Plant More Seeds vs Tending The Crop
One of the questions facing venture capitalists in the internet/web sector is how big a portfolio is optimal. The economics of internet/web startups means the capital requirements for each investment are often lower and the best ones get profitable on one or two rounds of investment. That leads many venture capital firms participating in this sector to conclude that they need to build larger portfolios because the investments per portfolio company will be smaller.
When my partner Brad and I started Union Square Ventures back in 2003, we constructed a model portfolio for a $100mm fund. We assumed we'd start with an average investment of $1.5mm to $3mm and that our average investment would be $6-8mm. We thought we would make 12-14 investments. We raised $125mm so the numbers are 25% larger, but we ended up making 21 investments. If we had raised $100mm, we'd have made 17 investments. So over the course of the four year investment period of our first fund, we increased the number of investments we decided was optimal by 30%.
When we planned for our second fund in 2007, we modeled a $150mm fund with 30 investments, an average of $5mm per company, reflecting a further 20% increase in the investments/fund ratio.
There's another factor at work here. All early stage VCs understand that there will be losses/churn in the portfolio. Longtime readers of this blog know that I like to talk about the 1/3, 1/3, 1/3 model in which 1/3 of the investments are wipeouts, 1/3 return capital but are underperformers, and 1/3 are winners that produce all of the returns. When you have an investment flow dynamic where the early rounds require very small amounts of capital but the later rounds in the winners can require a lot of capital (which is very much the case in the internet/web sector), then it behooves you to make lots of small investments, see which ones become the big winners, and then go "all in" on the winners.
There are quite a few experienced VCs making early stage investments in the internet/web sector now. And many of them have developed models that allow them to build and manage larger portfolios. Probably the best example of this is First Round Capital, which got started a year or two after Union Square Ventures but now has over 70 portfolio companies. But there are plenty of other venture capital firms, large and small, new and established, that have figured out that they need to make more smaller earlier investments in the internet/web sector.
The challenge all of this presents is how a VC should allocate his/her time. You can spend the majority of time hunting for deals (planting seeds) or you can spend the majority of your time working with the portfolio companies (tending the crop). Not all of the portfolio companies need a VC's help. Many entrepreneurs are highly self sufficient. That's a good thing. But every entrepreneur can use some help now and then and some need a lot. And the best VCs make it a point to be there when the entrepreneur needs you. And that is time consuming. It's very time consuming if you have ten or more portfolio companies and you make it a point to be a "valued added" VC.
I am "old school" in some things related to the venture business. It's probably because I got my apprenticeship in the mid 80s and have a hard time giving up old habits. One of them is "the portfolio comes first." I was talking to my partners the other day about the best use of our time. We have a great portfolio of companies that have created a lot of value and are poised to create a lot more. If we can spend time helping these great companies become more valuable, will that result in greater returns to us and our investors than doing more deals? Hard to say, but my initial instinct is yes. Again, that's my "old school" training coming into play.
So that's the never ending debate inside the head of a VC. And it is certainly the debate inside my head these days. This doesn't mean that USV is going to do less investing in 2010. And it doesn't mean I am going to do less investing. I spent a fair bit of time recently laying out exactly what I want to invest in this coming year. We generally make 6-8 new investments per year, roughly 2-3 per partner and I expect we'll do that again in 2010.
But it does mean that we will be working a lot with our existing investments this year and we may not be the most aggressive firm out there chasing new deals. That bugs me at times. But I think it's the right choice for us, our investors, and our portfolio companies.
I agree with your “old school philosophy Fred. We should “feed” the children we have before we make more of them.
As an entrepreneur and also as an LP I do no like the “spray and pray” school of VC investing (that is, throw as much spaghetti against the wall as possible and see if anything sticks, versus tending the portfolio)As an entrepreneur, I want investors involved — helping with governance and management and business development and recruitment and PR and M&A etc etc.As an LP, I am constantly being sold on the value-add of the team of GPs, their experience, brains, network, whateverIn theory, thats why VC firms. funds and GPs are paid such huge compensation (in salary alone typically 3x-10X what their portfolio company CEOs earn, plus huge expense accounts, plus carried interest, plus teams of underlings etc)Which isn’t to say funds can’t or shouldn’t practice “spray and pray.” But if they do, the honest thing to do would be to collect much lower fees.
the market sets the compensation of VCssadly it’s a step functionyou raise a fund and get compensated for a long period of timeif you aren’t very good, you don’t raise another fund
In theory the market sets VC comp — but in practice, notHow much varition is there in VC comp? Almost noneIs VC comp tied to performance? Carried interest, in theory. For the lastdecade though, carried interest has accounted for little (in most cases,none) of most VCs compManagement fees are collected based on funds committed, with noaccountability or even transparency how many VC firms submit (or evenshow) operating budgets to their LPs? Only two that I have ever heard of(Greylock and Venrock)Sorry, but saying the “market” has any influence on VC comp is at best aplatitude. The best (worst?) case scenario is, LPs don’t participate in afuture fund, but the first fund is a long done deal which has huge compwithout any governance or transparency for 7-10 yearsAs I’ve said before, if the VC funding and comp structure actually made anysense at all, VCs would use it themselves with their own portfolio companies but they don’t.In fact, they use pretty much the polar opposite structure smallincremental fundings over time, de minimus cash/salary/present valuecompensation plus some performance bonuses plus (theoretically) lucrativelonger term equity comp for operating managementI think the entire entrepreneurship/startup/VC/LP/innovation culture andspectrum would be vastly more healthy if VC GPs did have to submit to marketreviewed comp (as VC portfolio company management team members do)
Interesting look Steven. Jives with my dynamic fund allocation model, failing fast, and supporting winners. There would be a time cost, so the best would suffer, and the worst would be weeded out faster.Now that I think about having liquid fund management as well as liquid business leadership would be pretty Net like. Gotta chew on this one, but it’s certainly deserves consideration. It would destabilize relationships/social structures- might be too much of a strain on founders.
why not mandate that a far larger % of the fund has to come from the GPs?
