In a recent IBF Panel on the topic of Angel and VC cooperation, I made the observation that I believe Angels should avoid valuing startups in priced rounds, and rather should invest using a convertible note. I said that nothing could screw up a follow-on VC investment more than an unrealistic early angel valuation.
I want to elaborate on that observation. First, I want to divide the startup world into two general categories: 1) startups that can reach their goals with a small infusion of seed capital within the reach of angel financing (i.e. less than $1M), and 2) startups that will ultimately require VC scale financing and are raising angel capital to eliminate some risk factor and improve their ultimate VC valuation. Frankly, this is an easy way to divide startups coming to angels. Is this deal a nearly self-sufficient business, or is it seeking seed capital before later going to the venture capital community.
In the first category, angels setting valuations are probably taking a defendable position. But frequently it isn’t clear at the outset whether the angel raise will be all the money the startup raises. So I think the convertible debt approach is still a good way to go. The note should have an automatic conversion privilege after a reasonable period of time, at a clear valuation.
However, more often it is better to assume the seed angel round is a precursor to a later VC round. In this case I strongly suggest that a convertible debt approach is the right way to go. Let me explain why, by showing the pitfalls of angels valuing a deal. Again there are two possible cases: A) setting the valuation too low, or B) setting the valuation too high.
Suppose the angel (or angel group) succeeds in convincing the entrepreneur to accept a lower valuation than a VC would demand, i.e. case A. Frankly, in my experience over the past few decades, this is very rare. Valuations tend to be set by the golden rule --- whoever has the gold sets the rules. VCs have more money in play, with the potential for multiple subsequent rounds, and will therefore be most likely to get a lower valuation. But for the sake of argument, assume that a low initial valuation is successfully negotiated by the angels. In that case, a follow-on VC round will likely see this as an invitation to lower their valuation proposal below what they might have otherwise offered. This will hurt the entrepreneur and the angel prorata. Even if the follow-on VC chooses a more “fair market” valuation, the entrepreneur will still be getting a worse deal. Either way you end up with a less happy entrepreneur, and maybe the angel is unhappy as well.
Now suppose the opposite happens, i.e. the entrepreneur manages to convince the angels to give him a high valuation, higher than he might get from a VC. In my experience, this is actually a fairly common experience. Seed rounds are often made by Friends and Family, and they are emotionally involved with the entrepreneur. They will accept a valuation set by their friend or “son” because “he knows more about this”. But again, for the sake of this analysis, assume the entrepreneur gets a higher than “fair market” valuation. When the follow-on VC comes to see the deal, they will quickly come to understand the valuations previously set and the expectations of the entrepreneur to up that valuation. They know to get this outon the table early. I can say that my VC fund sees this case a lot and it often stops a deal cold. Frequently, the entrepreneur has taken the high seed valuation to heart, and is insulted by a VC opinion that it is excessive. For the VC to proceed, they will have to offer a down round deal. Remember that VCs often are investing to a formula promised to their LPs, that mandates their seeking a certain percentage of ownership. An overly optimistic valuation in the seed round directly hurts both the entrepreneur and the seed angels.
So in summary, if there is even a chance that follow-on VC money will need to be raised, in my opinion, an angel-priced seed round is a lose-lose situation. The best outcome is the angels set a valuation very close to what the VC expects --- and that is exactly what a properly constructed convertible debt deal will deliver automatically.
In essence, a convertible debt deal is saying that the angels want to be in the same boat as follow-on investors, rather than starting out in opposition to, or second guessing them. I can clearly state that the VCs I have worked with will respect the greater risk that the seed capital took, and will accept a discount or warrant to reward that risk. They will appreciate the effort angels took to make the deal follow-on financing-friendly.
But a priced angel seed round is at best a breakeven exercise. Much of the time it will be to the disadvantage of the angel and it will almost always be to the disadvantage of the entrepreneur.
