Capital vs People
I have a friend Charlie who is a serial entrepreneur and he says that venture capital "values capital over people". That’s a criticism that has a ring of truth to me (as opposed to much of what Adeo said the other day).
We just spent the past day with our investors and we are blessed to have a collection of great people behind us. They provide the capital that we get to invest in startups. And I am incredibly grateful for their support. But it isn’t capital that drives the startup ecosystem. It’s the entrepreneurs who drive it. And it’s important to remember that.
Back in 2005, I wrote a post called The VC’s Customer. In that post, I made a point publicly that I’ve been making privately for years. VCs that serve the entrepreneurs win and VCs that serve the market lose.
I think in times like we are in, it’s worth remembering this. And I want to thank Charlie for suggesting to me last night that I return to that post.
Comments (Archived):
I wonder if viewing Entrepeneurs are customers are a partial reason why it may be difficult for VC’s to approach the business as “lets do lots of small bets” in a manner that was kicked around a bit on yesterday’s post. Lots of small bets means lots of customers – using this perspective here – and that may mean there’d be too many customers to service well. Does that put us back into the “hit driven” model of making a few big bets?How much of your time is spent servicing your existing entrepeneurs versus investigating new deal flow?
most of my time is spent on our portfolio not on looking at new investments
The far majority of my time is spent on portfolio companies rather than sourcing new deals, and we don’t have near the portfolio size as USV has (although we have a very different focus/model). But, most investors I know are like this. The model of lots of small deals is fading, in my opinion, which we talked about some yesterday (prepare for a shameless plug … http://marktomarket.typepad…. Being in life sciences/energy/real estate and in public equities, we’ve already been focusing on building value rather than volume, but I think more VC’s will start to follow suit, especially as they’re experiencing the trials of the current marketplace, where they will be forced to help their investments navigate the hurdles the market throws at them.
Uh-oh… after a day with his capital providing LPs, Fred says: “It isn’t capital that drives the startup ecosystem [but rather the people in it]”… The VC business must be worse than previously reported. 🙂
Fred, I think Adeo’s slides (however incomplete and perhaps inaccurate) did spark an important debate. When you couple this presentation with Roger’s post about the Pyramid structure and the comments on the thread from you post yesterday you can see that the broader AVC community is thinking about ways to improve the venture process. This really gets me excited.As for serving the entrepreneur vs. the market — I would love to believe in this as an absolute framework. I think there are some challenges with it. First, as you point out, funds — like businesss — go through different cycles with fundraising events that invariably shift their focus to selling LPs and, as a result, at least hinder customer focus if not change who the customer is for some period of time. Second, and again like any company, some customers are more important than others. Roelof Botha claims he spent 30 -75% of his time with YouTube during its final year as an independent company. I think this is really done in the interest of shareholders more than the other customer/entrepreneurs in your analogy. To me, this blurs the line between customer and shareholder.Some venture capital firms talk the talk about entrepreneurs as “raw material”, but use a classic Porter model analysis to determine whether the entrepreneur’s business plan makes sense. To me this makes the entrepreneur more of a supplier than customer in the venture capital Porter diagram. This may be one cause of the “sector” “fad” or “me2” investing phenomenon. There tends to be a lot of portfolio theory within firm cultures and that limits which customer/entrepreneurs a firm can serve.Like many industries over the next couple of decades, change is coming to the venture asset class. The first change appears to be shrinking the size of capital under management. The next phase appears to be new companies/models that don’t use the 2/20 framework or the LP/LLC legal structure to invest. I think this phase has a long way to go.What I can’t figure out is how the recession helps or hurts the emergence of these new models?
Fred, thanks for this. After 4 startups, this issue has always lived with me just below the surface. The capital, as an enabler, is in the eyes of the investor, more valuable than the resource that makes capital perform.I fear though, it will be a cold day in hell when that topic receives more attention in the board room than the cold silent stare from “your” VC.
Very good point. I think The Funded has changed the way VC’s treat entrepreneurs. As an entreprneur, the first thing i would do before trying to raise capital, would be to review TheFunded.com. I’m sure you know that there are a lot of sharks in the VC space (either trying to negotiate term sheets a producer would blush at or consultants posing as VC’s). Entrepreneurs are smarter than ever. If you lack integrity, everyone will know about it 🙂
Yes, but keep in mind, The Funded can also be an open forum for anyone to say anything about anyone. Just b/c a member didn’t like the way a meeting was conducted and therefore left negative feedback doesn’t necessarily reflect the true effectiveness of the investor. The comments about not receiving an email from a VC annoy me … what would you rather your Board members be doing, working on business or responding “no” to every request they get? Conversely, let me also say that I totally agree with some of the complaints – there are some major primadonnas in the VC world and I regularly make fun of these guys who think they are the end all/be all to a company’s success!
Great post Fred and perfect timing to revisit. It speaks volumes in such a concise and effective manner.
It feels to me like innovation is getting less capital-intensive, more talent-intensive. Moore’s law drove a generation of investment (quadruple the price of the chip fab to double the density of the chip — and sales volumes go up ten-fold); that model percolated through the economy for a generation. The new model invests ‘opportunity cost’ — talented engineers and designers and marketers who take a risk and forego the (perceived) security of a corporate job to bet a few years of their career on a startup and a vision. The capital inputs (Fred, you’ve written about this before) get cheaper and cheaper (the residual of the Moore’s Law effect, actually), but the “War for Talent” heats up.
