Posts from October 2013

The Role Of Personal Chemistry In Investment Selection

My friend Matt Blumberg and I are co-teaching a class at Princeton in a few weeks. The subject of the class is the VC/entrepreneur relationship. As part of doing this class, Matt and I are doing two posts each in a point/counterpoint model. Today is the first of these two co-posts about the selection process. Next thursday will be the second. Matt's post on today's topic is here and should be read directly before or after this post.

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From the outside, most people think that VCs are just looking for the best ideas that will generate the biggest companies. And that is true. We want to invest in big ideas, big markets, and big outcomes. That is a necessary part of our investment selection process, but not sufficient to get us to pull the trigger. We also want to invest in people and teams where we feel a personal chemistry.

Venture capital investing is not like angel investing or public stock investing. We don’t make a lot of small bets (angel investing) and we can’t easily get in and out of our positions (public market investing). We make big concentrated bets in a handful of carefully selected companies and hold these positions for between five and ten years on average. We sit on the boards of these companies and become business partners with the founders and management teams. We don’t run the companies but we have a meaningful amount of influence and impact on them.

For this model to work, VCs need good personal chemistry with the founders and management team. They need to like and respect us. And we need to like and respect them. The way investors choose teams to back and the way entrepreneurs pick VCs to take money from is very much like the way you recruit and hire a team. Or the way you date before getting married. It’s a process and the more facetime you can spend together before making the decision and the more asking around you do, the better decision you will make.

There are four phases to this process.

  • The first impression – That can be in a minute or an hour. It’s the first meeting. You walk away from that meeting and you think “I really liked that person” or “That person is awful.” Both the entrepreneur and VC will have an opinion coming out of the first meeting.
  • Subsequent meetings – If the first meeting went well enough, both sides are inclined to take a follow-up meeting or in all likelihood a series of follow-up meetings. This is where the first impressions are confirmed and validated or where they are determined to have been incorrect. This is also where others are brought into the process. In our firm, all the partners will meet the entrepreneur and, ideally, key members of the team as part of our investment process.
  • Reference checking – This is not about calling the references someone gives you. This is about triangulating between who you know well enough that they will tell you the truth and who has worked closely with a person. I like to call people who have worked with a person in a bad situation. When they tell you “she was the only person who really shined in that moment” you know you’ve got a winner. When they tell you “he created that situation and was painful to deal with” you know you don’t. You cannot take all the references you get as gospel because some people just don’t work well together. But if you call enough references, a picture will emerge with consistency and that is likely to the truth.
  • The negotiation – It is important that some stress is injected into this process to determine how well both parties work through a tense situation with some conflict. Because a five to ten year relationship between an entrepreneur and a VC will almost certainly include some difficult moments. Being able to work through those difficult moments constructively is the hallmark of a good VC/entrepreneur relationship. The negotiation of the investment deal is a good way to introduce that tension and both sides should pay a lot of attention to the little things that are said and done in the negotiation. It is a rehearsal for the main event.

If you find working with an entrepreneur difficult, you should not invest in his or her company. If you find working with a VC difficult, you should not take their money, no matter how good a deal they are offering you or how strong their reputation is. Personal chemistry is exactly that, a connection between two people. We all know that some people work well together and others don’t. Pairing the right people together to get something done is the central act of good business people. And it is the central act of venture capital investing.

What I Have Learned From Kickstarter

Today, Perry Chen announced on the Kickstarter blog that he’s moving up to Chairman and that his co-founder Yancey Strickler will step into the CEO role at the start of next year. Like all things that involve Kickstarter, this is a classic Perry move. Perry and Kickstarter have always done things their way, and today's news is another example of that.

As I reflected on this change, I started thinking about all the things that Perry and Kickstarter have taught me. I believe that entrepreneurs teach VCs and Kickstarter has been full of important lessons for me.

Maybe the most important lesson I have taken from Kickstarter is that you have to build your company in your own mold. There is no one right way to do it, as much as the advice giving pundits (me included) would tell you otherwise.

