VC Blog on Storage, Wireless/VoIP, Internet

Customer intros NOT a strong VC value prop

I am a young venture capitalist (33) but have been doing this since 1998.  So, I have heard a maybe a thousand entrepreneurs answer the standard question VCs use to wrap up a meeting: “What are you looking for in a financial partner?” Every now and then, a VC meets a real wild man who answers the question honestly: “Valuation.” The wild man gets bonus points for honestly, but that is all. I bet even corrupt Congressmen taking bribes don’t like to hear the yellow envelope labeled a bribe.  Call it “constituent management” or something if you plan to bribe a Congressman. We all like perfume.

So, when entrepreneurs are asked what they are looking for in a VC, they usually supply some mealy-mouthed answer about how we don’t just want the highest price or the prettiest face, but we want you because you are so great at X, oh, and customers… we want intros to customers and we think you could help since you invested in company Y.

In other words: BS, BS, BS, and customers. I have heard hundreds of entrepreneurs raising money from VCs say that customer intros are the primary non-financial value proposition they are seeking from VCs. 

Well, I have to say, with the exception of a few VCs that deliver on that (notably, I am told, Kleiner Perkins in selective cases), high level customer intros on a sustained basis should rank about last on the list of benefits you should expect to get from a VC.  It just isn’t what we do. We do a lot of things, some of them we as an industry do really well.  Corporate governance, interviewing IPO bankers, and self congratulation come to mind.  But, we do NOT, as a general rule, make many customer intros.  That isn’t the world most of us traffic in. Sure, each of us has 1-2 CIO friends or 1-2 VP friends at carriers.  Every mobile VC knows or at least knows he needs to pretend to know Paul Reddick. Maybe we can get you meetings with serious prospects to be 1-2 of your first 10 betas, but if you get more than 5% of your first 100 customers from VC intros, well then you need to tell me who your VCs are cause I have not met them and I want to. 

One thing we VCs can do well (most don’t but we can) is executive recruiting.  Some VCs are great at that. And that is a real and sustainable value proposition to the entrepreneur.  More on that in future postings I hope…

Sales force size as a barrier to entry

As a young venture capitalist (33), I still remember some of the lessons I was taught in VC 101 when I entered the profession as a pup 9 years ago.  Part of the venture business is pattern recognition regarding making new investments (don't invest in knowledge management software, etc.).  Part of the business involves applying past lessons from your partnership's investing or operating experience to help guide portfolio companies. 

For example, venture backed entrepreneurs are much more likely to overspend on sales & marketing, or international expansion, too soon rather than too late in a market's development.  The entrepreneur, passionate by nature, believes in the real estate value of a land grab before the land has emerged from the sea, and flushes his B round, his founder's equity and his company down the toilet hiring too many sales reps chasing early adopters in the nascent stage of a market's development.  So, the young VC is cautioned by his mentors to tell all his companies to run an experiment.  First, hire 1 sales rep in NYC, then see if he sells.  If he does, hire two more in 6 months, maybe one in Boston and one in Chicago or DC.  Then, 6 months later, if 2-3 of the 3 are performing, hire another 4-6 sales reps in SF, LA, Texas, Seattle, Philly, etc.  9 times out of 10, maybe 49 times out of 50, I believe this is the right answer.

But, what about the other one time?  What about the entrepreneur whose passion and confidence in the market's rapid development is an accurate read on the market's readiness for a new hot product... the new Google, the new iPhone, the new core router, the new iSCSI SAN box.  In these rare cases, which, by the way, are where the bulk of venture returns are made anyway... it is an advantage to build out a formidable sales force EARLY in the market's development.  Clay Christensen says that the first entrant in a new market with a high quality national sales force often has a large barrier and reaps much of the rewards (that was from memory... may have some of my spin on it).

I have a friend named Marcus Ranum who is a world class e-security pioneer.  As a techie, he built the world's first commercial firewall Gauntlet for a company called TIS which had a successful outcome.  As an entrepreneur, he built the world's first world class IDS platform (intrusion detection) for a company called NFR.  It was loved by the security IT thought leaders at Fortune 50 companies, and deemed much superior in performance to the rival product by ISS.  But, ISS, like EMC in storage, built a world class national sales force (ultimately led by a friend of mine, Tom McNeight).  And ISS whupped poor Marcus and NFR and because a successful company worth billions (now part of IBM) wheras NFR became worth a few million I believe in its modest exit.

As an active investor in the storage appliance world (LeftHand Networks, SEPATON, for example).  I am seeing hyper growth by my companies and my companies' rivals in some emerging storage categories, such as iSCSI SANs, WAFS, disk-based backup, and dedupe.  These markets are so hot that many companies are "winning."  But who will win biggest?  Will it be the companies first to build an EMC-class or ISS-class national or global sales force? 