Do you really think Sequoia serves entrepreneurs? Not many do.
One thing we need to remember is that while VCs may want to serve entrepreneurs, in the end their job is to maximize the return for their investors. So they are very limited in what they can do to help.If the goal is to help entrepreneurs, then you need to change the legal structure that frames VC’s work.This is what I am trying to do with Entrepreneur Commons (www.entrepreneurcommons.org), removing some of the constraints that are currently built into the model.To follow up on @Chrisndodge comment, a lot of small bets is a possible option if you get organized to handle this. This would resolve the famous “funding gap” issue. For Entrepreneur Commons, we are looking at having self-help teams of entrepreneurs, so that making small loans to many becomes having more self-help teams, but will not strech the people involved in the fund. A similar concept works for microfinance, there is no reason why we could not make it work for Entrepreneurs in developed countries…
I think serving entrepreneurs is the only way to consistently deliver returns to investors over the long haul.
Thanks for the mention and for reposting. I know it’s not so cut and dry–it’s definitely a tough subject. I wonder if there’s a better model. Some SRI funds I know are going through the same thing as the rest of the industry, and while they want to be different in how they handle capital vs people, their venture model is effectively the same, which will ultimately value the capital over people.At the same time, any VC will say that great companies are a mix of great people, solid execution, a decent idea, and capital. I’d love to see the model that favors the first three over the last in a deal structure.
I remember that 2005 post as if I first read it yesterday. I have thought of it many times since it was published. I’m not in VC, but it applies to other businesses. Your employees (your creatives) are your most valuable resource. They are the treasures. There is always a mystique to true artists. And they are usually much more interesting as dinner guests than the richest guys on the block.
You got that right!
I can’t tell you how many people came into my bricks and mortar store,and once we knew each other well, revealed that one or another of my employeeshad ‘good mouthed’ me behind my back, which led to their patronage.Conversely, when a business has treated people badly, I will not patronize them.And it goes well beyond that.When my retail manager saw me ‘get arrested’ (ficticiously for Jerry’s Kids/MDA),and get dragged out by the police, into a cruiser, and have to ‘raise bail’ (donations),she evolved into a different team member overnight. She had a family member with Muscular Dystrophy, and saw her employer’sactions with a smile on an overly busy day. She started doing amazing creative work for us, at night, on her own time.Multiply that concept times a huge corporation.Imagine.
VCs appearing to value capital over people is a direct result of the over-investment in VC as an asset class.With so much money in the asset class, valuations are bid up. When management teams eventually get around to missing their projections, exits are lower than hoped for. Hence, returns are down. Entrepreneurs want higher valuations but they often don’t get that VCs need cash on cash returns. The most phenomenal entrepreneur will never be more than one of the ingredients a VC must assemble to make success possible. With VCs managing a portfolio of companies, staying on top of deal flow, keeping up relations with LPs, and staying current on market developments it is understandable that entrepreneurs might feel neglected. Your friend Charlie is just one of the many people in the VC industry feeling the pressure that comes with more assets in the space.
First, this isn’t about me or my situation–it’s just my opininon of the relationships in the venture ecosystem (LPS>>VC>>Entrepreneurs>>employees, customers, & vendors, etc)Second, I didn’t say I felt neglected or feeling the pressure that comes with “more assets in the space”. I said that venture capital values capital over people.Also, I think you’re overstating the role of the VC when you say “ingredietns a VC must assemble tomake a success possible.” Most VC I know aren’t in the business of assembling the ingredients–that’s the entrepreneur’s job in most cases–at least on the initial investment.I wrote more extensively about it over at the blog (http://charliecrystle.blogs…). The bottom line is that venture talks about great teams, a decent idea, and capital to make a good company, but in that equation, at the end of the day, capital gets the better end of the deal at the expense of people (through preferences, risk mitigation, policies, cramdowns, add to the list if you’d like).
Charlie, I enjoyed reading the post on your blog. Looks like a good resource to help people understand the entrepreneur side of the VC dynamic from someone who has been around the block a few times.I should have been more clear on what kind of success I was talking about in my “entrepreneurs are just one ingredient” comment. Given Fred is blogging from the VC’s perspective I was only talking about success from the VC’s perspective. They need cash on cash returns to satisfy LPs so they can raise their next fund. They get those returns through a combination of the occasional big exit, liquidation preferences, cramdowns, and all the other policies that generally seem onerous to entrepreneurs.I definitely agree with your summary that capital gets prioritized over people. That’s one of the prices of taking VC money. Many of the problems get created when people go the VC route without really understanding what the implications of that decision are.fun quote of the day: “get off the VC crack.”
I think the VC landscape is changing, but I don’t completely agree with the claim that there is an over-investment in VC as an asset class. The allocation of capital is based on institutional investors’ percentages and allocation from total AUM. The percentages haven’t changed (actually they have declined somewhat in the past six months), just the amounts. I’m discussing this further b/t my blog and Adeo’s post today at http://marktomarket.typepad…
This is a great sentiment. However, in an age of people saying anything and doing the opposite, I wonder if there is a way to validate a VCs follow-through on their stated “philosophy”. I don’t know if I know any VC who doesn’t say they’re not their to service the entrepreneur — at least not publicly anyway.
You have to check them outEvery VC firm makes their portfolio companies publicYou can use LinkedIn to find out a way to get the the founders/CEOs of a VCsportfolioThen you call/email them and ask if they are good to work with