Posts from August 2008

Venture Fund Economics: Allocating Follow-On Capital

It’s time for another entry in my Venture Fund Economics series. This time I’d like to talk about the importance of allocating follow-on capital.

One of the great things about early stage venture capital, as compared to many other investment disciplines, is that you get to build your position in the company over time, sometimes over a very long (5-7 year) period.

So this allows the venture investor to allocate capital to the investments in his/her portfolio based on the performance of those investments. I’ve likened each investment to a hand of poker and it’s certainly a lot like that.

Let’s start with my 1/3, 1/3, 1/3 assumption that regular readers will be familiar with. This says that 1/3 of an early stage venture portfolio will be losers, 1/3 will get your money back or make a little money, and only 1/3 will deliver the kind of performance you expect when you make an investment (5-10x).

If each investment was allocated the exact same amount in a theoretical portfolio, this is how the 1/3, 1/3, 1/3 scenario would play out.


You’d get 2.2x your total invested capital on a gross basis (before fees and carry) and as we discussed in prior posts on this topic, that’s not good enough.

So let’s say you did a $1mm round in your losers, two $1mm rounds in your break evens, and three $1mm rounds in your winners. That would look like this.


You’d get 3x your total invested capital on a gross basis and that is not so great either although it gets closer to acceptable performance.

But fortunately, most companies need more capital as they grow. So let’s assume the one, two, three rounds is right, but that the first round is $500k, the second round is $1.5mm, and the third round is $3mm. Then the numbers play out like this.


This results in 3.7x on a gross basis which is about where you’d need to end up to generate a good return to your investors after fees and carry.

So it’s pretty clear that allocating capital is a key aspect, possibly the most important aspect, of generating good returns in a venture fund.

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Sometimes You Just Have To Walk Away

The title of this post is a line in a Damon Gough (aka Badly Drawn Boy) song that I heard on my bike ride this morning. You can click on the black banner at the bottom of the screen and hear it play while you read this.

And it took me back to an email exchange that I’ve been having this week with some friends about "breakage" in a venture capital portfolio. Tim (Connors I assume) from USVP left this comment on my blog the other day:

i was at the ycombinator event yesterday and i think PG said they have
had 102 companies through and 14 so far have been series A funded by VCs

I was surprised that the number of VC funded YC companies was so low and forwarded the comment via email to some friends in the VC business with the following comment:

I would have thought it would be much higher

To which I got back a bunch of comments about "breakage", meaning companies that don’t make it. Early stage venture portfolios should have a decent rate of failure, and the earlier the portfolio, the higher the rate should be.

I’ve said a bunch of times on this blog that I think an early stage venture portfolio should have 1/3 failures, 1/3 money back situations, and 1/3 that deliver the returns the VC expected when the investment was made.

But that hasn’t been the case in the USV 2004 portfolio so far. We are done putting new names in that portfolio and have made a total of 21 investments. We’ve sold three companies to date, leaving 18 active portfolio companies. And to date, we have not written off a single investment. That realization prompted me to make this turn in the email discussion:

No writeoffs yet after four years

But then, that was true for flatiron from 1996 to early 2000

And then we had breakage non-stop for two years

Flatiron had 59 portfolio companies and we eventually wrote off 20 of them without getting anything material out of them. That’s one of the places I get the 1/3 failure rate from but not the only one.

But the thing of it is, we had made every single one of those 59 investments before we wrote off a single investment. From 1996 to early 2000, we had a run where we had 17 exits and no writeoffs. We went into the market meltdown with a portfolio of 42 companies (we’d exited 17) and over the next two years we wrote off 20 of them. The remaining 22 companies are almost all realized now and about half of them have been money back situations and about half have been big winners.

The 1996 to 2008 time period is not a totally normal period to be making any conclusions from, but it’s interesting to go back and look at this data anyway.

One thing is clear to me and it was stated by my friend John Borthwick in his reply to my email from above:

From what i see the VC model doesn’t offer a lot of visibility into failure until there is an external forcing event, the tendency to get someone else to invest and plug an existing investment w/ their dollars can blur what is in fact failure

That is true. The forcing function is usually a bad market when nobody wants to write a check. Then the existing investors are forced to look hard at each other and decide if they want to keep investing. And then, if the company is really not making good progress, the answer is usually no.