Wouldn’t that make GPs, who already considered fairly conservative, even more conservative- how do you build into the system enough reason to take risks..
first time VCs can’t do thatsuccessful VCs do that all the timesequoia and KP’s funds have huge allocations to the GPsfunny that the LPs actually get hurt by this
In theory, the market by acting as a weight does do that. The really successful funds are extraordinarily successful and everyone else sucks. You should know by just how much return the fund has done. The problem is that in Year 1-2 the fund could be underwater and 3-7-10 the fund could be out of the water to amazing, just because of how the initial investment works.So how do you measure compensation when you have to manage a fund that you know could potentially be underwater and rise to great returns after that. I mean on some level these are supposed to be S curved shaped funds? No/Yes?Maybe? I mean, what you are betting on is the shape of the S, too flat, that’s bad, too curved may also be bad, may be too much risk and cause loud explosions at the end of the life of the fund causing exit problems and management issues inherent to the risk as defined by the shape of the S and the space defined underneath it.At what point are you compensating? How much risk management do you want to put into the compensation? (That’s essentially what you are asking for…) What should the shape of the fund look like because of the nature of risk here?Just thinking…
Everything you say is true……but all is also true vis a vis portfolio companies.Yet somehow portfolio company boards and vc’s figure out how to properlyalign interests and manage short and long term incentives and haveaccountability and transparency.This is not a complex practical situation. It is a calcified politicalsituation. Until/unless LPs insist on transparency and accountability in GPcomp, it will never happen why would anyone (me included) voluntarily giveup comp?
Unfortunately, part of the problem of this conversation is that you really can’t take the academic geek quirks out of me…. :)The end goal of all social sciences, whether we realize it or not, is to analyze the human factor(s). I’m not one of those people who think, if you look at the history of businesses from a social science perspective across time, that we have managed to solve the incentive alignment problems that come up with boards.And I think its true it’s true with large companies as well…And I think its largely that we’re really only barely getting at the surface of what’s what about people and how they work. And people in groups is a whole other story.I think one of those issues you need to work out, is how is it different for boards, founders and venture capitalists to move information versus LPs and GPs. If you think there is less clear flow, as you are saying, you might want to think of the systems and background causes that create that stock of information. It may not be just the pay (remember in this system, we still want people to take risks) It may be some unknown. It may be that you need to be more diligent, or create more systems to cause diligence to automatically happen and be fed top the LPs.Be aware that you still could shift the risk profile of everyone involved by doing so. Don’t say I didn’t say anything.(FYI, these comments kind of scare me: I’m a total outsider to the deal process. I have no idea how I figured this out…Just goes to show you what commenting does I suppose.)
The VC comp model is the best in the world with only the hedge fund model even being in the same league. And maybe the big time institutional real estate investment fund but here you’re dealing with hard assets which cannot go to zero in value.GPs getting paid for “assets under management” and not being penalized for their own investment decisions while selling the 1/3, 1/3, 1/3 outcome is sheer genius. Being able to put only sweat equity into the deal as your investment is almost a license to steal.Such models often invite the classic “make or buy” approach and dilemma for LPs and thus far very, very few LPs have been able to attract the talent or to offer the compensation to truly attract the folks to enable them to do it themselves.When Charles Schwab revolutionized the stock brokerage business, he really only was able to automate the execution part of the business not the real stock picking. The great stock pickers still get paid for their expertise.If the LPs could find a better deal, they would do it, so in many ways the market has spoken. And the market has the last word.
it’s a tough model. the most successful VCs often take more and more of their fund’s allocations. i can’t get the kinds of returns i am getting from USV anywhere else. i want more of that. but we are not going to increase fund size. we might shrink it. so we crowd out our LPs. it’s tough.
well if you look at the compensation of a given VC over his lifetime as a VC, the market very much sets compensation
That’s a truism I thinkThat’s true of everyone, isn’t it?The whole point of market influence over comp is for comp to be adjusted ifnot frequently, at least regularly, with rewards for excellence andpenalties for poor performance, and rewards for desirable skills andpenalties for obsolesence etcNone of that occurs with VC comp except, as you cite, at the end of a”lifetime” in the business, looking backwardsNo VC would allow their portfolio companies or portfolio operatingmanagement teams to be judged and managed only “over his lifetime” in therole. So, I rest my case.