Convertible debt seed financing can be done with a timeout conversion at the angel’s option, with a time matched escalation of reward, and with interest and dividend privileges. In the end, the seed round is very exposed, and angels are investing monies they should never expect to get back. The lack of security for the loan is therefore relatively unimportant. And the conversion will be to a preferred round with all its carefully constructed advantages crafted by the VCs. In contrast, I often see priced seed rounds where the angels bought common stock. That opens the door to the VC constructing preferred terms that put the common stock class at a major disadvantage.
I will acknowledge that this advice is Bay Area centric, where there are many many venture capital funds. When the angel investment is coming in geographic areas with limited local VC financing, the value of this advice is lower.
As a general rule, ANY investment in a startup should be made so that follow-on financing is not inhibited. Valuation can be a big inhibitor to venture capitalists. And VCs will usually craft the best terms to protect their investment. It is better for angels to try to be under that same umbrella.
Sunday, October 14, 2007
Tuesday, October 2, 2007
How close is Too Close?
A common axiom is “Invest in what you know.” I want to amend it. “Invest in what you know enough about… but not too much about.”
I’m struck by something I see in my own investing behavior. In the market areas I have spent years getting to know intimately, I have a natural tendency to be pessimistic when presented with a new approach. It is only natural to think that if I didn’t see that idea when I was in the thick of it, why should it be so successful now. I’ve spent years understanding all the pitfalls around a market area --- to use medical devices as an example, I know all the regulatory and reimbursement and hospital politics reasons why a new device play could fail. I understand all those failure paths in gruesome detail. I’ve experienced them all.
You spend most of your operating years working through or around problems. The victories you zoom right through, like General Patton’s armies. You spend more time bogged down in the trenches than racing across the plains. So, what makes you grizzled --- “experienced” --- is the scars. You built that ego on the problems you have encountered and blown through. Your ego can now potentially blur your ability to see that the time is right for a major disruption in that market, or a revolutionary product approach.
In effect I’ve lived my life in the world of the past. But --- and it’s a big but, I haven’t lived in the future, yet. I’m still trying to get there. I truly don’t know the pitfalls of the future that well. Yes, I can extrapolate from past experience. But I want to suggest that VCs with extensive operating backgrounds may tend to be too pessimistic about new ventures that seek to enter their old stomping grounds. It’s only natural to remember the painful parts of the past. And you tend to take the things in your past that went well as just the planned outcome. It is harder to remember the successes of the future --- you can quote me on that one. But I think grizzled VCs can easily project their past travails onto the future.
So I think it’s possible to be TOO close to a market. You get comfortable that you understand the market with all its ins and outs, and then you miss the big hairy disruptive idea out of left field, or the new online way of getting to the patient.
The best VC positioning to evaluate a deal may be basically knowledgeable and able to ask penetrating questions, but also somewhat disengaged from that market and not too “invested” in the way it’s always been done. The best VCs are renaissance men, not domain specialists, in my humble opinion. You need to be able to peek over the horizon without being overly preoccupied about how you stumbled to get to this vantage point.
I’m struck by something I see in my own investing behavior. In the market areas I have spent years getting to know intimately, I have a natural tendency to be pessimistic when presented with a new approach. It is only natural to think that if I didn’t see that idea when I was in the thick of it, why should it be so successful now. I’ve spent years understanding all the pitfalls around a market area --- to use medical devices as an example, I know all the regulatory and reimbursement and hospital politics reasons why a new device play could fail. I understand all those failure paths in gruesome detail. I’ve experienced them all.
You spend most of your operating years working through or around problems. The victories you zoom right through, like General Patton’s armies. You spend more time bogged down in the trenches than racing across the plains. So, what makes you grizzled --- “experienced” --- is the scars. You built that ego on the problems you have encountered and blown through. Your ego can now potentially blur your ability to see that the time is right for a major disruption in that market, or a revolutionary product approach.
In effect I’ve lived my life in the world of the past. But --- and it’s a big but, I haven’t lived in the future, yet. I’m still trying to get there. I truly don’t know the pitfalls of the future that well. Yes, I can extrapolate from past experience. But I want to suggest that VCs with extensive operating backgrounds may tend to be too pessimistic about new ventures that seek to enter their old stomping grounds. It’s only natural to remember the painful parts of the past. And you tend to take the things in your past that went well as just the planned outcome. It is harder to remember the successes of the future --- you can quote me on that one. But I think grizzled VCs can easily project their past travails onto the future.