When Perry came to see me in 2009, just after they had launched the site, he said he was wary of taking money from VCs. He said he had no intention of taking the company public and no intention of selling it. He wanted to build a long lasting sustainable business that would always put creators first and serve as a resource for the creative community to get funding for their work. He saw the race for the big payday as orthogonal to his goals for the company and wanted no part of it. I understood the argument but wasn’t sure Perry really meant it. We invested anyway, because we believed that a network/market based approach to funding creators made sense and that it would be a good business. It does make sense and it is a very good business. And, as it turned out, Perry did mean it.

Kickstarter has been profitable from shortly after we invested. It has never needed to take outside money and it has not done much to optimize its profitability. The profits have been spent investing in the team and more recently in a new headquarters in Greenpoint, Brooklyn that will open next month. Instead of agreeing to pay sky high rents and sign a long term lease that the Company would quickly grow out of, Perry chose to buy an empty old Pencil factory on the waterfront in Greenpoint, Brooklyn and spend the Company’s profits fixing it up and making it into a physical instantiation of Kickstarter’s role as a resource for creators. They will be their own landlord.

I suspect that Perry could have bootstrapped Kickstarter without VC and maybe he should have. But I am sure glad he did not, as we feel incredibly fortunate to be along for this ride. Networks and markets are slowly changing the global economy and the creative sector is at the forefront of these changes. Instead of going to Hollywood studios for the funds to make their next movie, directors are choosing to harness the network of their fans. Instead of going to the publishing industry for their book advance, authors are choosing to harness the network of their fans. Instead of signing a deal with a record label, musicians are harnessing the network of their fans. The same thing is happening with comic books, video games, theater productions, and many other creative endeavors. Kickstarter has changed the way creative projects come to life.

Four and a half years after launch, Kickstarter is a very important and sustainable business. It will continue to grow, it will continue to fund creativity, and it will continue to do things its own way. Kickstarter was built in Perry’s mold and the unique culture and mission of the Company are derived from him. I suspect his decision to step up to Chairman and allow the team to run the business day to day is Perry’s way of saying to the team that they have his confidence to lead Kickstarter into the future. Kickstarter will always be Perry’s work and we are very happy to be a part of it and be inspired by it every day.

The Computer Science Education Fund

I'd like to announce something that a few of us have been working on for some time now. My colleagues at The NYC Foundation For Computer Science Education and I are raising a $5mm seed fund to invest in computer science education in the NYC public school system. The Gotham Gal and I have been investing out of this fund for several years, and now we are now opening it up to others who want to participate alongside of us.

Though we call this a seed fund, and we do think of it as an investment vehicle, this is a non-profit entity, 501(c)(3), and any committments to it are tax deductible and you will not be getting any money back from us. But you will be getting karmic value in that 1.1mm kids (the largest public school system in the US) will be getting exposure to computational thinking and learning how to code.

If you, like me, had that life changing experience some time in your childhood where you entered some instructions into a screen and the machine executed them, well then you know the power of coding to make you think differently, make you think more, and endow you with superpowers that others just don't have. If you want to help me inject that experience into the NYC public school system, then think about investing in this fund alongside us.

If you want to change something as large as the NYC public school system, you need to start small but think big. We have started with a friends and family round and have some things to show for it.

Csnyc map
Now it is time for seed capital so we can replicate these programs in more schools and back new programs, like Code.org, and help them come to NYC. That's where this seed fund comes in.

Eventually, it will be time for a growth round, and that's where the large philanthropic organizations come in. If you work at or with one of them, please reach out to me and we would love to come talk to you about what we are doing.

All of this investment is leveraged by the significant investments the NYC Department of Education is making in new schools, new school leaders, new curriculum, teacher development, and over 80,000 teachers. Think about it this way. The one time investment we made to get the Academy For Software Engineering off the ground is less than 20% of the annual operating budget of that school, all of which is funded by the NYC Department of Education. The power of public/private partnerships is that private capital can fund new things, that when they work can be scaled by public investment. That's what we are doing here.