The market clearly sets GP compensation….unfortunately. But, it’s more complicated than that.There are two parts to GP compensation, one is management fee (generally 2% of AUM) and the other is carried interest on profits (generally 20%). Let’s look at the former (which is really the one that’s out of whack).A firm like Union Square, with two funds under management totaling $275 million, generates ~$5 million in fees annually (operating expenses). There are six employees listed on the web site, so that probably means salaries of $1.2 million ++ to each of the Partners and above average salaries to the other 3 folks.How many CEO’s of Union Square’s portfolio companies make over $1 million a year? In fact, how many CEO’s in the entire United States have a contractual salary (for 5-10 years) of over $1 million? …regardless of performance. Very few, if any.These ridiculously high salaries are completely out of line and, unfortunately, only go up with more assets under management — which is why every new VC fund a firm raises tends to get larger. Union Square went from $125 million to $150 million in their second fund. Does that $25 million increase match inflation? Of course not! It’s hard for a GP to not take more money, because more money means a bigger contractual salary.The reality is that GPs in funds should only make above average compensation if/when their funds generate a return. As is, a 5-10 contractual salary is a “great gig” that no portfolio company CEO can get, so why also pay a GP a salary 5-8x higher than most CEOs.Even hedge funds have to live & die by there performance, annually. If a hedge fund has a terrible year, then they face redemptions, lose there assets under management, and see a reduction in salary. And, very often, see a shut down of their firm. A hedge fund manager can make a lot of money, but only if he/she performs. VCs can make a lot of money without any performance (a big salary for 5-10 years). Not that it’s easy to raise a fund, but it’s not easy to build a successful company either so why should one get exponentially better compensated?I can’t imagine anyone would argue with this…. So, Steven, as an LP, it’s up to you focus on management fee when you “plant your seeds” and negotiate reasonable terms. Even with all that’s happened over the past decade, he LP industry hasn’t taken the reins and still lets GPs dictate terms; seems like an odd arrangement if you ask me.
I am a miniscule LP, usually in small “side by side” friends-of-the-firmfunds, so I have no leverage regarding fund fees and structuresA lot of LPs are voting with their feet these days aggregate VC fundraising is shrinking fast due to a decade of poor performance by VC assetclass. So some funds/firms/GPs are disappearing. But the basic fee structurehas not changed to my knowledge. The situation you describe continues, justin a smaller universe of funds and GPs.And now that we are in 2010, the last big fat bubble year (1999) will fallout of 10-year return calculations, meaning the sad state of affairs will bestarker and more readily apparant to LPs looking at history. So if thedownsized industry doesn’t create returns and relatively quikcly, maybe,just maybe, the basic ridiculous fee/comp structure will get reset.Always amusing how VC GPs preach the virtues “creative destruction” forevery business model…except their own…
In many ways the compensation structure of VC funds followed the structure of large institutional real estate investments (not usually in the form of a fund but in the form of a simple Limited Partnership) made by insurance companies and pension funds.This is because as an diversification of typical stock and bond funds, real estate was an asset class which was added well before VC funds were added to the acceptable mix of fiduciary funds. The allocation to real estate has typically tracked at 3x VC or another way to look at is that VC has been 33% of real estate.As an asset class, real estate cannot really go to zero. Not true with VC funds which is why it took so long to add VC funds to the mix.Typical real estate institutional LP looks like this:Developer/GP finds appropriate deal and pitches it to the pension fund/insurance company world. This is a tough club to break into but it is a club. And a small one.LP puts up all the cash required (including any contingency funds), developer/GP puts up nothing — other than some contractual hold on the deal under consideration which may have cost some considerable money to tie up the land or to obtain tenants for the project.LP is entitled to a 6-10% preferred cumulative return on investment plus 50% of all profits.Developer/GP is paid property management fee of 4-5% of the gross income of the property which is actually passed along to the tenants in a NNN leased property plus 50% of the profits.In addition, since most pension fund investors are not taxpayers the developer/GP used to get a “special allocation” of the tax benefits (interest expense, depreciation, operating losses). Still generally happens but is through the active v passive partner allocation.The odd developer/GP is able to get a 1% AUM fee if they are also a RIA (registered investment advisor) though this causes conflict problems.They key to success in the institutional real estate world is to “be in the club” — go to lots of pension fund seminars — and to spend a lot of time on the road talking to pension funds/insurance companies.The critical operating parameter is great reporting. Timely and perfect reports which pension fund execs can send around to their colleagues is the key to internal recognition and success. Plus lots of great building pictures, investment tombstones and signing pens.
Love the analogy and underlying philosophy. I’ll go with your gut and add:You don’t teach your kid to ride a bike in a day.
Fred love the fact the lessons you talk about transfer. We have the same issue as an umbrella organization for indie content productions. This is a great post. We don’t necessarily put $ into anyone…but we do introduce $ and invest time and work. We look at lots of content creators, and our own initial interest and logic bring many to our table and phones…but we tend to not put much into a new production unless our passion leads us there, ..as people who have passion which was shaped by the field and our personal lives to be honest. I guess we have less “numbers” to lead us, as content is more of an art.. ..but only a bit “more of an art” I think
i’ve often thought that VC and entertainment have a lot in common
all sculpture, beauty and effectiveness…have to say I am learning that similarity
for sure boss
Great post. Not only are the investment requirements smaller for early stage Web startups, but the high quality startups want more then just money from a VC-they do value the help, access to the partners, etc. and they certainly don’t want to feel like a small chip has been bet only to be showered with attention when they show traction. So, I think you guys are doing it right. Striking a balance between the new economics of VC investing in this space, but also being true to building authentic relationships and being there for your portfolio companies when they need you. Bravo.
Fred, gotta say I’m pretty stoked about seeing your views on this one. It’s hard not to respect an open look into a sharp investors head, that’s $$. There’s certainly lower upfront costs with Net startups now, compared to even a few years ago. So investing in more is feasible, but it would require growing a VC partnership to match the bigger portfolio at least in terms of reviewing/filtering candidates. For mistimed/unfeasible businesses, the faster startups fail the better for all involved. This goes with the “histogram” of 1/3, 1/3, 1/3. Does it makes sense to shift those curves to more failures that cost less per investment to ensure more big returns? Hypothetical case, you can invest in 100 startups of which 10 are big returns, or you can invest in 10 startups where only 3 are big returns. I understand “spray and pray” is not USV fund philosophy, but I wonder if funds like this may perform better over the next 5-10 years as the cost to fail drops.*edit* the funds that are upfront to their founders about failing fast can close down an investment funnel as rapidly as the tap is started. Ownership /vesting happens over time as the startup grows. In this way startups can end the invesment early if they are doing well.The organic analogy of tree branches and leaves competing for light seems fitting here. If they’re getting light, more resources divert to support the branch growth. Unlit branches wither remorselessly or simply freeze growth (market saturation). It’s a lot more complicated, trees learn about their environment and have some ability to predict best trunk locations.