So I think it’s possible to be TOO close to a market. You get comfortable that you understand the market with all its ins and outs, and then you miss the big hairy disruptive idea out of left field, or the new online way of getting to the patient.
The best VC positioning to evaluate a deal may be basically knowledgeable and able to ask penetrating questions, but also somewhat disengaged from that market and not too “invested” in the way it’s always been done. The best VCs are renaissance men, not domain specialists, in my humble opinion. You need to be able to peek over the horizon without being overly preoccupied about how you stumbled to get to this vantage point.
Monday, September 24, 2007
Startups Then and Now
A few years ago, I remarked to a friend that Microsoft Word took longer to start up on my 3GHz Pentium laptop than my DEC EDT word processor took in 1980 on a PDP-11/34 running RSX-11M. My modern laptop was hundreds of times more powerful, but I was still waiting 10 seconds. True, MS Word is much more powerful, but for the basic stuff, I was still waiting…
Nevertheless, when you read about productivity nowadays, it is apparent that in this decade we are reaping the benefits of the digital age --- all those computers and Internet linkages mean that the average information worker is much more productive today than he was just 20 years ago. In fact, according to the U.S. Department of Commerce Bureau of Labor Statistics, productivity in software publishing is up by a factor of 17x in the past 20 years. In Computer and Electronic Manufacturing, it is a factor of 9x.
So what does this mean to Venture Capital and startup financing? I submit that it simply takes less money to start a high tech company nowadays. Particularly in software development, the costs of developing a product are far lower compared to 20 years ago. And the reach of the Internet and the ease of leveraging viral marketing and messaging, means the costs of customer cultivation and product marketing and deployment are far lower as well.
I frequently see startup teams who have launched their company on less than $100K of total capital in, and only need $200-300K to get to breakeven. They can almost bootstrap it, if they use all the tools available to them, play the blogosphere right, leverage the buzz… Now it’s debatable whether trying to do it that cheap is always the best way to go, but it is certainly a viable option.
So one clear trend in my mind in seed venture capital is that deals are going to get smaller and VC funds are going to have to adjust to that. Six digit seed checks will become more common in the coming years, even with the effects of inflation. ($100K isn’t what it used to be…)
I actually believe that is healthy for the VC funds. As I’ve mentioned in my first post, I’m a big fan of Nassim Nicholas Taleb’s writings, particularly his most recent Black Swan book. He persuasively argues that a good way to invest in our inherently unpredictable world is, among other things, to expose yourself to as many positive Black Swan opportunities as possible, with a portion of your money. I think all VC funds would benefit from setting aside a portion of their funds, say 20%, and taking “fliers”, betting “hunches”, but most importantly making more, smaller bets. Yes, they can take up time, but I think it is manageable. And as Taleb says, your downside is limited to 1x, but your upside is largely unbounded.
The irony is most VC funds are going the opposite direction. They were so successful in the last decade that they have had little trouble raising gigantic new funds. When a partner group has to invest $1B, they are discouraged from making $250K investments. So they set a policy of investing no less than $5M in a first round investment, and reject deals that don’t “put that much money to work.” They say “your deal is very interesting, but it isn’t big enough for us”. In my humble opinion, this is a big mistake, and heading in the wrong direction.
VC funds, particularly those than do Early Stage investing, will necessarily have to evolve in the coming decade. This is a particular focus for me in this blog. More on this topic to come…
Nevertheless, when you read about productivity nowadays, it is apparent that in this decade we are reaping the benefits of the digital age --- all those computers and Internet linkages mean that the average information worker is much more productive today than he was just 20 years ago. In fact, according to the U.S. Department of Commerce Bureau of Labor Statistics, productivity in software publishing is up by a factor of 17x in the past 20 years. In Computer and Electronic Manufacturing, it is a factor of 9x.
