Posts from Venture capital

I've been thinking a lot about the differences between first time and serial entrepreneurs. We invest in both and do not have a preference betweeen the two. But there are significant differences.

The best first time entrepreneurs have been stewing on their idea for quite a while. It is a personal passion of theirs and they bring to it a fresh take, a stubborn insistence on their approach, and they obsess about the idea 24/7. They often get the right product into the market at the right time and they capture the user's attention and usage with that product/market fit.

Where first time entrepreneurs often struggle is when the product works so well that they have to quickly build a company to support the product. Most of the time, the first time founder has not spent anytime thinking about what kind of company they want to build, what kind of people they want to surround themselves with, what kind of culture they want to create, etc. The first time founder often has no experience recruiting, managing teams, and building organizations.

Serial entrepreneurs, on the other hand, often struggle with the founding idea and getting to product/market fit. They start the second and third and fourth company because they love startups and they don't know any other way to work and be productive. But they often lack that passion around a singular idea that drives first time founders.

But when serial entrepreneurs do settle on the right idea and find product/market fit, they are usually terrific at building the company. They know when to step on the gas and where. They know how to recruit, manage, and structure organizations.

I was talking about this dichotomy with another venture capitalist the other day. I likened it to the first album/second album issue with rock bands. So many bands struggle with the second album and there are many reasons for it. The first album is something they have been working on for years. These are the songs they played night after night in the clubs working their way up. These are the songs that got them their fanbase and got them signed. The album hits, people love it, and then they spend the next year touring like crazy to build their fanbase. And then they have to go back into the studio and write and record a second record in a matter of months. It is no wonder that is is terribly hard to produce a second record as good as the first.

Likewise, it is often hard for the serial entrepreneur to produce a second startup that is good as their first. It takes a lot of patience and collaboration with others, two things they probably did not use much of in their first startup.

As I said at the start of this post, we work with both first time entrepreneurs and serial entrepreneurs with equal interest. We love the ability of great first time founders to nail the product and get significant user traction quickly. And we work closely with them to build the company once that happens. And we understand that is an area they are uncomfortable with and need our patience and support with. We also love the serial entrepreneur's gifts around building the company and taking control of a market once they have gotten product/market fit. We work closely with them in their efforts to find product market fit and we understand those challenges and are patient and supportive during that time.

These observations are generalizations and certainly do not speak to each and every situation we've been involved in. But they do reflect our experience broadly and we think it is important to understand what situation you are investing in, where the challenges will be, and how best to support the startup. Those things will most likely be very different when working with first time founders and serial entrepreneurs.

In all the posts over the past year or so outlining my thoughts on the financing and valuation environment in the internet sector, I've avoided using the word Bubble. It is intentional. For me Bubble will always be inexorably linked to what went down in 1999 and 2000 in the internet sector. And I agree with Mike Arrington that what is going on now is different. I do not think we are in a Bubble per se. That is why I don't use the word.

But I am equally sure that we are in the glass is half full part of the cycle. Investors are focusing on the upside and ignoring the downside. That part of the investment cycle lasts for a while and then things change and investors focus on the downside and ignore the upside. Markets are defined by greed and fear. We are in the greed mode right now.

I don't view this as whining. There is nothing to whine about. Investors are making money hand over fist. Why would I whine about that? But I do think it is important to point out the inevitability of the market cycles. There will come a time when the environment we are in will be in the rear view mirror. And entrepreneurs should be crystal clear about that. This is a time to raise money and sock it away for a rainy day. Because it will rain.

And investors should recognize that the current valuation environment will not exist at some point in the future. The companies we invest in will need to grow into these valuations or we will face writedowns and writeoffs. We should not let the greed emotions cloud our judgement. Yes, that hot deal sure looks damn good right now. But deals are actually companies and most venture investments are held for five to seven years. I've likened them to marriages over the years. Don't let the lust for the deal lead to a bad marriage that you have to be in for the next decade.