the good thing is we will find out
I think a slightly differntly paradigm. organic versus intensive farming. Or how much management we’re talking here and how this shapes risk.We talk about management- but how management is neccessary before everything goes awry, and how much is actually good? In some ways, you are letting go when you use organic farming methods, but they tend to cause the overall earth to be better over the long term…In some ways it requires more management, not less. In some ways it requires more throwing at the wall, in some ways less.I keep thinking that might be the ideal here, and that’s why you see the 3-3-3 ratios. You can only control certain things, and only know certain facts. Rain ends up being from God…
Fred – love this post as I think it relates to all things business (as well as many aspects of life). Do I focus on new business or foster existing clients? Do I make more connections or cherish the ones I have? Do I need more or am I okay with less? I think we can all relate to having this debate inside our heads.What I love about you and what you’re saying in this post is that while your “old school” approach may not be the most aggressive, it leads from the heart. In the end, I think your approach will prevail and be much more sustainable.I also firmly believe that internal experience = external experience. Or rather, how you tend the crop has a direct correlation with how well you’ll plant seeds. I would think that by tending the crop, you’ll gain far more meaningful insights and knowledge than the other firms out there merely chasing new deals. But maybe that’s the “old school” in this Gen-Y gal. :)Thanks for the insightful post this morning!
great insight that tending the crop makes you a better seed planteri love thatthanks
I don’t want to put words in your mouth but when you ask what’s more important aren’t you really just prioritizing what’s more important to you – clients or the management teams you back?
our clients are the management teams we back
also the good job you do of tending the crop attracts seeds. That’s why we are all on this blog and listening to you and in a discussion with you because you have grown good crops.
more fair to say identify and help people that can grow good crops
you’re being modest. someone who picks good horses is lucky and a gambler.do you think you are a lucky gambler?
Fred, your decision making process and almost all others listed here were PREDICTED IN THE FIRST MaTH FORMULA to describe human behavior.Huygens formula basically predicts that a gambler will risk X% of their current wealth inversely to the size of that wealth.Thus,if you as gambler look at your current pofrolio and see that none have worked out and none hava a good chance to do so in the future, then you would likely concentrate on investing all your remaining money in other start ups, looking for a hail mary homerun.As it stands now, you look at your porfolio and see a lot of wealth and your priority becomes protecting that wealth, as opposed to investing alot in other start ups.
hmm. that’s an interesting way to look at it. but it doesn’t explain why we end up spending the vast majority of our portfolio time on the middle third.
Yea, Huygens formula isn’t perfect of course ( and i may not have summarized it correctly), but it is a framework that pretty much encompasses anyone’s risk making decisions and all the different points of view expressed in the comment
Your point about sustainability is a good one. Although it could be debated whether tending to the crop or planting seeds yields better financial returns over the life of a fund, I would argue that the intangible benefits of successful crop-tending (specifically the relationships developed and the knowledge/experience an entrepreneur gains from working closely with a VC) add to the value of that approach.At the end of the day, the most valuable capital a business has is its people, and I’m a believer that long-term strategies like crop-tending foster more intellectual/relationship capital that can be re-invested at a later point in time (which gets to your point about it making you a better seed planter).
Chris – very well said. Nice add with your point about the people. Your comment inspired me to think of how social technologies play into all of this… your point that “crop-tending foster more intellectual/relationship capital that can be re-invested at a later point in time” – this is what the internet helps us do better, faster and more easily than ever before. The benefits too are often intangible. Our shift from web 1.0 to web 2.0 has impacted every aspect of how we live and communicate. We use the internet and social technologies like twitter, foursquare, facebook, etc. to solve the problem of keeping in touch, crop-tending, knowledge sharing, etc. How can we solve this same problem, at scale, for business?
funny that crop tending is the activity that generates the most rewards in farmville, one of the most popular social apps
ha! great call.
yes, that is very much so
While I’m not going to go so far as to suggest that your transparency hands your competitors a silver platter, and I know nothing on God’s green earth would convince you to stop writing, it does seem like this blog may have had some role in creating a more competitive environment for your firm. Ultimately, of course, reading and thinking about something is not the same as doing it. I always take evangelical Christianity as an example when thinking about celebrity influence. The born-again can study, sing about, and praise Jesus’ teachings all day long, but that doesn’t make them able to replicate his character or even his good deeds.
Ehhh….if a competitor VC firm wants to know what USV is investing in, planning to invest in and all of the other supposedly secret details, I’m guessing they’d have to go no further than a 20 minute meeting and the paperwork associated with becoming an investor in the fund.In fact, I’m pretty sure that Fred’s openness is really just bringing him more quality deal-flow and even helping to filter it down to more manageable levels. I know when I start another business, USV will be on a very short list.
LOL I always like to imagine a world where everyone has the mentality of a sports star. Car safely into the parking spot? Kiss hands and point skyward. Boss congratulates you on closing a sale? Thank Jesus Christ for your ability.