On November 18th, we are hosting an event at USV where we will talk in more detail about how we intend to invest this $5mm fund. It will be 6pm to 8pm in the USV Event Space. Because we can only fit about 60-70 people in that space, attendance is limited to those who can make a $5,000 investment or more. If you would like to come, please RSVP here.

We will be doing a crowfunding campaign so that everyone can participate in this fund. I plan to announce that next week so stay tuned.

There will also be opportunities for everyone to volunteer time instead of money. We are already seeing the power of that in action and I am incredibly grateful to everyone who is taking time out of their day to go into schools and teach kids to code.

I got to this place initially out of self interest (how to get more coders for our portfolio companies in NYC?), but it quickly became about way more than that. When you walk into a school and see kids from neighborhoods like Brownsville and the South Bronx sitting in front of laptops and making software using modern tools like Ruby On Rails, Github, and StackOverflow, you see a pathway for them and for our city and for our country to change what ails us. This is about that. I hope you will join us in this effort.

How Big Is The NYC Tech Sector?

A few weeks back, I wrote about a study commissioned by the Bloomberg Administration that said the tech sector was the second biggest industry in NYC and was responsible for 262,000 jobs. The comment thread to that post was full of debunking those numbers, particularly for counting media industry jobs in that 262,000 number. So after seeing all of those comments, I reached out to my friends at the Partnership For NYC, which is the chamber of commerce for NYC, and asked them what the right numbers were.

They did some work and published new numbers on their blog yesterday. The Partnership thinks the number of people in NYC working in positions that require "avanced tech sklls" is 150,000. That feels about right to me too.

In any case, what all of these studies point to is that the tech sector is growing nicely in NYC, at rates well in excess of other industries right now, and will become more and more important to the NYC economy in the coming years.

The Fall Of The Alphas

Fall of alphasI read a book this weekend. It is called The Fall of The Alphas. It was written by my friend and former colleague Dana Ardi. Dana is a corporate anthropologist. She studies what makes management teams work. She has also been a writer, a recruiter, a coach, a VC, and a private equity investor.

There is a change afoot in the global economy that is impacting every institution, every market, and every business. Hierarchies are giving way to networks. At USV we have turned this observation into an investment thesis.

Dana has seen the same change impacting management teams, managers, and the companies themselves. Her book is about this change and in it she explores how the iconic Alpha CEO is giving way to a new kind of leader/manager that she, naturally, calls the Beta CEO.

Unlike many business books, this one is not boring or hard to read. Dana tells stories to make her points. Her language is light and airy but the lessons are clear and actionable.

If you lead a company or a team inside a company, you ought to read this book. It will change how you think about leadership and leadership styles.

Profitless Prosperity

If a Company is making huge profits this year but will not make any profits in the future, it is worthless in the eyes of an investor. But if it loses money this year and next year and may lose money for a few more years, it can still be very valuable in the eyes of an investor.

Amazon had negative net income in 2012 and pretty much zero net income this year to date. And yet it is worth $166bn in the eyes of investors.

This is because companies are worth the present value of future cash flows, not current cash flows, and certainly not past cash flows.

Amazon is not the only company that is plowing back all of its incremental profits into growing its business. This is very common for enterprise software companies as well. Salesforce has made or lost a small amount of money every year for the past four years but it has grown its revenue from $1.3bn to over $3bn in those four years. And its market value has gone from $12bn to $32bn in the same time frame. Workday hasn't made any profits in the last four years, in fact the net losses have been increasing. But the stock has doubled in the past year and the Company is now worth almost $14bn.

The lesson here is that you can't just value a company by taking its current performance into account. You really need to have a view towards its future performance. And you need to understand why the company is not currently profitable.

In the case of Amazon, it is making huge investments in warehouses and logistics to be able to continue to grow its retailing business and it is making similarly large investments in data centers to be able to continue to grow its AWS business. If Amazon did not want to continue to grow, it could stop making those investments and start generating profits. If you believe, as Amazon management does, that the future growth is going to be there for Amazon, then you ignore the current P&L and think about what a future P&L might look like. 