So what does this mean to Venture Capital and startup financing? I submit that it simply takes less money to start a high tech company nowadays. Particularly in software development, the costs of developing a product are far lower compared to 20 years ago. And the reach of the Internet and the ease of leveraging viral marketing and messaging, means the costs of customer cultivation and product marketing and deployment are far lower as well.
I frequently see startup teams who have launched their company on less than $100K of total capital in, and only need $200-300K to get to breakeven. They can almost bootstrap it, if they use all the tools available to them, play the blogosphere right, leverage the buzz… Now it’s debatable whether trying to do it that cheap is always the best way to go, but it is certainly a viable option.
So one clear trend in my mind in seed venture capital is that deals are going to get smaller and VC funds are going to have to adjust to that. Six digit seed checks will become more common in the coming years, even with the effects of inflation. ($100K isn’t what it used to be…)
I actually believe that is healthy for the VC funds. As I’ve mentioned in my first post, I’m a big fan of Nassim Nicholas Taleb’s writings, particularly his most recent Black Swan book. He persuasively argues that a good way to invest in our inherently unpredictable world is, among other things, to expose yourself to as many positive Black Swan opportunities as possible, with a portion of your money. I think all VC funds would benefit from setting aside a portion of their funds, say 20%, and taking “fliers”, betting “hunches”, but most importantly making more, smaller bets. Yes, they can take up time, but I think it is manageable. And as Taleb says, your downside is limited to 1x, but your upside is largely unbounded.
The irony is most VC funds are going the opposite direction. They were so successful in the last decade that they have had little trouble raising gigantic new funds. When a partner group has to invest $1B, they are discouraged from making $250K investments. So they set a policy of investing no less than $5M in a first round investment, and reject deals that don’t “put that much money to work.” They say “your deal is very interesting, but it isn’t big enough for us”. In my humble opinion, this is a big mistake, and heading in the wrong direction.
VC funds, particularly those than do Early Stage investing, will necessarily have to evolve in the coming decade. This is a particular focus for me in this blog. More on this topic to come…
Sunday, September 9, 2007
Dangers From Friends&Family Money
There is one truism in the startup business. The more an entrepreneur can reduce the technical and market risk in their startup before seeking outside money, the better valuation they will get, and therefore the more ownership they will retain. VCs and angels will value a startup by the size of the opportunity and the inherent risks in that opportunity. An entrepreneur can only clearly describe the size of the opportunity --- it is what it is, but he/she can definitely reduce the technology risk by building a proof of concept demonstration, or reduce the market acceptance risk by signing up pilot customers.
These early risk reduction efforts typically require some seed capital. Entrepreneurs often self-finance this seed stage, or they turn to “Friends & Family” angel investment. In general, this is a good idea, and it helps a startup get later financing if the idea has been better validated, and if the entrepreneur seems to have some “skin in the game”. However, I want to discuss some aspects of F&F seed financing that may be under-recognized and hurtful to the entrepreneur’s efforts.
Here is a great saying that I have always respected for its wisdom:
“Reasonable people adapt themselves to the world. Unreasonable people attempt to adapt the world to themselves. All progress, therefore, depends on unreasonable people." -George Bernard Shaw
Entrepreneurs almost have to be unreasonable, even irrational, to try to start a business around a new idea. They have to visualize something that doesn’t exist, create it out of thin air, and sell it to others, particularly VCs and early adopter customers. If it was obvious, everybody would be doing it. Instead, it is usually obscure and often seemingly crazy. Who will invest in such a raw idea?
Mom and Dad, ... your best friend… that’s who. They trust you for reasons unrelated to the idea you are promoting. In fact, in the case of parents, biology drives them to support their offspring, even irrationally. In the case of friends, it can be payback for that time you bailed them out of a DUI in college, or any number of pre-existing debts, or irrational friendship.
I’m going to ignore the argument that parents investing in their kids is an unwise concentration of assets. I’m concerned with the hazier issue of irrational seed investors not giving the entrepreneur unbiased feedback. There is danger in F&F seed funding.