That is part of the fun of a Celtics game, no doubt. 🙂
I am undoubtedly the least qualified person on the planet to comment upon anything religious (though as a disclaimer I was educated by Sisters of Charity, Mercy and the Christian Brothers and then went to a military school which was easier by comparison?) but I will offer:what one reads about one thinks about;what one thinks about one speaks of;what one speaks of is often translated into action;one’s actions define one’s character; and,in the end, our character defines us.So, I agree with you completely that it is the deeds which are important, all the rest is just preparation.I am personally suspicious of people who wear their religion on their lapel. It makes me feel very uncomfortable but I am very fond of people whose religion or spirituality immediately translates into good works.I was at a chi chi Christmas Dance which is quite the social gathering and is by exclusive invitation and vote of the membership. Just the kind of snotty social gathering that I personally hate. I was visiting with several of my friends and Ben Crenshaw, the golfer. Who is every bit as nice as he seems to be. [We did not talk about Tiger, it was Christmas after all.]He said that his family had stopped giving any Christmas gifts and was making a contribution to the Wounded Warrior project instead. Several other folks made the same comment. It inspired me.
That is inspiring, about the charitable donations.(I was amused by how many Tiger Woods conversations I had at holiday parties, though, I must say! People were very seriously engaged with the phenomenon.)
A Univ of TX marketing prof is going to offer a course this summer on the “unbranding” of the Cheetah. He has developed a complete rant about the total destruction of the Brand Tiger and its implications for the underlying stock value of the companies with whom he had endorsement contracts.The entire Tiger saga is very, very, very sad on so many different levels. I must say that my disappointment is very personal as I loved his life story and work ethic. Guys are just so stupid. We should all get help.
i would humbly challenge the 3rd step
yep, but for non politicians. otherwise “rarely”?
Agreed. I must say that the current administration making me feel like a $2 whore. Used, abused.
“beware too pious a man”
Pretty short list these days, no?
Cool. Secular philanthropy.
70 portfolio companies is one hell of a responsibility for any VC partnership, I wonder how USV can support such a large portfolio? You posted two options Fred, #1 focus on supporting existing companies (but still continue to invest) or #2 carry on investing as before. Is there not a third option?; #3 Hire some associates to assist with both?If I had to choose between #1 and #2 I would go for #1 (focus on additional support for the portfolio). Especially if the exit market (IPOs and trade sales) is weak. Otherwise your number of exits won’t match your number of new investments and you’ll spread yourself too thin. As you intend to continue investing with #1 I don’t see any downside apart from investing in 6-8, versus perhaps 8-10 new companies.
fyi: it’s First Round that has 70 portfolio companies.
Thanks Reece, do you know the number of companies in the USV portfolio by chance? I wonder what the max point is for a firm? Some ratio per partner? Not exactly a scientific formula I’m sure, but there’s got to be some point where a VC firm reaches full capacity? I guess if they still have capital they need to put into action they’ll do so even if this means being overstretched, but I expect Fred and USV wouldn’t do that.
Fred mentions between 20 and 30 per fund. (Edit: thats investments, not active)
How did you do that? That was really cool…
Now I need to find a way to record that. That’s just way too irresistible for something you clearly shouldn’t be googling…
And I think Fred has laid out their partner averages pretty well in theabove post.You should read it. 😉
oh snap. that is literally the coolest thing i’ve seen all morning. but it’s 7:19am. still very cool reece
Yeah it’s early, but I’m more and more convinced that you don’t sleep anyway.
just to be clear, we don’t have 70 portfolio companies. we have 30.as for associates, we have two. and they are amazing. we could not do what we do without them.but i believe in a partner driven model.we have three partners and two associates.entrepreneurs want to work with partners for the most part, so that’s what we need more of
Totally agree with you about Entrepreneurs wanting to work with partners. 30 companies seems to me like a manageable number but still quite a lot. And I would think supporting early stage companies requires a significant amount of time and resource versus growth companies.
Fred,The two functions don’t have to be mutually exclusive. I think that’s what you’re getting at in the conclusion of the post. By being active at both ends of the spectrum, don’t you succeed in making the whole stronger? In assisting your portfolio companies during their growth phases, you keep the flywheel moving at a quick pace. You give of your knowledge and experience to ensure that these companies reach the full potential that you saw when they first pitched you.Keeping to your farming anology, tending to the crop includes ensuring that the soil is as fertile as can be for when you have to turn the crop over. In paying equal attention to your crops and the health of your farm’s core foundation (its soil), you give yourself the best chance not just for sustainability, but for significant growth.Wouldn’t you agree that staying active at the seedling stage of the startup industry leads you to find companies and answers that can strenghten your existing portfolio? Both seedlings and later stage companies can exist together, and support one another, to achieve the greatest good for the whole.
yes, but it gets harder and harder the larger your portfolio gets. you must do both. you cannot take yourself out of the market for new deals
The sales analogy is “it’s easier to sell more to your existing customers.”In this case, “sell” = “provide more value.”The more value you provide to your existing customers, the more dominant you become in your existing market which will bring in leads to new customers/markets on its own.
IMHO VCs need to focus more on connecting their portfolio investments, and looking for investments that they will be able to integrate into their portfolio. when pursued fully, i think this will lead to smaller investments, faster returns (more like public markets), and much greater scalability of both dollars and time.of course, the real problem is there is no more venture capitalism, only venture fascism. all these conversations are fairly irrelevant/meaningless until that is addressed directly.
venture fascism – explain?
fascism = merger of corporations and state. venture fascism = investing in the private equity/startup part of that system. USV’s investment in AMEE is my favorite example of a fascist investment, as that is a market legislated into existence by carbon tax laws (which end up being lobbied for by carbon/green companies….and are completely unnecessary to solving any environmental issue). as govt gets bigger and bigger, it basically makes the entire economy centrally planned, which means capitalism basically doesn’t exist; wealth goes where govt says it goes. we’ll still have investors and public markets in this environment, but it’s a fundamentally fascist system. so it’s more like venture fascism.
