal individuals who put their thoughts out there.  As a side note, for those of you who do not read Chris Dixon’s blog or  Dave Mcclure’s blog you are totally missing out.

3. Social media creates unprecedented reach.  Event the best known firms only get 10-30K hits on their website.  It should be no mystery why that is - the content is rarely refreshed, and it serves mostly as information and marketing pages to entrepreneurs who are researching a particular firm.  But blogging (and social media in general) expands the voice of VC’s way beyond a bio and list of companies. It’s content that’s actually helpful and appeals to a much broader audience.  Union Square Ventures for example has over 100K uniques, 20x the uniques on their website.  And the richness of their content justifies it (for example, see Fred Wilson’s new series on MBA Mondays).

This last point makes me think more broadly about the reach of VC’s on the internet.  Stay tuned as I pull some additional data together.

Rob Go Thanks for visiting my blog! Learn more about me or ask me a question.