I've made all of these mistakes. I know what happens. I am prepared for it. That doesn't mean we aren't investing in this cycle. We are as active as we've ever been. But we are investing at this stage of the cycle with our eyes wide open. And I'm writing about it in the hopes that others do the same.

The Gotham Gal and I have been fortunate to accumulate signficant capital over the past fifteen years. And the vast majority of it is invested in startups. We get distributions from a sale of one company and within months that capital (after taxes) is invested in more startups (including non profit startups). This has caused a few liquidity issues over the years. The Gotham Gal is always saying that we'll set aside a bunch of cash next time and then we go and do the same thing. I guess we can't help ourselves. Investing in startups is more appealing to us than leaving cash in the bank or putting capital into the bond market or the stock market.

When I think about the history of silicon valley and startup ecosystems in general, this is the pattern I see. Entrepreneurs, angel investors, and VCs take the profits from one deal and turn around an invest in more deals. They recycle capital back into the startup economy. If you look at silicon valley right now, particularly in the early stage/angel/angel list market, this is what is going on. Early employees of Google, Facebook, and a bunch of other succcessful tech companies have taken a considerable part of their paydays and become angels. And it makes sense. They work in the startup economy. They understand the technology, the market, and the gestalt of startup life. They are allocating capital to the startup ecosystem.

I bumped into a friend last week who sold his company a few years ago. He spent the required time with the buyer and then left. He's been spending his time since starting a family with his wife and investing in startups. He told me he's not sure he'll make a lot of money angel investing, but he's hoping to at least breakeven. So he's not doing it soley for the returns. He's doing it to stay connected to startups and support other entrepreneurs. I am certain he's not alone in his approach to angel investing.

I've been told that the US venture capital and startup system is the envy of the world. If so, then I think the rest of the world should pay as much attention to the way entrepreneurs recycle their capital as anything else. Yes, the institutional venture capital system is a big part of the success of our tech startup economy. But it starts with entrepreneurs and angels. Most VCs don't supply capital in the first year or so of a company's life. So startups need to get their initial capital elsewhere and that early money is where the real special sauce is. Think about Andy Bechtolsheim's $100k check to Google or Peter Theil, Mark Pincus, Reid Hoffman, and Sean Parker's early angel investment in Facebook. These entrepreneurs were recycling their capital back into the startup economy. Yes, those investments have paid off bigtime. But they also supplied capital when the company needed it the most.

The Gotham Gal and I allocate most of our capital to startups for many reasons. We do think we are going to generate good returns over the long run doing this. We have generated almost all of our capital over the years by investing in startups. But we also do it for the psychic benefits of investing in startups. When you back an entrepreneur early on, it is like making a large gift to a good cause. It feels really good. And when that entrepreneur uses your early support to create something important and valuable, it feels even better. You can't get that kind of feeling earning interest from a bank or trading stocks and bonds. And that's a good thing. Because capital formation for entrepreneurs and startups is the key to a healthy economy. And for all the problems we face in our country, we have a startup financing culture that is the envy of the world. And I'm really happy and fortunate to be part of it.

Of all the things we have done at USV this year so far, the thing I am most proud of is the work of Gary Chou on our USV Jobs page. Gary wrote a bunch of code that hits the Indeed jobs service (Indeed is a USV portfolio company) and finds all the open jobs across our entire portfolio. The code then parses through the jobs, finds out where the jobs are, what kind of job it is, what the job title is, etc. And then all of the jobs are published and sorted on usv.com/jobs.

Right now, 24 of our 32 active portfolio companies are hiring. There are 557 jobs open across 27 cities and several continents. I am proud of Gary's work on this service and I am proud that our firm is helping to facilitate that kind of job creation activity.

All of us at USV constantly get emails from people who want to work in our portfolio. We love getting these emails because our companies are always in search of great talent to hire. Often these emails come via an introduction from a trusted relationship. And often they come in unsolicited. But they almost always come without much context. So it requires a fair bit of work to take that initial email and turn it into a good lead for our portfolio companies.