If for no other reason, subsequent investors will be looking to see who has invested before them. They will be looking for previous validation. Mom’s money is weak validation.
It’s a tough balance to strike --- you want some seed money to validate the idea, but you also want unbiased input on whether you are drinking too much of your own KoolAid. And believe me, after an unreasonable, irrational entrepreneur fixes on an idea and throws their weight behind it, it is hard to be convinced otherwise. The danger is that calling on the easy money, may delay getting a cool, rational dose of reality.
So I guess my advice is to validate that idea before seeking VC money, but test it both with F&F money and with unbiased, “tell you the honest to God truth” advice that a family member or close friend cannot give you. Don’t just labor away in stealth mode, eating up your parent’s money. Find “seed advisors” you can trust who know the space and the technology, and continually test your idea and fine-tune your pitch on them.
VCs have a phrase for Friends and Family money. Sometimes it’s just called Friends, Family and Fool’s money. Don’t trust the F's to validate your idea, and definitely don’t trust them to Value your idea. They love you and love is blind.
These early risk reduction efforts typically require some seed capital. Entrepreneurs often self-finance this seed stage, or they turn to “Friends & Family” angel investment. In general, this is a good idea, and it helps a startup get later financing if the idea has been better validated, and if the entrepreneur seems to have some “skin in the game”. However, I want to discuss some aspects of F&F seed financing that may be under-recognized and hurtful to the entrepreneur’s efforts.
Here is a great saying that I have always respected for its wisdom:
“Reasonable people adapt themselves to the world. Unreasonable people attempt to adapt the world to themselves. All progress, therefore, depends on unreasonable people." -George Bernard Shaw
Entrepreneurs almost have to be unreasonable, even irrational, to try to start a business around a new idea. They have to visualize something that doesn’t exist, create it out of thin air, and sell it to others, particularly VCs and early adopter customers. If it was obvious, everybody would be doing it. Instead, it is usually obscure and often seemingly crazy. Who will invest in such a raw idea?
Mom and Dad, ... your best friend… that’s who. They trust you for reasons unrelated to the idea you are promoting. In fact, in the case of parents, biology drives them to support their offspring, even irrationally. In the case of friends, it can be payback for that time you bailed them out of a DUI in college, or any number of pre-existing debts, or irrational friendship.
I’m going to ignore the argument that parents investing in their kids is an unwise concentration of assets. I’m concerned with the hazier issue of irrational seed investors not giving the entrepreneur unbiased feedback. There is danger in F&F seed funding.
If for no other reason, subsequent investors will be looking to see who has invested before them. They will be looking for previous validation. Mom’s money is weak validation.
It’s a tough balance to strike --- you want some seed money to validate the idea, but you also want unbiased input on whether you are drinking too much of your own KoolAid. And believe me, after an unreasonable, irrational entrepreneur fixes on an idea and throws their weight behind it, it is hard to be convinced otherwise. The danger is that calling on the easy money, may delay getting a cool, rational dose of reality.
So I guess my advice is to validate that idea before seeking VC money, but test it both with F&F money and with unbiased, “tell you the honest to God truth” advice that a family member or close friend cannot give you. Don’t just labor away in stealth mode, eating up your parent’s money. Find “seed advisors” you can trust who know the space and the technology, and continually test your idea and fine-tune your pitch on them.
VCs have a phrase for Friends and Family money. Sometimes it’s just called Friends, Family and Fool’s money. Don’t trust the F's to validate your idea, and definitely don’t trust them to Value your idea. They love you and love is blind.
Friday, August 31, 2007
Shiny pennies
So what is VC investing like today? The one thing that is hard to appreciate until you are doing it, is the magnitude of the deal flow. This is simply drinking from a fire hose. You see new deals every day, occasionally a dozen new deals a day at a pitch conference. But an active early stage fund may only close a financing on one deal a month and an active partner may only do one deal a quarter. So there must be an aggressive triage process to whittle down the hundreds of new deals down to the one you will devote significant time to. Being a VC means very aggressive time management --- you have to, or your life turns into an endless series of digressions. (It sort of looks like my desk, with stratigraphic layers of papers and ppts, but that is another story.)
