Posts from VC & Technology

Investor VCs and Operator VCs

The Venture Capital business is full of great firms that were founded by entrepreneurs/operators who became investors mid/late career. From Gene Kleiner and Tom Perkins in the early 70s to Marc Andreessen and Ben Horowitz at the end of the 00s, this is the iconic model of the venture capital firm and the formula that built Silicon Valley into what it is today.

When young people ask me what the best way to get into the venture capital business is, I tell them “go work in startups in your 20s and 30s, and then turn to venture capital in your 40s and 50s.” That is certainly the best way to do it. You build domain expertise, operating experience, and relationships/networks that help you win deals and help entrepreneurs by doing it this way.

The only problem with that advice is that is not how I did it. And it is not how Mike Moritz did it. And it is not how Jim Breyer did it. And it is not how Bill Gurley did it. And it is not how Peter Fenton did it. And it is not how most of my partners at USV did it. It is not how many/most of the top venture capitalists in the business did it. And I have been mulling over this fact since coming to that realization a while ago. I ruminated a bit on it in the Q&A after the lecture I gave at MIT a few weeks ago.

I think there are a bunch of reasons why many of the best VCs, at least of my generation, were not entrepreneurs and operators before becoming VCs.

First on my list is “avoiding the temptation to operate.” Jerry Colonna tells a story about one of the first Boards he joined at Flatiron. Jerry had been an operator before leaving to form Flatiron Partners with me. He joined the Board of an early stage company and on it were a couple experienced VCs. Every time the Company struggled with an issue, Jerry jumped in and tried to help. Eventually, one of the experienced VCs pulled Jerry aside and said “You aren’t an operator anymore Jerry. You have to let them run the Company.” I have never had that issue. I am not an operator and have never worked in a startup or a company, other than a short stint in an engineering firm the first two years out of college. I wouldn’t know how to manage a team, run a business, lead a company. But I know how to manage the people who do know how to do that. There is a huge difference and I think that VCs who aren’t handicapped by operating experience bring great respect for operators. And that helps a lot.

The second reason on my list is “a strategic mindset.” I think of strategy as the opposite of execution. Strategy is about setting the stage for execution. Many of the best strategic minds I know aren’t operators. They are consultants, analysts, investors, pundits. I don’t know exactly why brilliant strategists often make terrible operators but I see it all the time. And all of the best venture capitalists I know are brilliant strategists. They understand where value is going to be in an emerging market, they understand how to get to the best strategically positioned companies first, and they understand how to guide those companies toward a strategy that wins the market.

The third reason on my list is “being a portfolio player.” Operators work on one thing all the time. VCs work on many things at the same time. In one day, I can be trying to win a deal with one company, working an M&A situation for another company, doing a strategy offsite for a third company, helping a fourth company develop its compensation plan, and sitting in a board meeting for a fifth company. That’s a typical day in the VC business. You have to love having your hands in multiple things all the time and the diversification that comes from that. You aren’t all in on anything but you are all in on all of it.

I am not saying that entrepreneurs/operators don’t make good VCs. Obviously, they do. The entrepreneur oriented mindset that firms like Kleiner Perkins brought to the VC business is why Silicon Valley emerged as the best place in the world to do startups. And being too financially oriented is why Boston failed to keep pace with Silicon Valley in the 70s and 80s.

What I am saying is that there is something about the other pathway into VC, via investing, consulting, writing, that works equally well, or better in some cases. And all you have to look at are the top investors in the business to know that.

My Talk At MIT

I mentioned a few weeks ago that I was going to give the first annual Georges Doriot Lecture at MIT.

I traveled up to MIT on April 13th and gave this talk. I really enjoyed doing it and I want to thank MIT for doing it.

Starting Is Easy, Finishing Is Hard

Starting a company has gotten much easier over the past decade.

The capital requirements to get started have come way down in both software and hardware businesses.

The supply of seed and venture capital has increased dramatically as well.

And there are all sorts of programs aimed at helping entrepreneurs get started.

All of this has caused a rapid expansion of entrepreneurship, startups, and innovation.

This is all great.

The one thing that has not gotten appreciably easier in the last decade is finishing.

Finishing can be anything that ends a startup project.

It can be an M&A exit, becoming a sustainable business, becoming a public company, or it could also be failing and shutting down.

None of those have gotten easier in the last decade.

There was a period where the “acquihire” was a thing and many companies that could not figure out how to become a business got bought for their talent.

But it feels like that wave has come and gone.

And so entrepreneurs and the investors who support them are back to grinding it out, trying to get to the finish line.

And, for many, that finish line feels like it is moving farther and farther away every step you take.

Startups are not for the faint of heart, both on the founder and investor side.