“economic fascism” is a strong term, but you explained it well. One have to agree that the larger the gov part in the GDP, the less wealth goes to skill and efficiency. However, the corporate had a fair chance to fill this gap for half a century and completely failed. The US is much better in those criteria, isn’t it? But the principle (although i’m not sure the application in carbon tax or VC investing) is clear. It’s a definitely something to worry about.
Truer words were never spoken.Who caused the recent financial melt down? Ahh, Wall Street sure had a big hand in things.Who get healthy first — Main St or Wall St? Ahh, Wall Street.But, President Obama fussed at them and then slapped them all with a check book. Which is like waterboarding for investment bankers, no?There is no question that government is picking the winners even when they can’t, can’t, can’t win — a la GM.
unless of course if you are wrong about carbon and i think you are
lol, well boss you were the one who said you didn’t want to talk about a carbon tax, only that you were in favor of it, lol. how about we do a two part series here on AVC: you go pro carbon tax, then i’ll explain why it’s a bad idea. don’t worry, the people want to be ignorant, so it doesn’t matter how much truth i drop (i been kooking for years now, they’re still willfully ignorant), nor how little truth you have on your side.
i agree and we are doing a lot of that right now. in fact yesterday we had many of the sales/BD/marketing folks in our portfolio together for a meetup over lunch. that is one of the ways we can scale
I think it was Norm Brodsky who said “focus and discipline are more important than identifying opportunities, but they have to be balanced with flexibility”, I subscribe to this philosophy.
I’d love to hear about how the VC time investments relate to each of the 1/3, 1/3, 1/3 groups – common sense probably leads you to believe that there is a very direct correlation.I also suspect that big winners don’t need the type of help that takes loads of time and the washouts do. Which also leads me to believe that the middle 1/3 is where most of the debate arises.Finally, obvious upon actual investment events an investor is making a decision about further commitment – both time and money. I wonder how often, other than continuously, an investor is making an interim performance evaluation and subsequently an explicit decision about making additional time investments.
yes, i mentioned this in another part of this thread. we spend most of our time on the middle third
I would imagine you have a certain gut feel about your portfolio allowing you to bucket each of your investments. Perhaps you’re gut is just telling you that you have several high-potential deals in the “fund maker” category and you need to focus on those as 2010 could be a defining year for them.
that was the conversation i referred to in my post
It seems that the fewer portfolio companies you have, the fewer the demands on your time will be. Given your 1/3, 1/3, 1/3 model, what would be the smallest number of companies you’d feel comfortable having in a portfolio to give your fund a good shot at producing positive returns?
For the type of people writing on this blog, demands expand to consume all of your time regardless of what you do. And, then, you die.
Hmm, why do you do say that? And it sounds awfully existentialist of you.
Sounds like perspective to me, Shana. 🙂
I don’t have that perspective and I doubt I will.
It sounds like they are close to the minimum, if you think about it…
i think VCs need at least a dozen, but 15-20 seems ideal
Fred, you work from the heart as this post shows. I would venture a guess that you tend to choose investments that you can add operational value to. We all do what we are good at. Good thing for your portfolio companies and your investors.
yes, i turn down good deals all the time saying “there’s a better VC out there for this deal than me”
Your considerations assume that your capacity stays the same. And although I am also convinced that small and nimble VC firms (and funds) are better than larger ones, I think that an effective way to increase the size of your crop is to spend some time training good farmers.Transferring your and your partners’ experience to younger partners is important for many reasons: social, financial, personal, etc..I am sure you’re doing it already but it doesn’t seem to be taken into account in the post. Carefully selected and trained juniors can become a huge asset and if the process is managed at the right pace you needn’t worry about the obvious challenges of a growing business.
yeah but it’s hard. the most dangerous person to the financial returns of a firm is a young inexperienced VC. john doerr has a great quote on this. he says you have to lose $30mm to become an experienced VC. i prefer to recruit experienced VCs to join our firm than to take that hit. that said, there are always exceptions to any rule.
Speaking from the other side, judging from the 12 VCs I had in my boards since 2000To become a GOOD experienced VC you have to1. Understand you are accountable to the losses as well as the gains2, Understand the companies have to come first before the petty VC math, or else the petty VC math looses.3. Understand it’s impossible to micro manage the companies, even though you can force the CEO to take a decision.4. Have a big enough rolodex to help in HR marketing and buis dev.Loosing $30mm is one way of learning that, not the only way.
My point was less about the junior vs senior practitioner and more about carefully increasing your capacity as a firm by finding or forming professionals that share the same values you and your partners have.And in my experience forming is easier than finding. Although nobody has lost me (or made me) $30m yet.
Interesting post, glad you answered my question from 4 weeks ago (comment on post “action oriented”) in such details :-)There’s an equivalent dilemma on the entrepreneur side: should we pursue small opportunities that can be quickly acquired or should we go for something larger, riskier, that will take longer?These days it’s inexpensive and fast to build something that’s more like a feature than a business. A good example is xoopit, which in essence was just a feature to add to webmails (to organize attached photos) and got acquired by yahoo supposedly for $20M. Not bad for the founders (and not great but presumably OK for the VCs). Building a real company like sugarCRM takes much longer yet it’s about as risky, with a much larger potential payoff.The VC dilemma is how to spend time among parallel opportunities, the entrepreneur how to spend time among sequential opportunities, but they have a common root: the lower cost/faster pace of product-creation.