In passing, this is one reason that VCs often seem to ignore entrepreneurs and aren’t polite enough to even say no. They live in a deluge, and can’t spend too much time responding to each submission. If they did, they would have no time for follow up study and pursuit of the best deals they see.
At the risk of trivializing what I do, in some ways, my VC life reminds me of the time back when I was a kid and an avid coin collector. My dad had this giant jar of coins and once every month or so, I would get access to it and avidly sort through the coins looking for the proverbial 1947 D Lincoln penny in “Fine” condition. I had a book of pages with little round slots numbered with all the preceding years and mints and variants, and I was always trying to fill every hole with a better example of that coin.
And my attention was inordinantly driven to penny-collecting because during the Second World War, in 1942, due to a shortage of copper, the U.S. Mint made pennies out of steel for one year. Some of these steel pennies were still in circulation when I was a kid, and to a coin-oriented kid such an obvious anomaly suddenly appearing in your hand made the whole idea of coin collecting just fascinating.
So there is my Dad's bottle, and initially every coin looks roughly the same. Some are a little shinier, but at first they blur together. You looked sequentially at each coin and roughly evaluated it: what was its year and its mint stamp, what condition was it in, was there anything special about that year… You put aside maybe 1% of the coins as possibly worthy of further study, while the rest went into rolls to be taken to the bank. Then you took the promising ones and did “due diligence” on them, comparing to your previous best coin in each category, and looking them up in the coin collectors handbook. Rarely, and with great pride, you would replace a coin in your collection with a newly found one. Some people looked at different coins, i.e. nickels, dimes, silver dollars (different investment focus areas). Some people went to shows and shops and traded for already discovered coins (later stage investors). I liked the adventure of searching for coins in general circulation, gleaning value from the worldly flow. I confess I would sometimes go to the bank and buy rolls of coins, scan through them, and then return the leavings. (I recall my local bank began to take a dim view of this after a while. Fortunately, a lot of my relatives had bottles of coins.)
I liked the penny business. The upfront cost was low, the deal flow was high, and yet if you found a 1909 VDB, it wasn’t worth 10% of what an equally rare dime was worth. Suddenly a coin’s value became detached from its face value. It wasn’t even proportional. It was all about uniqueness and rarity, and diligence, luck, perceptiveness and knowing when to flip them…
In passing, this is one reason that VCs often seem to ignore entrepreneurs and aren’t polite enough to even say no. They live in a deluge, and can’t spend too much time responding to each submission. If they did, they would have no time for follow up study and pursuit of the best deals they see.
At the risk of trivializing what I do, in some ways, my VC life reminds me of the time back when I was a kid and an avid coin collector. My dad had this giant jar of coins and once every month or so, I would get access to it and avidly sort through the coins looking for the proverbial 1947 D Lincoln penny in “Fine” condition. I had a book of pages with little round slots numbered with all the preceding years and mints and variants, and I was always trying to fill every hole with a better example of that coin.
And my attention was inordinantly driven to penny-collecting because during the Second World War, in 1942, due to a shortage of copper, the U.S. Mint made pennies out of steel for one year. Some of these steel pennies were still in circulation when I was a kid, and to a coin-oriented kid such an obvious anomaly suddenly appearing in your hand made the whole idea of coin collecting just fascinating.
So there is my Dad's bottle, and initially every coin looks roughly the same. Some are a little shinier, but at first they blur together. You looked sequentially at each coin and roughly evaluated it: what was its year and its mint stamp, what condition was it in, was there anything special about that year… You put aside maybe 1% of the coins as possibly worthy of further study, while the rest went into rolls to be taken to the bank. Then you took the promising ones and did “due diligence” on them, comparing to your previous best coin in each category, and looking them up in the coin collectors handbook. Rarely, and with great pride, you would replace a coin in your collection with a newly found one. Some people looked at different coins, i.e. nickels, dimes, silver dollars (different investment focus areas). Some people went to shows and shops and traded for already discovered coins (later stage investors). I liked the adventure of searching for coins in general circulation, gleaning value from the worldly flow. I confess I would sometimes go to the bank and buy rolls of coins, scan through them, and then return the leavings. (I recall my local bank began to take a dim view of this after a while. Fortunately, a lot of my relatives had bottles of coins.)