I don’t know if we are getting to that point yet in this cycle, but my bet is we are getting closer. It will be interesting to revist this post in a year.

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Crunchbase SMS Interface

Fred, for the Crunchbase link via SMS, text "cbsms tumblr" OR "cbsms fred wilson" to 41411.  The SMS bot will send you a link to the most relevant page on Crunchbase for any search term that follows "cbsms" (Crunchbase SMS)… companies, people, financial institutions, whatever. 

Russell, very cool!  I’m not a developer, but it took just a few minutes to figure this out on Textmarks.  What a great tool.

Originally posted as a comment by Joe Lazarus on A VC using Disqus.

There were a bunch of comments to that post with suggestions on how to get an SMS interface to Crunchbase but Russ suggested textmarks and did a halfway solution and Joe picked it up and finished the job. This community even does open source projects! Thanks everyone for solving this one for me.

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Friends and Neighbors

We are all used to the idea of friends in social nets. It’s not entirely clear to me what a "friend" in the context of a social net is and it’s getting more confusing all the time.

But neighbors is something I can get my head around. I know what a neighbor is.

I’ve been loving the newly redesigned lately. I have 178 "friends" on and rarely, if ever, look at them.

But I have 60 musical neighbors on and I pay a lot of attention to what they are listening to. Because is about music and I care about what people who share my taste in music are listening to.

This guy whitnorris lives in Japan but has basically identical music taste to mine. So when I see that he’s been listening to a lot of the Silversun Pickups, I’ll head over to hype machine and do the same.

One thing that doesn’t do (that I know of) is give me the intersection of my friends and neighbors. Here’s a screen shot of my top six musical neighbors.


Two of my close friends (suesol and bijan) are among my top six musical neighbors. That is both amazing and cool.

If had a page where I could see my top neighborhood friends and either listen or check out what they are listening to, that might be make friending someone on more useful.

In any case, I hope that more social nets start adding other ways to categorize friends and ideally automatically the way does with neighbors. It would make the services a lot more useful.

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Fred's Mountain

  View From Fred’s Mountain 
  Originally uploaded by fredwilson.

My friends Brad, Amy, Matt and Mariquita took a hike up Fred’s Mountain  (on the Wyoming/Idaho border near Grand Teton) yesterday and sent me this from their phone on the hike. That is a glorious view.

I wish I was there, but getting a photo like that "phone to phone" is kind of like being there for a moment.

It’s true that I’d like to fund teleportation (but not beta test it), but short of teleportation, mobile social media isn’t too bad to take you to another place for a moment.

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VC Tip Of The Day

Last week I saw my friend Bryce, a partner at OATV in SF, twittering VC tips like this one:

vc tip-o-the day: if you’re not funny, don’t use humor in your pitch.
vc meetings aren’t the best venue for trying out new material.

Being obsessed with twitter bots, I immediately thought, "this would be a great twitter bot". And so I sent Bryce a message to that effect. He liked the idea but we weren’t sure how to set it up so that the only people who could post to the bot would be real venture investors.

We turned to Whitney who built the lotd and shakeshack bots and he came up with a slight modification and voila, vctips was created.

Bryce announced the creation of vctips on his tumblog this morning. He’s invited a bunch of VC’s to join the posting group and any others who would like to join should contact Bryce. This is his sandbox, we just get to play in it.

If you want to follow along, just join twitter and then go to this page and hit follow. This should be fun and informative.

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Ten Things I Want On My Mobile Phone

1) Shazam for places – I blogged about this when I was in Scotland earlier this month. I met a company at TechStars yesterday that might be able to build it. I hope they do.

2) Shazam for people – same idea. even more possibilities for this one.

3) Twitter or sms bot for Crunchbase – When I hear about a company, I want to send the name of the company via twitter or sms to crunchbase and get a link back to a the entry on it.

4) Handshake two mobile phones and share contact info – apparently coming soon to the iPhone. man we need a real app ecosystem for the blackberry.

5) Internet radio that can run in the background – internet radio is a killer app on mobile phones, but not if you can’t multitask while listening to it.

6) A bike odometer – i’ve got a bike odometer on both my road bike and mountain bike. the batteries have died and i am too lazy to replace them. i’d rather have a mobile app that i click at the start of my ride and the the end of my ride. lot’s of possibilities for this one.