I feel as if this is much the same conversation I was having a friend and fellow entrepreneur last Friday night. The spin on it is that he was looking at it from a business starting point of view rather than an investment one. He believes that if he starts a lot of companies and gets the MVP (Minimum Viable Product… concept of lean startups) done for each of them and then throws up a website to promote it, one of them will catch on by itself. When it does, he’d bring his focus back to that idea and grow it. This is comparable to your seeding the field point of view and one that I feel that by itself is like throwing ideas at a wall to see which one sticks. It hasn’t worked for him thus far.My feeling is (and I told him this) that its a better idea to choose an idea that you really believe in and have a passion for and then giving everything you’ve got to it for a set period of time. This would be your concept tending the crops. Tending to the crops allows you to try different things to make the crop grow and flourish (different execution, different marketing, etc). Over time, you often learn how to manage that type of crop (type of company) better. The key though, is to recognize when it just isn’t going to work and its time to move on, something that’s hard to do.As a VC, it seems that you would definitely need a good balance of both to allow you to diversify while also tending well to the crops you have. And when/if your farm gets to big, perhaps the best way to deal is to hire more farm hands.
but not everything scales. it’s like a gourmet restaurant
They have a large issue surrounding them in that they are a high demand firm for companies that want funding and they are comparatively tiny. They could make themselves into something slightly larger, but I don’t think that is the sweet spot: It probably is something really small or really large.It may be though that the balance of power may shift to really large. PE, their closest equivalent, used to be really tiny. Now a lot of the major players are huge. It is surprising in some ways and not surprising in others that USV is able to do what they do on a comparably small fund.
one of our secret weapons is our size. small is the new big.
Agility is the new in thing.
Trouble is, a lot of small companies want nothing more than to be, erm, ‘big’ as a measure of success. That’s the irony, lol.
There is a “sweet spot” for the size of companies in which the product, competition, talent of the management and financial results are in equilibrium. It may be a dynamic and moving equilibrium.Inexperienced business folks do not recognize this phenomenon and strive for “bigness” as its own reward. I think it would be fair to say that Fred is telling the story of his sweet spot. He likes what he is doing, he can captain his own ship, he has some unique advantages which attract business and the financial rewards are excellent. He is in the sweet spot.It is at this juncture in time that you have to ask yourself — am I “running a deal”, building a great company or operating for distributable cash flow. It also depends upon who owns the company and what their motivations truly are.The focus on creating a “liquidity event” seems to obscure the opportunity of building a sustainable company which provides a stable cash flow. I am not criticizing this as individual entrepreneurs are quite right to create wealth as the market provides the opportunity.Great companies and stable cash flow are not given enough consideration. Oil and real estate provide the opportunity and operating companies can do the same thing.
Interesting …A concern I have had for a few years now has been witnessing the approach of: “Let’s invest in ‘xx’ startups. throw some money at them for a while, and hopefully ‘x’ will do OK and ‘x’ will be a success so we’ll come out ahead- doesn’t really matter if the rest fail.” – to my untrained eye this imbibes a spirit that lacks good old business fundamentals, P+L, etc – some VCs who want to be active in ‘hot’ sectors (at any cost) seem to take this approach and lose sight of the fundamentals, at times.Am I being too simplistic/harsh, Fred?
nope. very observant as usual.
That is the big difference between VC’s and Angels. Cash works the same no matter where it comes from, but it’s the effort and expertise behind the cash that makes the difference.
The ideas seem to be mixing now
When i saw the title i thought “another Farmville post”. The simple solution would be to heavily increase the wipeouts ratio :D. Fred, if it’s possible to reveal, when you invest 6-8 a year, how many runners-up, I mean real alternatives are there? BTW I always wondered why not go to the other extreme side: spread some 25K$ for many prominent companies provided they have a working launched product + an option for further investment in agreed terms. Even if the winners rate here is 10 times lower, you can get 3.3 winners for 2.5M$, instead of 0.33 winner for the same amount in traditional investment (25K$ * 100 = 2.5M$ * 3.3% = 3.3 winners,plus the following investment)? Or i have a real stupid mistake here?
the really big winners end up requiring significant capital when they scale. we want to be able to provide that too.
I have always appreciated VCs who actually know what they want to invest in. I never understood why less successful VCs would never take the time to build even a shred of a thesis and then target appropriate deals.One of my favourite questions is “all things being equal, what 5 deals would you do tomorrow if they walked in the door?”. Occasionally the VC will reach for their BB and say “well, I have 10”,. but more often they “hem and haw” and start naming generic industries.In the absence of that focus, I think it would be hard to properly allocate time because you would always be looking at everything that comes through the door, which leaves less time to think about existing portfolio companies as well as new opportunities that are aligned to the VCs capability.Know your limits and use them to your advantage.
I agree with Jevon that just as there can be an issue of ‘focus’ with a business, the same applies to a VC. Understand what niche you are filling and continually innovating with a clear understanding (opinion) of where you want to participate and where you do not allows folks raising money and the VC the ability to not waste each others time. Additionally it allows the VC to go deeper in a particular sector or sector of a sector so they can optimize the contribution they are able to make to their portfolio companies with a deep rooted knowledge of a much smaller space. Over time the focus of new investments and the expertise they staff with evolve with the market and like any good entrepreneur the good VC’s will see where markets are going and steer their funds in the appropriate direction.
