Wednesday, August 15, 2007

From Angels to Professionals

In some ways, Venture Capital seems like a bank, accepting deposits and making loans, but this venture capital business is more focused both in what it tells its investors it will return to them, and how it will do it. And the goal is subtly different: the focus is on appreciation of equity value, not generating income. VC’s don’t want dividends or profits so much as they want to sell (or distribute) their stockholdings at a big profit over what they paid for them at the outset.

From the post war era and the early Venrock, the next jump is to raising a fund from a diversified group of investors, instead of a single individual or trust. In other words, we go from investing from one’s own money, to investing OPM (other people’s money). It isn’t clear to me who first made that transition (and I’m not trying to write the definitive history here, just outline some trends). I’ll mention the early firm of Davis & Rock, because they were very early, and because I had the pleasure of counting Arthur Rock as an investor in one of my startups in the early ‘90s (I wish I had returned more to him). He was a crusty and demanding investor but fair and focused.

Venture Capital is “bank-like” in the simplest terms --- you collect funds from depositors, use those funds to create profit, and return much of that profit to your depositors. What is important to me here is the types of skills needed in the early days to be a venture capitalist. You needed people who could raise money, and people who could invest it wisely in ventures that would grow enormously. I have the impression that in the early days, the technology was not that deep, and a well-educated individual, particularly one with an engineering background, could sufficiently fathom the core technology in most startups to make intelligent decisions. Maybe that is from the benefit of hindsight. To the earliest investors in Digital Equipment Corporation, the mini-computer may have seemed like quantum computing.

But one change from the early days to the late 20th century is the increasing specialization of the venture professionals and their frequently narrower technical focus. Most of the successful VCs in the 1980’s and 90’s have technical backgrounds and engineering or science degrees. Often they began their careers in those fields, graduated to management positions, and then transitioned into the venture capital field in mid-life.

As venture capital became an established and respected profession, generating sometimes huge success stories, the major business schools began churning out MBA’s that were educated expressly to become VCs. I remember encountering these young VCs starting in the late 90’s. Frankly I was not particularly impressed. As a seasoned entrepreneur, it was somewhat strange to be evaluated and judged by a young VC who had never hired (or fired) someone, made (or missed) a payroll, created a product (or category). The older style VC was much more credible if they had “done it” themselves. Particularly in the evolutionary 90’s, it wasn’t clear to me that you could educate someone to be a VC. There were exceptions, of course, but generally I was always more impressed by VC’s with operating backgrounds and technical depth.

Arguably, as we underwent the revolutions of the Internet and mobile communications and mapping the genome, young, freshly-minted MBAs had at least one advantage over older school VCs --- they often WERE the target demographic, and had grown up with these revolutions. But it is hard to underestimate the value of having BEEN an entrepreneur, and having started and run a company in your past.

So here we are today. Most funds are investing OPM, other people's money, under fairly standardized financial structures, in fairly well defined technical market areas that jive with their team expertises. VCs are frequently technical, often have operational backgrounds, but the younger VCs are more likely now to be educated as MBAs and to have jumped right into the field. More in my next post on speculating where the VC world is headed…

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