7) a way to use the ringtones on my blackberry that i made for my iphone with garageband

8) a blackberry twitter client that doesn’t suck

9) brickbreaker for the iphone

10) the mobile phone e-ticket – an app that lets you check into your flight on your mobile phone (via the web) and downloads the ticket to your phone. the gate attendant scans your phone instead of the ticket.

Ok. I’m done. Now I have to go get the ticket to my flight home the old skool way.

Feel free to create any and all of these. Just let me know about them when you do. And if any of these exist already, please let me know in the comments.

Speaking of the comments, please leave anything you want on your mobile in the comments and I’ll reblog the ones I like

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When You Wake Up Feeling Old

Yesterday I posted about youth and inexperience. Today I am going to post about getting old. Because I am 47 today and getting close to the age where I have always thought venture capitalists start to fade.

I got into this business young, too young. And so as a young VC, often the youngest person in the room, I formed some opinions about age in the venture capital business.

The 20s are for getting some expertise. The 30s are for building a reputation. The 40s are where a VC peaks. The 50s are where you start managing the firm, handling relations with the investors, and the 60s are when you retire.

Like any generalizations, there are exceptions to this rule, most notably my partner Brad who hit his stride in his late 40s/early 50s. But like any generalizations, there is a lot of truth to it. VC is a young person’s game. It’s about being on the cutting edge of technology and trends.

I try super hard to stay up to speed on the lastest thing. It’s frankly an obsession for me and one of the reasons I blog every day. You all tell me about more stuff than any other source I’ve got. But I see my kids coming home these days knowing more about the latest indie band, iPhone app, and  cool blog. I can’t compete with their youth but I can pay attention to it, and I do. When they are gone from our home, I’ll lose that connection. And that’s not too far away, unfortunately.

We’ve got two great junior investment professionals in our office, Andrew and Eric. They share an office. When I walk into their office and chat for a while with them, I always walk out knowing something I didn’t know when I walked in. They understand how the web works at a level I’ll never understand.

Of course, with age comes experience and I’ve gotten a bit of that over the years. And I try to share it on this blog as much as I can. But experience is something you have to earn. I can tell stories until I am blue in the face, but unless you’ve had to shut down a company, write off $20mm, or shut down your venture firm, you just don’t know what those things are like and how to avoid them.

I honestly don’t relish the idea of being the VC who brings the experience piece to the equation. I like being on the cutting edge. So I am going to try even harder in the coming years to do that. And I will rely on this blog and all of you to keep me there.

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The Human Piece Of The Venture Equation

We’ve been attending a lot of “demo days” in the past month and I am attending one more this week, TechStars in Boulder tomorrow. These startup accelerator programs, inspired by the success of Y Combinator, are launching something like 100 new web startups a year, possibly more. And the founding teams of all of these startups are young and inexperienced, mostly by design.

That youth and inexperience is an asset to many of these startups. We’ve been through why that is before. The founders have low personal burn rates so $25,000 can take them six months. They are largely developers/hackers who know how to build stuff quickly and inexpensively. They create lean, mean, capital efficient companies. They grew up with the web so they have a “native” feel for how web apps and services should work. And of course, they don’t know why they are going to fail so they “just do it”.

It would be interesting to take all of the companies that have come out of these startup accelerator programs over the past four years and track them.  Of course some have failed and some have been bought. But that’s not really the data I’d be most interested in. How many have built a real business with real revenues? How many are profitable? How many have raised a significant amount of venture capital? And how many have hired experienced managers to run their companies? And how is that working out?

I am most interested in the human piece of this analysis. When do the advantages of youth and inexperience give way to the advantages of maturity and experience? And what are the tell tale signs that the young founders are maxing out on what they can give the company? And what does it take to get them to willingly hand over the keys to the car to someone else? Does it happen without VC investors forcing the issue?

We have one Y Combinator company in our portfolio, Disqus, and no other companies that come out of these startup accelerators. But we have young founders running a bunch of our companies:

Tumblr’s founder/CEO David Karp is 21. 

Disqus’ founder/CEO Daniel Ha is 22.

Etsy’s founder/CEO Rob Kalin is 28 and he recently turned over the reigns of the company to new CEO Maria Thomas.

Greg Yardley, the founder/CEO of Pinch Media is 29. 

Jack Dorsey, Twitter’s CEO and the initial creator of the service, is 31.

Return Path’s CEO, Matt Blumberg, is 37, but he’s been running the company since 1999, when he was 28 years old.