Our hope is that usv.com/jobs can change that. If you want to work in a USV portfolio company or if you have a friend or contact that wants to do that, a visit to usv.com/jobs before you send the email can help a lot. There's a big difference between an email that says "I'd like to work in one of your portfolio companies" and one that says "WorkMarket is looking for a QA Engineer and I know of a really good one I'd like to intro you to."

We are all hoping that usv.com/jobs will result in a lot more of the latter and a bit less of the former. And if you know of a great QA Engineer in the NYC market, please send me an email.

Bijan has a really good blog post up today about Spark's approach to investing in competing companies (they don't). He says:

I’m quite sure that we will miss a few important investments and i’m sure we could be more aggressive with and flirt with the gray line that we are trying figure out every day.

Our firm takes an almost identical approach to Spark on this topic. Back in early 2007, I wrote a blog post at USV.com on this topic. After reading Bijan's post, I went back and re-read my blog post. I wouldn't change a word four years later. Which feels really good to me.

I believe that VC is a service business and our customer is the entrepreneur. Our shareholders are the limited partners who allow us to invest their capital. And I believe that in order to service the entrepreneurs we work with to our fullest, we cannot and should not have competing investments.

I know that there are VC firms out there that don't share this view. And I am sure they have found a way to make it work for them and the companies they invest in. But we haven't and I am sure we never will.

We closed an investment recently. It was a seed round. Our firm priced the round and we were joined by a number of small VCs and a few well known angels. We agreed to close on a standard set of "light preferred" documents without negotiation. There was no investor counsel on the transaction. We just signed the standard documents which were tweaked to reflect the round size, share price, and board provision in the term sheet.

The legal fees for this transaction were $17,000. I talked this over with the entrepreneur and we agreed to pay the legal bill. We are both big fans of the law firm involved and felt they earned their fees on this transaction.

But I've been thinking about this situation over the past week and I'd like to issue a challenge to startup lawyers. When you have a seed stage company that needs to incorporate and close a seed round where all parties are willing to close on a set of standard docs without negotiation and where the investors agree to go without counsel, I think the legal fees for such a transaction should be $5000 or less. I just don't see why it should cost more than that.

The complaint used to be that VCs would negotiate everything and then whatever the VCs didn't negotiate, their counsel would negotiate. Well our firm and many other firms who invest at the seed stage have taken that criticism to heart. We don't behave that way these days and many of the firms we invest with don't either. But the fees have not really come down dramatically like I had hoped they would.

What more do we need to do to get to a $5000 legal fee for an incorporation and seed round?

When an entrepreneur gets a $500k or $750k or even $1mm seed round every dollar counts. And $15k, $20k, $25k of legal fees hurts. That's one less developer working for three months. Think about what a developer can build in three months.

I'm not talking about follow-on rounds where things get more complicated and round sizes go up. I'm talking about the first money a company gets when the company needs to incorporate, set up a bank account, and get real. I'd like to see $5000 of transaction costs. What do we need to do to get there?

Last night I attended a meeting/dinner of many leaders in the NYC tech sector with the folks in city hall who work on economic development. We listened to a bunch of reports. One of the most telling was from Larry Lenihan of Firstmark who is managing an early stage venture fund focused on NYC tech companies. Larry explained that many of the best opportunities that come to them don't get funding because of the lack of a technical co-founder.

NYC has a wealth of business people with domain experience in many important sectors. But they seem to be having a hard time of pairing up with technical talent to form great startup teams.

Enter Pair Up. Pair Up NYC is an effort from InSITE, a group of grad students at NYU and Columbia who help startups. They've noticed the same issue and are doing something about it. Pair Up is a matching program between people who want to do startups.

I've tweeted out the link to Pair Up a few times, but I am writing this post to let everyone know that the deadline to apply for the first Pair Up program is tomorrow, March 18th. If you are looking for a cofounder and want some help, here's where you can apply.