It takes great tenacity to see things through. And I think that may be truer today than ever.

From The Archives: General Georges Doriot

I am flying up to Boston today to give the inaugural Georges Doriot lecture at MIT. It’s a great honor to kick off this annual lecture and remember General Doriot, who was the founder of modern venture capital. Here is a blog post I did back in 2008 about General Doriot and a book about him by Spencer Ante. At the time of this post, I had not read Creative Capital, but I did read it and I strongly recommend it to anyone who is interested in the early days of the modern venture capital business.


Who is the father of modern venture capital? Surely someone from Silicon Valley in the late 60s and early 70s, right? Wrong.

The father of modern venture capital is General Georges Doriot who helped to form and run American Research and Development, the first modern venture capital firm in Boston right after World War II. Doriot also taught at Harvard Business School and was a mentor and teacher to the first generation of Boston VCs who operated in the 60s and 70s.

With all the focus on the bay area and its history as the center of innovation in information technology, Doriot’s contributions are often overlooked. But now we have a new book and a blog, courtesy of Spencer Ante of Business Week.

Ante’s Creative Capital is about Doriot and the start of the venture capital business here in america post world war II. I haven’t read it yet, but I just ordered it on Amazon. Here’s a short excerpt from the Harvard Business School blog. I suspect the readers of this blog are the perfect audience for this book so you should all go check it out.

Using Debt Like Growth Equity

If you are in the venture or startup business and don’t read Dan Primack, consider changing that. He’s great.

From his newsletter this morning:

Indebted: Last week we noted that Wal-Mart subsidiary Jet.com had acquired ModCloth, an online retailer of vintage women’s apparel. No financial terms were disclosed, but this didn’t feel like a success for either ModCloth or the venture capitalists who had invested over $70 million into the business since its founding 15 years earlier. Here’s what happened, per sources familiar with the situation:

  • In 2013 ModCloth went out in search of Series C funding, but the process was felled by a back-to-back pair of lousy quarters. So instead it accepted $20 million in unsecured bank debt.
  • ModCloth effectively treated the debt like growth equity, rather than recognizing the time bomb it could become.
  • When the debt first came due in April 2015, existing ModCloth investors pumped in new equity to, in part, kick repayment down the road for two years. This came amid four to five straight quarters of profitability, and just after the company brought in a former Urban Outfitters executive as CEO.
  • Once the income statement returned to the red, ModCloth again tried raising equity ― but prospective investors cited the debt overhang as their reason for passing on a company whose unit economics were otherwise fundable. Insiders could have stepped up but didn’t.
  • Jet.com heard of ModCloth’s debt coming due debt month, and pounced. We’ve been unable to learn the exact amount it paid, except that the amount left over for VCs after repaying the debt (and accounting for receivables) won’t be nearly enough to make them whole.
  • 2 takeaways: (1) Debt is not inherently troublesome for startups, particularly if it’s supplementing equity as opposed to substituting for equity. But startups must recognize that not all cash is created equal. (2) ModCloth was founded in Pittsburgh, but later moved its HQ to San Francisco. It’s impossible to know if things would have worked out differently had the company remained in the Steel City, but some of its quirky retail culture did seem to get commingled with the “grow grow” tech etho

I have lived this story several times in my career and we are seeing this play out again in the market.

It is tempting to use debt instead of equity to finance a high growth company, particularly when you cannot get equity investors to value your company “fairly.” When a company has achieved “escape velocity” and is growing quickly, lenders look at it and say “there is enterprise/takeout value here and we are senior to the equity so the risk to us is pretty low.” And so they will underwrite a loan to the company even though the market hasn’t made up its mind on how to properly value the equity. So the temptation all around the table is to take the debt and kick the can down the road on the equity in the view that more time, more growth, more market validation will fix things.

This can work out well. Our portfolio company Foursquare is an example of where this did work out well. A debt deal in the middle of a business model pivot gave that company the time to re-engineer its business model and validate it. And time also allowed the company to come to terms with how the equity markets would value it and its new business model. Foursquare went on to raise another round of equity capital and refinance its debt and is in a great place now.

But, as the Modcloth story points out, debt can also work against you. If you can’t execute well post raising debt and get to another equity round or some other transaction (an attractive exit being the other obvious option), then you can have your debt called from under you and lose the control over the timing and terms of your exit. I lived through this story with a company I backed in 1999 and which was sold a few years ago in a transaction that was very good for the lenders and good for the management and very bad for the early equity investors.

Dan’s point that substituting debt for growth equity is a risky bet is spot on. That doesn’t mean it shouldn’t be done. But it should be done with care and with eyes wide open.

