Posts from VC & Technology

There are many different styles of investing. At USV, we choose to be thesis-driven investors. This is our current thesis.

When an opportunity shows up that is right down the middle of our strike zone, we generally jump on it.

It really helps to know what you are looking for.

I told this story yesterday to Rebecca as we were talking about a current opportunity that fits our current thesis like a glove:

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When Brad and I were raising the first USV fund in 2003 and 2004, we spent most of our time on the road, pitching investors to invest in our fund.

On the road, we would talk a lot about what we would invest in once the fund was closed.

We wanted to invest in the applications layer of the Internet and we were seeing search and social turning into interesting opportunities.

One day Brad said to me “What if job listings worked like search? Instead of posting your jobs to a site like Monster, you just post them to your company website and buy traffic to them?”

Brad has always been fascinated by business model disruption and the power of moving to a new model.

We thought about it and talked about it a fair bit and concluded that if something that looked like that showed up, we would jump on it.

Right after we held our first closing of USV 2004 (which happened in November 2004), I read this blog post on my friend John Battelle‘s blog.

John was writing his book on Google at the time and was obsessed with the search business.

I ran into Brad’s office and said “your search engine for jobs is here, it is called Indeed.” I showed him John’s post.

So we reached out to Paul and Rony, the Indeed founders, and told them we wanted to invest in Indeed.

They weren’t so sure about that. They were self-funding Indeed after selling their previous company and did not need our money.

But we kept after them and eventually, in the fall of 2005, we did invest.

I wrote this blog post on usv.com explaining why we invested in Indeed.

The rest is history. Indeed was possibly the best company we ever invested in at USV.

There have been bigger returns as Indeed chose to sell to Recruit instead of staying independent and going public.

Had they done that, I bet they would be worth north of $10bn now and we owned a lot of it.

But that’s another story.

This one is about knowing what you are looking for and jumping on it when you see it.

It is usually a recipe for success.

I’ve been interviewed many times and while interviews are OK, what I enjoy a lot more are public conversations between two people.

Listening to two people talking as friends and peers is more enlightening to me.

My friend Chris Dixon was in NYC a few weeks ago and he came by my office and we talked about stuff for about an hour.

I told him it would be fun to do the same thing but record it and put it up online.

So I went over to the A16Z offices in NYC a few days later and we did that.

And this is an hour-long conversation between the two of us about what we are thinking about right now.

I hope you enjoy it.

Today is Labor Day in the US. It is a day to celebrate labor, the union movement, and the role of the worker in our economy and our society.

I have always struggled with the idea that labor and capital are intrinsically opposed to each other.

It is obvious that workers have been taken advantage of by employers since the dawn of an industrialized society and possibly/probably for much longer than that.

But does it have to be that way?

In the tech sector, we typically issue between 15% and 25% of the company’s stock to the employees and we keep granting this equity as the company grows and expands.

And it is also the case that the tech sector is largely a non-unionized industry.

There are large portions of a tech company’s workforce that are in short supply, most notably software engineers and other technical positions where demand outstrips supply and has for as long as I have been working in this sector.

So there are things about the tech sector that are different from other large industries and I’ve always felt that human capital (as we like to call the people in the tech sector) is more valued in tech companies than traditional industries.

But when a tech company stumbles and starts bleeding cash, one of the first things to go is headcount.

Capital demands that a company have a profitable outlook or it will not flow to a company.

So there are fundamental economic realities that put capital and labor in opposition to each other at times.

But both capital and labor want sustainable companies that grow and prosper.

So it can be the case that labor and capital work together and succeed together.

And that has largely been the case in my career in the tech sector and I enjoy that feeling of shared success.

The Economist has a cover story this week called Peak Valley.

The article suggests that Silicon Valley’s lead as a hub for innovation has peaked and other regions are rising. It ends with the concern that innovation more broadly has peaked.

I somewhat agree with “the rise of elsewhere” narrative and disagree that innovation has peaked.

Our experience at USV has been that we can and do find high impact startups to invest in outside of Silicon Valley but that we find just as many in Silicon Valley.

In our first four funds spanning the vintage years of 2004-2014, we have had twelve very high impact startup investments. Seven of them were from outside of Silicon Valley and five were from Silicon Valley. The seven outside of Silicon Valley came from NYC (four), Pittsburgh, London, and Austin. Each of the funds we raised and invested during that period have had at least one high impact investment in Silicon Valley and at least one outside of Silicon Valley.

