Posts from VC & Technology

My friend Matt Blumberg and I are co-teaching a class at Princeton in a few weeks. The subject of the class is the VC/entrepreneur relationship. As part of doing this class, Matt and I are doing two posts each in a point/counterpoint model. Today is the first of these two co-posts about the selection process. Next thursday will be the second. Matt's post on today's topic is here and should be read directly before or after this post.

—————————————————-

From the outside, most people think that VCs are just looking for the best ideas that will generate the biggest companies. And that is true. We want to invest in big ideas, big markets, and big outcomes. That is a necessary part of our investment selection process, but not sufficient to get us to pull the trigger. We also want to invest in people and teams where we feel a personal chemistry.

Venture capital investing is not like angel investing or public stock investing. We don’t make a lot of small bets (angel investing) and we can’t easily get in and out of our positions (public market investing). We make big concentrated bets in a handful of carefully selected companies and hold these positions for between five and ten years on average. We sit on the boards of these companies and become business partners with the founders and management teams. We don’t run the companies but we have a meaningful amount of influence and impact on them.

For this model to work, VCs need good personal chemistry with the founders and management team. They need to like and respect us. And we need to like and respect them. The way investors choose teams to back and the way entrepreneurs pick VCs to take money from is very much like the way you recruit and hire a team. Or the way you date before getting married. It’s a process and the more facetime you can spend together before making the decision and the more asking around you do, the better decision you will make.

There are four phases to this process.

• The first impression – That can be in a minute or an hour. It’s the first meeting. You walk away from that meeting and you think “I really liked that person” or “That person is awful.” Both the entrepreneur and VC will have an opinion coming out of the first meeting.
• Subsequent meetings – If the first meeting went well enough, both sides are inclined to take a follow-up meeting or in all likelihood a series of follow-up meetings. This is where the first impressions are confirmed and validated or where they are determined to have been incorrect. This is also where others are brought into the process. In our firm, all the partners will meet the entrepreneur and, ideally, key members of the team as part of our investment process.
• Reference checking – This is not about calling the references someone gives you. This is about triangulating between who you know well enough that they will tell you the truth and who has worked closely with a person. I like to call people who have worked with a person in a bad situation. When they tell you “she was the only person who really shined in that moment” you know you’ve got a winner. When they tell you “he created that situation and was painful to deal with” you know you don’t. You cannot take all the references you get as gospel because some people just don’t work well together. But if you call enough references, a picture will emerge with consistency and that is likely to the truth.
• The negotiation – It is important that some stress is injected into this process to determine how well both parties work through a tense situation with some conflict. Because a five to ten year relationship between an entrepreneur and a VC will almost certainly include some difficult moments. Being able to work through those difficult moments constructively is the hallmark of a good VC/entrepreneur relationship. The negotiation of the investment deal is a good way to introduce that tension and both sides should pay a lot of attention to the little things that are said and done in the negotiation. It is a rehearsal for the main event.

If you find working with an entrepreneur difficult, you should not invest in his or her company. If you find working with a VC difficult, you should not take their money, no matter how good a deal they are offering you or how strong their reputation is. Personal chemistry is exactly that, a connection between two people. We all know that some people work well together and others don’t. Pairing the right people together to get something done is the central act of good business people. And it is the central act of venture capital investing.

If a Company is making huge profits this year but will not make any profits in the future, it is worthless in the eyes of an investor. But if it loses money this year and next year and may lose money for a few more years, it can still be very valuable in the eyes of an investor.

Amazon had negative net income in 2012 and pretty much zero net income this year to date. And yet it is worth $166bn in the eyes of investors.

This is because companies are worth the present value of future cash flows, not current cash flows, and certainly not past cash flows.