Convertible and SAFE Notes

Angel/seed rounds used to be done via priced equity securities, either common or preferred. Then, starting about ten years ago, we started to see convertible debt being used in the angel and seed rounds. By 2010 this was the norm and Paul Graham tweeted this in Aug 2010:

Which led me to write this blog post here on AVC. I was not a fan of convertible notes then and I am not a fan of them now. USV has done a number of convertible and SAFE notes since then. I would guess that we have done a dozen or more of them in seed and angel rounds we have participated in. We are not opposed to convertible and SAFE notes and will not let the form of security the founder wants to use get between us and investing in a company that we like.

But I continue to think that convertible and SAFE notes are not in the best interests of the founder(s).

Here is why:

  1. They defer the issue of valuation and, more importantly, dilution, until a later date. I think dilution is way too important of an issue to defer, for even a second.
  2. They obfuscate the amount of dilution the founder(s) is taking. I think many investors actually like this. I do not. I believe a founding team should know exactly how much of the company they own at every second of the journey. Notes hide this from them, particularly the less sophisticated founders.
  3. They can build up, like a house of cards, on top of each other and then come crashing down on the founder(s) at some point when a priced round actually happens. This is the worst thing about notes and doing more than one is almost always a problem in the making.
  4. They put the founder in the difficult position of promising an amount of ownership to an angel/seed investor that they cannot actually deliver down the round when the notes convert. I cannot tell you how many angry pissed off angel investors I have had to talk off the ledge when we are leading a priced round and they see the cap table and they own a LOT less than they thought they did. And they blame the founder(s) or us for it and it is honestly not anyone’s fault other than the harebrained structure (notes) they used to finance their company.

The Series A focused VC firms that often lead the first priced rounds get to see this nightmare fold out all the time. The company has been around for a few years and has financed itself along the way with all sorts of various notes at various caps (or no cap) and finally the whole fucking mess is resolved and nobody owns anywhere near as much as they had thought. Sometimes we get blamed for leading such a dilutive round, but I don’t care so much about that, I care about the fact that we are allowing these young companies to finance themselves in a way that allows such a thing to happen.

Here are some suggestions for the entire angel/seed sector (founders, angel investors, seed investors, lawyers):

  1. Do priced equity rounds instead of notes. As I wrote seven years ago, the cost of doing a simple seed equity deal has come way down. It can easily be done for less than $5k in a few days and we do that quite often.
  2. The first convertible or SAFE note issued in a company should have a cap on the total amount of notes than can be issued. A number like $1mm or max $2mm sounds right to me.
  3. Don’t do multiple rounds of notes with multiple caps. It always ends badly for everyone, including the founder.
  4. Founders should insist that their lawyers publish, to them and the angel/seed investors, a “pro-forma” cap table at the closing of the note that shows how much of the company each of them would own if the note converted immediately at different prices. This “pro-forma” cap table should be updated each and every time another note is isssued. Most importantly, we cannot and should not continue to allow founders to issue notes to investors and not understand how much dilution they are taking on each time they do it. This is WRONG.

Honestly, I wish the whole scourge of notes would go away and we could go back to the way things were done for the first twenty years I was in the venture capital business. I think it would be a better thing for everyone. But if we can’t put the genie back in the bottle, we can at least bottle it up a bit better. Because it is causing a lot of problems for everyone.

The Bloomberg Startup Barometer

I came across this index from Bloomberg that tracks the health of the US startup ecosystem.

This index “incorporates both the money flowing into VC-backed startups, as well as the exits that are making money for investors. To smooth out some of the volatility, we calculated the average value for the last 12 weeks.”

I like that they are tracking both inflows (investments) and outflows (exits). What’s interesting is that over the past year, the exit chart is looking better than the investment chart:

If exits continue to outpace investments, that’s a very bullish thing for the startup sector, particularly for investors. But what is good for investors is ultimately good for founders because strong performance will lead to more capital flowing into the sector.

This chart is investments since 2007:

You can see that the VC sector ramped its investing activity significantly in 2010 & 2011 and has maintained it at roughly those levels (with some tailoff recently) since then.

This chart is exits since 2007:

You can see that exits did not start increasing until 2014, roughly three to four years after the significant pickup in investment pace. That makes sense because of the “gestation period” of startups is at least four years and in most cases longer.

I will be keeping my eye on this new index from time to time. And I will be most interested in the shape of the exit chart because it is the strongest predictor of the long term health of the startup ecosystem.

Video Of The Week: Mark Cuban At Upfront Summit

I posted the discussion my partner Andy and I did at the Upfront Summit last week.

There were other great conversations at the Upfront Summit.

This discussion with Mark Cuban was great. I totally agree with Mark that we need more tech companies to go public and have been saying that publicly for several years.