As I told Matt when I first joined his board, “the failure rate of first time CEOs is incredibly high”. You just don’t know what you don’t know. And it leads to making rookie mistakes. Early on in a company, those mistakes don’t cost much. And some mistakes can even be turned into wins.

But as a company grows, the rookie mistakes become harder to manage around. The value that everyone has invested in the business, most importantly the work of the team, starts to weigh on everyone’s minds. The CEO’s job goes from managing the product, writing a little code, doing customer support, and raising money to managing people and teams, processes and priorities. It’s not a job that most people enjoy doing and it’s a job where experience really does matter.

Some young founders can make the transition. Matt Blumberg did. But he worked really hard at it and his personality is well suited to the CEO job. Rob Kalin chose not to make the transition and spent a year recruiting a CEO he was confident could keep what was important about Etsy and change what needed to work differently.

I’ve watched my friend Mark Pincus struggle with this issue over the course of his career. I first backed Mark in 1995 when he was 28 or 29. He quickly flipped that first company, Freeloader. He handed over the reigns of his second company, Support Software, when it went public. He handed over the reigns of his third company, Tribe, and it was a bad move. The hired CEO didn’t know what he was doing with Tribe. So this time around Mark, who is now 42, is running Zynga with a firm grasp on the wheel.

I’ve learned a lot from watching young entrepreneurs like Mark and Matt grow up in the CEO role. I’ve learned that nothing can replace the entrepreneur’s passion and vision for the product and the company. If you rip that out of the company too early, you’ll lose your investment. I think it’s best to wait until the initial product has succeeded in obtaining a critical mass of users and a business model has been developed that works and make sense for the business and is scaling. Then, if its warranted, you can sit down and have the conversation about bringing in experienced management.

Some entrepreneurs react very negatively to that discussion. They have their own ego and self worth tied up in the company and cannot imagine the company operating successfully without them in the driver’s seat. They also don’t know what else they’d do if they didn’t run the company. It’s a really hard transition and can cause great pain for everyone, including the company.

I always try to focus people on what is in the best interests of the company, not specific individuals. That, of course, is easy for me to say because nobody is talking about me leaving the company. I don’t work there. But even so, it’s the right point of view for everyone to take. Sometimes the founders get it right away and are happy to part ways and do something new. Sometimes the founders understand it intellectually but have a hard time emotionally. In that scenario, I think time and patience can yield the right outcome most of the time. But sometimes, it’s never going to happen without a fight. And of course, sometimes the founders shouldn’t leave at all.

How do you know if a founder can scale into the long term “permanent” CEO of the company? Well I don’t think you can know that when you make your initial investment unless the founder has done it before. We have plenty of those situations (successful serial entrepreneur CEOs) in our portfolio and frankly they are easier deals to do. But when you are backing a young, and most likely first time CEO, then you really don’t know if they can drive the car all the way to the finish line.

So it’s important to observe them in the CEO role. Do they communicate well? Do they excel at having difficult face to face conversations with their team and their investors? Do they hire well? Do they move quickly to get rid of problem employees? Do they think about the people side of the business most of the time? Do they have a sense of urgency? Do they command the respect and loyalty of the entire team?

Those are the kinds of things I look for in “long term” CEOs. Of course they need to be able to set the long term strategy and vision and hold the company on that line. And they need to be able to raise capital and manage a Board and investor group. But frankly I think that many young founders are pretty good at those things. It’s the human piece of the equation that is so hard and so few get right.

As we create more startups with young founders at the helm, we are going to have to face these issues more frequently. And even though I’ve been doing this venture capital thing for 22 years, I honestly can say that I don’t feel that prepared to deal with these issues. They are hard. And each one is different. But in order to build the best companies we can, we need to get the people side of the equation right.

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Brad Talks To The Deal

When you read this blog, you are getting the thoughts and ideas of not just me, but really of all my colleagues at Union Square Ventures. It’s impossible to separate what are my ideas and what are the ideas of our firm. There’s no better example of that than my partner Brad, who I founded Union Square Ventures with in 2003. Brad writes a fair amount on the Union Square Ventures blog, but if you don’t read that, you may not realize how thoughtful and articulate he is. Here’s an interview he did with The Deal last week and I think you’ll recognize a lot of the ideas I’ve been blogging about lately in here.

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