Amazon is not the only company that is plowing back all of its incremental profits into growing its business. This is very common for enterprise software companies as well. Salesforce has made or lost a small amount of money every year for the past four years but it has grown its revenue from $1.3bn to over $3bn in those four years. And its market value has gone from $12bn to $32bn in the same time frame. Workday hasn't made any profits in the last four years, in fact the net losses have been increasing. But the stock has doubled in the past year and the Company is now worth almost $14bn.

The lesson here is that you can't just value a company by taking its current performance into account. You really need to have a view towards its future performance. And you need to understand why the company is not currently profitable.

In the case of Amazon, it is making huge investments in warehouses and logistics to be able to continue to grow its retailing business and it is making similarly large investments in data centers to be able to continue to grow its AWS business. If Amazon did not want to continue to grow, it could stop making those investments and start generating profits. If you believe, as Amazon management does, that the future growth is going to be there for Amazon, then you ignore the current P&L and think about what a future P&L might look like. 

In the case of Salesforce and Workday, they are making huge investments in sales and marketing to secure additional customers. They are also making significant annual investments in R&D to maintain the market leadership of their existing products and bring new ones to market. If you think that Salesforce and Workday can continue to grow their revenues at or near their current growth rates, then you ignore the current P&L and think about what a future P&L might look like.

Profits are critical to the health of a business, but that doesn't mean a healthy business has to currently profitable. It needs to be able to be profitable if it wants to be and it needs to be profitable at some point in the future, at least hypothetically. So when you read that a company is losing money, don't read that as a bad thing. It could be a very good thing. It all depends on why. 

This won't be news to many of you who figured this out a while ago. But USV has a new front door and has had it for a few weeks now. I blogged about the desire for a new usv.com back in June of 2012, when we started thinking about what the new website should be. I framed the problem we were trying to solve as:

We started having the conversation all over the place. We've been having the conversation here at AVC since 2003. But we also have the conversation at continuations.com, aweissman.com, unfinished work, christinacacioppo.com, garychou.com, and on countless tumblrs, twitters, disqussions, and elsewhere around the web.

You might ask "why did it take you 16 months to build a new website?" and you would be right. When it comes to VCs, do as we say, not as we do 🙂

But seriously, we went down a few dark alleys and it took a while to figure out they were leading nowhere. We ended up with something that some have characterized as a "clone of hacker news" and you would be right to say we were inspired by the design of hacker news in our new website. We hope it is not a clone because if it is, we have contributed nothing new to the Internet.

The new usv.com looks like this:

First and foremost, it will be a place that we can cross post the things we write from around the web. As you can see, I cross posted my blog from yesterday and it is currently at the top of the feed.

But it is also a public view into the links we are sharing with each other at USV. You can see Andy sharing a post written by our friend Bijan, Brittany sharing a post about the Lanyrd startup story, and me sharing one of my favorite Tumblrs.

Most of all, it is a place for everyone to have a public conversation with USV about the things they think are interesting right now. Anyone can post to the new usv.com. All you need to do is login with your twitter handle and you are cleared to post.

If you want to show us your new startup, it is cool to pitch us publicly. We would encourage you to use the "Show" syntax, so if you are pitching, start your headline with Show USV: and everyone will know what is going on. Pitching is not spamming at usv.com if its done correctly.

New posts go onto the new page not the front page. Many of us at USV and a growing number of others are visiting the new page several times a day and upvoting posts. When you get upvotes and comments, you get onto the home page, and if you post something awesome, you will get the top of the front page. Nothing new here. Reddit, Hacker News, and others have been doing this sort of thing for years. We finally got around to it oursleves.

Nick, who led the effort to get this out the door, along with Zach, Zander, and Brian, wrote a short explanation of why we did this. I have been encouraging him to write a follow up on how, what stack we used, etc. I hope he will do that.

We have some great tools to make it easier to participate on usv.com, you can find them on the tools link at the top of the feed. Commenting is powered by Disqus, of course, and we would love to hear your thoughts as often as possible. There is a post bookmarklet, a chrome extension, and an android share app. We will be getting a firefox extension out shortly. And if iOS ever opens up sharing in their OS, we will build an iOS share app.