It's friday so it's time for another suggested post from the amazing comment thread on the bloggers block post. Mark Suster suggested:

how about a post on your partners: who they are, how you guys work together & a bit more about how you guys reach decisions on deals?

I have two and half partners at Union Square Ventures.

Brad Burnham – Brad and I founded USV together in the summer/fall of 2003. We had both been in the venture business for more than a decade, had made a fair bit of money, but were still hungry to prove ourselves. Brad is the strategist and the most principled investor in our firm. It was Brad's idea to write a treatise on venture capital and the internet before we set off to raise our first fund and that exercise we did together continues to be our guding light. Brad is the person behind phrases like "the application layer of the technology stack" and "large networks of engaged users" that I use all the time. He gives me most of my good stuff which I often get credit for.

Albert Wenger – Albert was the President of Delicious until it was sold to Yahoo!. After that sale, he joined USV as a venture partner and as a general partner when we raised our second fund in 2008. I can't image operating USV wihtout Albert but we did for our first several years. Albert is hacker who still codes stuff up in his spare time. He's been a CTO, a VP Engineering, and has run businesses. And he is a great investor too. And he's the most underrated blogger in our firm. Albert has a very analytical mind, asks piercing questions, and thinks deeply about the web, its underlying technologies, and new business models.

John Buttrick – I can't link to John because he's managed to avoid any social media presence in his first fifty years on planet earth. We will get him on our website, but I'm not confident we will get him to do much more than that. John joined us officially in December when we raised our Opportunity Fund. You can read a bit about him in my post on the Opportunity Fund. John's been hanging around USV since formation advising us on legal, financial, and operational stuff. He's helping us evaluate the more established businesses we look at, but more than that he's helping us rethink the way we raise funds, structure funds, communicate with our investors, and run our firm. It's great having him around.

We run our busines in the model of the "sleepy little firm" that I spent my first ten years in the venture capital business with. We all work out of a single office. We have a total of six and half (John is half time) people at USV. It is quiet in the office on many days when we are out and about visiting companies. We value trust, respect, and consensus. We don't invest in companies that everyone is not 100% behind. We never vote. We don't exercise vetos. We don't yell. We don't blame each other for our failures, we blame our team, our process, and our collective decision making.

Many people think I am the "lead partner" at USV. That could not be further from the truth. Brad should get most of the credit for setting a strategy that we have executed very well. Albert should get the credit for steering us into new areas we would not have been in without him. I get to be the front man but that's really the easisest job in the partnership.

We are a true partnership where each person contributes deeply to our collective success. Trust and respect are the key operating words. And once a partner has worked one fund with us together, we are equal partners and share in the profits equally. We don't want to have too many partners and I don't think we will add many more. Maybe one more, maybe not. We will see. We are doing fine with the ones we have right now.

I love working in this partnership. It is easy, it works, and it has proven itself.

I went to business school in the mid 80s. Investment banking was hot. The leveraged buyout craze was on. Junk bonds were hot. Everyone wanted to work on wall street.

I was obsessed with venture capital and had worked in a small venture firm the previous summer and had gotten an offer to work full time in venture capital for $60k per year with no bonus and no incentive comp. I also had gotten a job offer from an investment bank at $125k per year with a bonus opportunity of $250k.

Those investment banking job offers were all over the business school and almost everyone I knew took them. They all went on amazing summer vacations and showed up on wall street in September 1987. In October 1987 the stock market crashed and by December many of my classmates were out of work.

I took the VC job, made basically enough to live and work in NYC for ten years (subsidized by The Gotham Gal's income), but I did set myself up for Flatiron and then USV.

I told this story in a comment to my MBA Tuesdays post and figured it was worth posting as a full blog post. Risk is not obvious. And reward is not obvious. Don't do the obvious thing. Because I can assure you it rarely works out as planned.