In the case of Salesforce and Workday, they are making huge investments in sales and marketing to secure additional customers. They are also making significant annual investments in R&D to maintain the market leadership of their existing products and bring new ones to market. If you think that Salesforce and Workday can continue to grow their revenues at or near their current growth rates, then you ignore the current P&L and think about what a future P&L might look like.

Profits are critical to the health of a business, but that doesn't mean a healthy business has to currently profitable. It needs to be able to be profitable if it wants to be and it needs to be profitable at some point in the future, at least hypothetically. So when you read that a company is losing money, don't read that as a bad thing. It could be a very good thing. It all depends on why. 

Feature Friday: Embedding Media

I was reading the latest Twitter S1 on edgar.sec.gov this morning and saw this tweet embedded in their filing. It made me smile to see that.

KD tweet
That is a great twitter conversation. It is one of my all time favorites. And, as many of you know, I also love KD. His game is pure pleasure to watch. I can't get enough of him. And if you want to see the flag football game in question, you can watch it here.

I will end this feature friday with some embedded music. My colleague Brian made this mix on a plane last week. I've been listening to it since. The A$AP beat that kicks it off is excellent.

What Are People Doing On All Those Cheap Tablets?

I saw this chart on our favorite analyst's blog this morning:

Screen Shot 2013-10-23 at 10.42.10 pm

And I thought "that's a shitload of cheap android tablets." 30mm cheap Android tablets in the first six months of 2013?

And of course Benedict was asking the same question I was thinking:

Why are people buying these? What are they being used for? They're mostly in China (that’s the pink bar above) and emerging markets and in lower income groups in the west. And it seems that they're being used for a little bit of web, and a  bit of free gaming. Perhaps some book reading. And a LOT of video consumption. In fact, one might argue that for many buyers, these compete with TVs, not iPads, Nexuses and Tabs. But regardless of what they’re being used for, they’re not being used the way iPads are used. In effect, they are the featurephones of tablets. 

I use the Nexus7 (the thin yellow line). I have a bunch of them. One on my bedstand at home. One on my bedstand at my beach house. I use them for remotes in our family rooms and I use them as recipe stands in our kitchens. I may make up that entire yellow band. I love the Nexus7.

But clearly most folks like me use the iPad. The people who are buying the cheap Androids are using it for something very different.

But how long will that last? I was at a school the other day. The school had laptop carts full of macbooks and the Principal was talking about getting iPad Minis for the kids. I suggested laptop carts of Chromebooks and Nexus tablets instead. It will save the school hundreds of thousands of dollars.

Education, Healthcare, etc, etc. These industries need commodity mobile devices but in volume price matters a lot. I think cheap Android tablets have a lot of room to grow and the use cases will widen and this chart will change. At least that's my bet.

Open Source and Our Government

A couple days ago, I saw a tweet by Henry Blodget and replied:

I am really upset by the problems with healthcare.gov. Leaving aside all the issues with Obamacare, and I hope and pray this discussion does not downgrade into a debate about that, I am very excited about the potential of marketplaces and marketplace economics on the price, availability, and transparency of healthcare insurance. It is way too complicated to buy healthcare insurance today and it costs way too much. The Internet and the power of marketplace economics has the potential to change that.

But our government has badly botched the construction of healthcare.gov and is now proposing a tech surge to fix it. More people, more money, and more promises thrown at a badly broken process. This will end about as well as Afghanistan and Iraq.

I'd like to suggest another way. Open source the healthcare.gov project, or at least all the components that easily lend themselves to open source. I think that some of it may already be open sourced. But instead of hiring an army of contract developers who will cost us so much money, harness an army of volunteers, who are likely better engineers, who will do the work for free.

That's what is increasingly done by technology companies and so much of the software that runs the web these days is open source. Why can't the software that runs our government be open sourced too? If you think this is a good idea, you can sign this petition. I signed it yesterday.

There is a lot going on in this area. My colleague Nick posted this link on usv.com today. GitHub now has a "subgit" on government projects. That's awesome and I hope we see the healthcare.gov codebase show up there soon.