I hope you'll make the new usv.com a place you want to visit regularly and if you are the kind of person who enjoys sharing and posting, please do that. The more the merrier I believe.

I got up early, even for me, took a car to the airport, and boarded a flight to SFO to join my partners who have been in SF since yesterday. From the moment I land at SFO until the moment I get on a flight back to NYC early friday afternoon, I will be in meetings or dinners or sleeping. 

Our firm makes a twice yearly trek to the bay area. Everyone other than our operations staff comes. We throw a big cocktail party and invite everyone who works at our bay area portfolio companies (if you work for a USV portfolio company in the bay area, I really encourage you to come), we meet privately with a few of our portfolio companies as a group, we meet with a bunch of companies we've been following but are not yet invested in, we have a private dinner for our bay area portfolio CEOs/Senior Teams, and we schedule a bunch of board meetings during this week as well.

We've been doing this for a few years now. It's a good practice and I am glad we do it. We have made 18 investments in the bay area and 15 of them are still active. All but one of our bay area portfolio companies are shown here. That's roughly a third of our portfolio and it represents an important cohort for us. We are not inclined to open a second office anywhere so we need to find ways to get closer to the companies outside of NYC, which is the majority of our portfolio (26 out of our 48 active portfolio companies are outside of NYC).

The VC business tends to collapse the engagement between a venture firm and its portfolio companies to a single relationship, usually the partner who sits on the board of the portfolio company. That is not ideal and Brad and I committed to each other to change that in our firm back when we started USV. We have sat on boards together. We have swapped boards a few times. We build real relationships between the other partners and the leadership teams. We have invested in the USV Network which brings all of our portfolio companies together to help each other. And we bring the entire partnership to the bay area twice a year.

These things matter a lot. It's easy to slip into freelance mode where each partner manages a portfolio of companies and there isn't much interaction between these mini portfolios. I have seen that at many VC firms over the years and it isn't the best way to add value.

We haven't perfected anything and all of this is a work in progress that will never end. But getting out of the office as a partnership and engaging with a bunch of our portfolio companies is a great way to spend a couple weeks a year. And that's what we will be doing this week in San Francisco.

There are a lot of awesome people in the startup community, but Paul is among the most awesome.

I am a bit surprised by this report, which says that NYC's second largest job sector is tech. According to The Verge, which wrote a post about this report:

Dr. Mandel counts 262,000 well-paying jobs in tech and information, an 11 percent jump since the economy crashed in 2007. The $30 billion in annual wages generated by the tech sector is small compared to the $90 billion in wages paid to the still-dominant financial sector, but tech wages have grown since 2007 while finance wages decreased.

I would have thought the real estate sector was larger (it may be) and it is also a bit surprising to me that tech is bigger than media & entertainment.

One of NYC's great strengths is the diversity of its economy – finance, real estate, media & entertainment, retail, fashion, health care, education, and now tech. And the reason tech is growing so fast in NYC is that it is embedding itself in all of these other industries. It's not entirely clear to me whether Gilt is a tech company or a fashion/retail company, it is not clear to me whether ZocDoc is a tech company or a health care company, it is not clear to me whether Codecademy is a tech company or an education company.

And you know what? It doesn't really matter to anyone other than those whose job it is to count jobs in various sectors. What does matter is if you want to work in tech, build a new company using tech, and be part of a vibrant tech community, NYC is one of the best places in the world to do all of those things, and a lot more.

AVC regular Donna White posted this to her Tumblr yesterday:

I'm a crotchety old guy. I worry about all these new companies. I’m glad that they’re easier to start, but the problem is, they’re just as hard to finish as they have always been.

The quote is from Mike Olson in this post.