I liked the penny business. The upfront cost was low, the deal flow was high, and yet if you found a 1909 VDB, it wasn’t worth 10% of what an equally rare dime was worth. Suddenly a coin’s value became detached from its face value. It wasn’t even proportional. It was all about uniqueness and rarity, and diligence, luck, perceptiveness and knowing when to flip them…
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…
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…
Friday, August 10, 2007
In the Beginning...
If I’m going to address the evolution of venture capitalism, it will probably help to first establish a context and starting points for this ongoing evolution. Starting enterprises is arguably the “oldest profession”, since the first prostitute probably needed seed capital to dress up for marketing to her first “sale”. OK, a poor joke… But in the modern era (i.e. the last 100 years) entrepreneur seed capital begins as angel behavior. At first you probably had to have money to start something new. You self-funded your new ideas. A good example might have been Thomas Edison. He made enough early money that he could afford to personally incubate ideas from his fertile mind. And he could borrow ideas from outside, improve on them and spawn another business. It’s my relatively uninformed opinion that this is how it gets started. Wealthy industrialists fund new ideas --- think Andrew Carnegie, Henry Ford. The seed capital comes from insiders and largely from themselves.
Wikipedia has a nice article on Venture Capital. It seems to suggest a second source of seed capital that it doesn't call out explicitly, e.g. the government, especially during extraordinary times such as WWII. The military had to create industries and suppliers from scratch to meet its needs in major defense projects. Think about the creation of atomic weapons, and all of the various components and materials that had to be created from out of the blue. General Leslie Groves was effectively a venture capitalist with a bottomless Limited Partner in Washington.
Wikipedia credits General Georges Doriot as the father of modern venture capital. My guess is that he got the idea from his experience in the wartime years, where the audacity of the military meant starting things from scratch under duress. Doriot was clearly a well versed business professor, having taught at the Harvard Business School, but I’m guessing it took the audacity of war to break through to the idea that you could start a company entirely from scratch, and do this as a repeatable business.
So we begin with wealth, expansive thinking, audacity. This is an angel dominated world. Wealthy people spending their money to make them more money and expanding their legacy. But in my mind, modern venture capital begins when you have professionals investing other people’s money. This seems to first happen with Venrock Associates, which starts as a group of professionals investing the Rockefeller fortune. Laurance Rockefeller starts it off, but he quickly hires pros to manage it.
Frankly this is the beginning… a couple of senior management types helping their boss, Rockefeller, to be a better angel investor.
Wikipedia has a nice article on Venture Capital. It seems to suggest a second source of seed capital that it doesn't call out explicitly, e.g. the government, especially during extraordinary times such as WWII. The military had to create industries and suppliers from scratch to meet its needs in major defense projects. Think about the creation of atomic weapons, and all of the various components and materials that had to be created from out of the blue. General Leslie Groves was effectively a venture capitalist with a bottomless Limited Partner in Washington.
Wikipedia credits General Georges Doriot as the father of modern venture capital. My guess is that he got the idea from his experience in the wartime years, where the audacity of the military meant starting things from scratch under duress. Doriot was clearly a well versed business professor, having taught at the Harvard Business School, but I’m guessing it took the audacity of war to break through to the idea that you could start a company entirely from scratch, and do this as a repeatable business.
So we begin with wealth, expansive thinking, audacity. This is an angel dominated world. Wealthy people spending their money to make them more money and expanding their legacy. But in my mind, modern venture capital begins when you have professionals investing other people’s money. This seems to first happen with Venrock Associates, which starts as a group of professionals investing the Rockefeller fortune. Laurance Rockefeller starts it off, but he quickly hires pros to manage it.
Frankly this is the beginning… a couple of senior management types helping their boss, Rockefeller, to be a better angel investor.
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