But our data set is small. We made investments in a total of sixty to seventy startup companies in that period. And we don’t invest in Asia, South Asia, Africa, The Middle East, and Latin America so we don’t touch large swaths of the area outside of Silicon Valley. And we are based in NYC so we have a home-court advantage there.

My point is that it has always been possible to build a high impact startup outside of Silicon Valley and invest in it too. But if we were to stop looking for investments in Silicon Valley, our opportunity set would be significantly reduced.

What is true is that Silicon Valley has gotten extremely expensive to operate in. We see that across many dimensions. Valuations of startups in Silicon Valley are significantly higher than outside of Silicon Valley. Cash compensation for employees is significantly higher in Silicon Valley than outside of Silicon Valley. Equity compensation for employees is significantly higher in Silicon Valley than outside of Silicon Valley. And the cost of living for employees in Silicon Valley is much higher than outside of Silicon Valley.

All of that means that capital (both human capital and invested capital) needs to achieve a much higher return on input in Silicon Valley than outside of Silicon Valley, all things being equal. I am not sure all things are equal though and that is really the rub.

Silicon Valley has always had one important advantage over other regions when it comes to the tech sector. There is a much higher density of talent, capital, employment opportunity, and basic research in Silicon Valley versus other locations. When I say density, I mean physical density. If you walked a mile, how many tech companies would you pass along the way? That metric in Silicon Valley has always been higher than elsewhere and still is. So even though the return on capital (human and invested) has significant headwinds in today’s Silicon Valley, it is still a lot easier to deploy that capital there. And I think that will continue to be the case for a long time to come.

The Economist piece ends with the observation that some macro dynamics (large incumbents capturing the lion share of the economics in tech and bad governmental policy toward tech) are making innovation harder. While both observations are correct, I do not think we are seeing any downturn in global innovation. What is happening outside of the US, particularly in Asia, is amazing and there are many new sectors that are just emerging now that will drive innovation in new and exciting directions. Things always look darkest right before the dawn and I believe we are seeing the dawn of a number of important new sectors. And I think Silicon Valley is on to all of them and will make a play in all of them. But so will many other regions around the world.

There is a framework I’ve/we’ve used over the years to think about where to invest and where not to invest that I call “atoms vs bits.”

I am not sure where I got it from but the concept is simple. Is the software being built and taken to market dealing with just bits or are atoms also involved?

The idea being that it is going to be easier to make something work if there are just bits involved. Atoms make things more complicated and more expensive.

In the 90s, when I first came across this framework, it led us/me to focus on areas like media and financial services where the product was end to end digital. And the first industries to be truly disrupted by the Internet were the ones, like media and financial services, that are end to end digital (or can be).

I’ve held on to this framework over the years and while we’ve veered from it from time to time, often unfortunately, it still holds up.

If you look at machine learning, possibly the most impactful technology right now (and I mean right now), you can see this at work.

Machine learning algorithms have massively transformed online advertising (just bits), online commerce (just bits on the UI), trading of financial assets (just bits), and our attention (just bits and neurons).

But in areas where atoms are involved, not so much. There appears to be a growing acknowledgement in the tech sector that the timeline to fully autonomous vehicles is going to be longer than some had thought. It is not that surprising. There are lots of atoms and lives involved.

I’ve been waiting patiently for the day that I don’t have to do the dishes after yet another amazing meal by The Gotham Gal. I will likely wait longer. Atoms are involved.

I am not saying that we should not work on these harder problems. We should. But we should also understand that the timelines will be longer and the road to adoption will be more challenging. That means these efforts will be more capital intensive and should ideally be investable at more attractive valuations. Sadly the latter has not been the case.

When you are investing other people’s money, you need to be mindful of where the timelines are shortest and the path easiest. And that has been bits for the totality of my investing career.

At USV, we have always had simple and investor-friendly terms with the institutions and individuals that provide the capital we invest.

I got thinking about that this morning in reading Brad Feld’s post about recycling management fees, something we do aggressively at USV (we have recycled between 20 and 25% of our mature VC funds).

We have never charged a premium carry or off-market management fee, we return all capital before taking carry distributions, and we recycle aggressively.

Certainly, we could charge more, but we have never wanted to do that.

When people ask me why not, I like to tell a story.

When Brad Burnham and I were raising the first USV fund, into the teeth of the VC and Internet meltdown of the early 2000s, we visited one of the top VC LPs in the world and he told us the story of a VC firm that they had been investing with for more than twenty years.

As the Internet bubble neared its pinnacle in late 1999, that firm came to the LP and told them that they were raising the carry from 20% to 30%. The LP, who had been supporting this firm for twenty years, was not comfortable with this hike in carry, but held their nose and went along with it.