In Sales, we talk about “Hunters vs. Farmers“, which is a similar analogy. The assumption is that the skills required for getting an account are different than helping it to grow. But obviously, you need more people to have this clear separation of duties. Does this model apply to the VC world perhaps in larger firms where some VC’s are focused on getting deals whereas others on growing/managing the existing portfolio or is the norm that VC’s are inherently both farmers and hunters?
nah. the best VCs are excellent at hunting and farming at the same time
as are the best sales folks… I was thinking about the similarity in success factors for sales as you outline in your model for VC’s – the most successful sales execs make sure their existing customers are well taken care of, move their existing pipeline of prospects to closure, and always are on the lookout for new opportunities. I’ve always tried to manage the 1/3, 1/3, 1/3 mix for these three items that you suggest you use for managing your efforts.
My grandpa Rock started a farm at the age of 23 with $2200 cash from pumping gas, fixing cars and hustling in Detroit. 70 years later, he died on that farm…which had grown to thousands of acres and yielded more food than his younger self could have ever imagined.How? “I bought land from guys that planted more seeds than they could sow.”
I have a “little” ranch and I only have a small desire — to own all the land that abuts mine.
Hey, careful – that’s how wars start … 😉
sounds like a amazing person
I like your thinking – shareholders first. Do you think you are more inclined to manage your portfolio based on the economic conditions (lack of exits)? What if our economy was booming – would you still put out this blog?
Totally unrelated, but something that might be of interest…An internet company that sells open source hardware – Sparkfun – had a “free” day today. That is, anyone could log onto their site and checkout with $100 worth of electronics for free, no strings attached (for an aggregate total of $100,000 at which point they start charging again).The idea by itself is pretty cool, a way to reward loyal customers. But what I find even more interesting is that today at 9 am (MST) when their store opened, (their site crashed, no surprise), they were the 3rd most popular Google search term. Pretty incredible for a relatively niche open source hardware vendor.http://twitpic.com/x2alwGood luck googling them today, but their website is http://www.sparkfun.com
There is a hilarious Tiger Woods joke in here somewhere.
I would think that you’d have more Andrew’s in your firm — a couple consultants that just work with your existing portfolio mainly, coming up with ideas, making the right connections for them, working some bizdev between your portfolio companies, etc … meanwhile still having some guys just doing due diligence on new deals. The VC is money, but more so the connections they can lay out — and if you also have some inhouse consultants that can help entrepreneurs, it seems like that’d be a help for these small startups..? [Th inhouse consultants could help you tend your crop better?]
there aren’t more andrews. at least not that i know of. he’s one of a kind.
There is a fine line between planting lots of seeds (spray and pray) and the “drive by” venture capital we saw during the bubble.Personally, I think many entrepreneurs would be fine with small amounts of money and attention if it didn’t come with the onerous terms that most Preferred Stock has. A little money/attention should get you a little control.
our terms are not onerous. i’ll defend them against anyone anytime of the day
I didn’t mean to imply that they were. I think most Preferred terms are onerous if they don’t come with an engaged, value-adding, VC partner. What I was trying to say is that having a ton of small bets means lots of boards per partner (more than USV today). There is no way the engagement level or value add would be the same. Personally, I think a “spray it around, lower value add” model should have a quid-pro-qou in the terms.
it might be a personality thing too. Mark Suster talks about his weakness of seeing things to completion and getting others to do that for him. You might be one of those people who are more content in that sort of way.
I have two marginally related thoughts as it relates to this subject. One is to never, ever, ever disregard a style with which you are personally comfortable. I believe that a small well run and experienced VC partnership with a slim overhead and a $250MM asset base is a very efficient size and is able to provide a sweet spot for compensation and overhead. It costs less than $1MM to run and the partners are well paid for their trouble being able to keep the balance of the fees.Conversely, there is an opportunity for a fairly large VC firm to develop a depth of services — “best practices” types of guidance to portfolio companies; CEOs in waiting for home grown deals; complementary layered and specialized internal skills; sharp edged cookie cutter exit strategy blueprints in place, etc — which allows the larger firms to manage gobs of money but makes the very running of the firm a business unto itself.What I think today may be the greatest “value add” is the ability for a VC to be an effective coach and mentor to the entrepreneurs and managers with whom they invest. This is a huge value and is quite personal rather than institutonal. Would you want to have Warren Buffett and Charlie Munger as your coach?As the world goes on, VCs become more experienced, canny and shrewd about people capital while the first time entrepreneurs stay about the same age. The effectiveness of the coaching therefore becomes more valuable as the VC become just that more seasoned and capable.You never really see or know everything but you soon learn to handle Airedale puppies and young bright motivated and inexperienced entrepreneurs. And, the really smart ones appreciate it.
i agree JLM, there are two models that work. the boutique model (our model) and the scale model. anything in the middle struggles
I would argue that the two are not unrelated. VCs that spend time being helpful to their portfolios build better reputations among entrepreneurs. In turn, that better reputation leads to higher quality deal opportunities.
I think the big missing aspect of this discussion is levels of engagement.I think it’s a misnomer to say we have 70 portfolio companies in the same way that you have 25 or so.You’re active on all of your investments over the life of the deal, but we leverage our later stage partners, because we don’t feel, given our skillset, that we can add the same kind of value three years in that we add in the first 12 months.So, we’re spending a lot of time in the first 12 months to help the company get on its feet, often with initial investments of less than 500k, and help get them to a larger venture round. When that happens, and we get a VC on our board from a Redpoint, Sequoia, or someone like you, we tend to go into more of an observer role.So don’t think that we’re still going to board meetings for 70 companies. That would be pretty nuts. I think you’ll find that there’s no difference between the kind of engagement that First Round has with its companies in the first 12-18 months that USV does. In a sense, you can think of us more like an angel investor. I certainly wouldn’t fault angel investors for not being as active in a company three years in, because they have great institutional partners with much larger ownership chunks in support of the company.
Thanks, me too.
nope. we all do it all.