The thing in Mike's quote that really speaks to me is the difference between starting and finishing. Starting requires an idea/inspiration, a team, some technical skills, the ability to iterate on the MVP and find product market fit. That's hard for sure, but what happens after you find product market fit is even harder. That's called building the company and building the business. And that is where I have seen all founders struggle. The ones that have done it before a few times seem to manage through this struggle better. The ones who are doing it for the first time really need a lot of help from mentors, coaches, and their team to get to the finish line. And many don't. Mike handed his company over to more seasoned managers and many other founders end up doing that too. Sometimes the VCs/investors have a role in making that happen. Sometimes the founder makes that call on their own.

The skills that get you from idea, through initial product, past product market fit, and into a market leading company are very different from what it takes to manage a 200-500-1000 person global business that needs to exectute well across a range of dimensions and keep everyone aligned, motivated, and working well together.

The quick pivots, the exhausting product/engineering sprints, the rapid fire innovation, the missionary zeal, etc work so well in the early days but they get old quickly and they don't scale. At some point calm, rational, supportive, and highly communicative management skills are required. And learning those on the job is hard. As Mike points out in his post, it is a bit easier to learn those skills from watching someone else who is really good at doing that. And that is why Mike argues that founders should pay their dues working in someone else's company before starting their own.

I agree with Mike that learning from someone else is a better model for becoming a great CEO. But often a first time founder has the right idea at the right time and assembles the right team and ships the right product. And getting behind that kind of founder has produced the best returns over time for USV and for many VC firms. So the art is helping the first time founder learn how to turn themselves into a great leader manager or helping them decide that they should step aside and let someone else take over.

I have seen both done both many times. There isn't a right way or a wrong way. But there is a right way or a wrong way in a specific situation with a specific founder and company. It all depends on whether the founder wants to make that shift, is making that shift over a reasonable period of time, and that the company is making that shift with them.

It's postseason baseball time. So I will use a baseball analogy here. The starter rarely pitches a complete game. Most times the winning team will leverage both a great start and a great close from two different pitchers. And there are plenty of both in the hall of fame.

Update: As my friend John points out, there are only 5 closers in the hall of fame. Not sure what that means for this post, other than my analogy was a bad one and I should have done some homework before using it.

Hunter Walk has a good post up on the coming competition among angels with syndicates to get into deals. Hunter observes:

My guess is there are also some angels who were popular when they represented a $25k check but won’t be as sought after if they try to push $300k into a round.

What Hunter is getting at is the difference between leading and following. A lead investor sets the price and terms of the investment, takes a large part of the round, and usually agrees to represent the entire round on the board. Then everyone else gets to pile in behind them and piggyback on all of that work. And the entrepreneur and lead investor allow the followers to do that because either they are likely to help the company in some way or because the company needs more capital than the lead is prepared to invest at this time.

USV is a lead investor. Benchmark is a lead investor. Gotham Gal is a lead investor. I suspect Hunter's Homebrew is a lead investor.

Angel List Syndicates are turning angels who have traditionally been followers into leads. That's a good thing in many ways. The more folks who can lead a round, the better, at least for the entrepreneurs. But, as Hunter points out, it will mean that less of these angels will get into rounds than before because they will all be showing up with a lot more money than before. 

It also means that they will have to learn to lead and lead well. They will have to step up before anyone else does. They will have to negotiate price and terms. They will have to sit on boards. They will have to help get the next round done. Essentially they will have to work. That's why they are getting carry from the syndicate, after all.

And over time we will get to see who is actually good at this and who is not. And I can tell you this. Not everyone is good at this. In fact, very few are. It's hard to be a great lead investor and a completely different thing than being a well sought after angel investor who can get into someone else's deals. Some will turn out to be great at this. Many won't. And only time will tell who is and who isn't.

A few weeks ago I did a 40 minute talk with Matt Turck at the Data Driven NYC meetup. Matt's a super sharp guy and talking to him was a lot of fun and we got into a bunch of interesting stuff.

Data Driven NYC #18 – Fred Wilson from Matt Turck on Vimeo.