Three years later, the firm came back for another fund, this time with a 1999 vintage fund in shambles.

They started out the pitch like this “we have had a wonderful and profitable relationship with you for twenty-three years.”

To which the LP retorted “Not really. We had a wonderful relationship with you for twenty years, then you reset the relationship and it has sucked ever since.”

That was the end of that LP/VC relationship.

That story has really stuck with me. Every time I think “we are well below market” I then think “but this is no time to upset the apple cart.” And I get back to work.

The same is true of entrepreneurs and VCs. You can push things too far and if you then stumble, it will come back to haunt you.

But if you are fair and reasonable, it will get paid back over time, particularly in times when you are struggling and need more capital.

That is how the world works. What goes around comes around. Best to be in good standing with your investors when it does.

At USV, we report to our investors on our portfolio and performance four times a year, once a quarter. We produce an audited report once a year, with our Q4 results.

We do that in writing and we also do a quarterly call for our investors three times a year (we combine our Q4 and Q1 calls since our annual audit process slows down our Q4 reporting).

In our annual and Q2 written reports, we prepare a short update on every one of our portfolio companies. We call these “one-pagers.”

This can be a fair bit of work but we do it regularly and have been doing it since we started USV.

I think it is a great discipline for investors to take the time on a regular basis to sit down and write and speak to their investors about what is going on in their portfolio and in the macro environment.

It is a time-honored tradition that fund managers write a letter to their investors explaining what they are seeing and doing. Warren Buffet’s letters are a particularly great example of that. But there are many fund managers who are excellent writers and whose letters get passed around and read by many in the investment community.

Everyone here at AVC knows that I think writing and investing fit like a hand and glove and writing and thinking out loud can make you a better investor.

The Gotham Gal and I are investors in a number of venture capital funds and I have noticed a trend among venture fund managers to reduce the amount of writing and verbal communication they do with their investors. I understand that it can be time-consuming and that many fund investors don’t even bother to read the reports.

But I would urge my peers to resist that urge and to take time to regularly sit down and write about what is going on in your portfolio companies and the markets you invest in. I think it provides insights, raises issues, and gets the entire investment team talking about things in a way that few other regular processes do.

Plus I really enjoy doing it.

For the past six months, Jed has been helping USV build some much-needed tools to connect people at our 60+ portfolio companies to each other.

It has worked out well, so well that we decided to ask Jed to join us full time in a new role that we call Developer In Residence.

Why would a VC firm need a full-time software developer?

Well, we have always had people at USV who can code, but it was always a side thing, never our full-time job.

And there are things that we are doing at USV that require a full-time commitment to the code.

Jed explained all of this and the fact that he moonlights as a bass singer in a barbershop quartet, on the USV blog yesterday.

At USV, we are committed to helping our portfolio companies without asking them to do a lot of the work to enable that.

Ultimately that requires intelligence that is automated and that means writing and maintaining code.

And so I’m thrilled that we now have a full-time person at USV who is doing that for us and our portfolio.

I read this post yesterday that says that 40% of VC investors went to either Stanford or Harvard.

Frankly, I am not surprised.

I’ve worked in this industry for over thirty years. It is full of Stanford and Harvard grads.

I’ve got nothing against either school. They are wonderful education institutions and full of great people.

We have Stanford and Harvard alums at USV so we are certainly a contributor to this statistic. But we don’t have 40% of our team from those two schools.

We don’t ask where you went to school on our analyst application. We ask you to answer four questions and we go from there.

I learned the VC business from a man who went to Case Western Reserve University, my co-founder of Flatiron Partners went to Queens College, and my co-founder of USV went to Wesleyan University.

We have hired analysts at USV that did not graduate from college and maybe didn’t even go, I really don’t know and don’t care.

What I have learned from all of these individuals is that curious and brilliant people come from all places, all genders, and all ethnic and racial backgrounds.

The VC business is making some progress on gender diversity. This chart is from the same post that I linked to at the start of this post.

Eighteen percent is not a number to be proud of, but 60% growth in two years is. If we continue at that rate of gender diversity growth, the VC business could be gender neutral by the middle of next decade. It would not surprise me if that happens. I feel the desire for gender diversity pulsing through our industry so powerfully right now.

But in most other ways, the VC business is still a very homogenous place. Mostly white and, it turns out, mostly educated at a handful of higher education institutions.

We can do better. We must do better. And, I hope, we will do better. Looking in the mirror and not liking what you are seeing is the first step to rehabilitation.