Would Juniper (a proud win by my former employer which taught me VC 101, NEA) be Juniper today if it had not hired a large sales force to compete with Cisco in the 1990s?

Long Term Asset Bubble and Impact on VC Biz

Here is a question for you.  How long will it take a high net worth family or small endowment to grow from $100m value to $1bn value?  If they earn 7%/year (10% historical stock market nominal return less 3% estimated inflation), then in 34 years, they will achieve $1bn. 

What does this mean?  It means that as we have a somewhat high number of families and institutions with $100m to put to work today seeking higher returns from "alternative" investments such as venture capital and LBO, in a few decades, if historical returns hold up, we may have many many more billionaire families and institutions seeking the turbocharged return promise of alternative investments.

What this says to me is that the absolutely staggering amount of wealth in the world today will grow many times from here, and there will not only be more yachts in the French Riviera, but the value of VC and LBO managers with "alpha" will grow over time, as probably will the value of beach front property in Carmel and the Hamptons.  Why?  The amount of money desirous of "beating the S&P 500" by investing in alternative investment vehicles is already so great as to almost be silly (for example, $2 trillion in hedge funds which as an asset class have a way of underperforming the S&P 500 after deducting 2% for fees and 20% of profits).  Yet, it will get even sillier, and the few VCs with a proven ability to deliver true value, not just as investors but as co-entrepreneurs (think Kleiner Perkins, General Catalyst) will be in such demand by these growing trillions of dollars that it will make one's head spin.

The result will probably be, as it has been in the hedge fund business and I would argue also in the VC business and the LBO business, too much money chasing performance depressing the excess returns sought by the asset class and enabling many mediocre managers to earn large salaries for not adding true value.

Of course, the VC and LBO businesses will have cycles.  VC returns peaked in 1999-2000 and perhaps LBO returns are peaking now... but the long term trend of the asset bubble funding the efforts by both asset classes seems to be well in place.  And the growing investment interest by rich people and governments in formerly underdeveloped economies will only add fuel to the fire.

Dare to Be Great & Dangers of Group-Think

I read a fantastic memo titled "Dare to be Great" recently by Howard Marks of tier-1 hedge fund OakTree.  In it, he quotes Barton Biggs who lists the following shortcomings of committees:

1. Collective rationalization of share illusions generally believed

2. Negative stereotypes of out-of-favor groups, techniques and individuals

3. Unwarranted confidence in chosen approaches

4. Unanimity, suppression of doubts and pressure on dissenters

5. Docility on the part of individual members

6. Free-floating conversations during meetings, and

7. Non-adherence to standardized methodologies.

This is interesting stuff.  The power of a venture capital partnership draws largely on its collective wisdom.  But, this very nature of group decision making can cause a reversion to mean behavior and stamp out the scary bits of excellence which could yield outsized investment returns.  For a great example, look at the Bessemer Venture Partners' courageous self-mockery of deals that were too scary for them to invest in that formed the anti-portfolio:  http://www.bvp.com/port/anti.asp

One example: eBay
"Stamps? Coins? Comic books? You've GOT to be kidding," thought Cowan. "No-brainer pass."

How best can a venture firm "Dare to be great" while still leveraging the power of the partnership?  Perhaps each partner should be given one bullet per fund (ever 3 years) in which he or she can proceed with an investment even if its gets voted down by the partnership?  I don't know the answer, but I think it is a darned important question for venture investors and for entrepreneurs of excellent but unconventional businesses, like eBay, Skype, etc.

By the way, I LOVE the phrase "Dare to be great."  When I worked at elite M&A advisory firm Lazard in the mid-1990s, our Chairman Michel David-Weill used to give a great Dare to be Great speech to the captains of businesses who were on the cusp of tackling transformational deals.  It had a powerful effect.  Few things are more inspiring that a call to arms to achieve excellence.  Think of JFK's "Ask not" speech for example, or MLK's "I have a dream."

It is what I love about working with entrepreneurs, their dare-to-be-greatness.  It is part of what America so great, that we have so many people daring to be great.  Let's encourage that...

Late stage? Early stage?

Some venture investors are religious about stage preference.  I consider myself stage agnostic.  Early stage believers feel "supernormal" venture returns are driven by getting into big winners early, and thus owning a bigger percentage.  I am sympathetic to this view.  Owning 20% of Yahoo is indeed better than owning 5%.  But owning 5% of Yahoo is better than owning 20% of Pets.com, and owning 5% of Yahoo might help you better pick the next Yahoo.  Case in point, Sequoia invested in Yahoo and Google (albeit in the first round of both).  The big question seems to be, can you get in the Yahoo's and Google's after the A round.  Yahoo was possible.  Google was not.  Some businesses are so profitable they don't need the capital of a B round.  And some businesses are so good the A round investors don't want to share with B round investors.  But sometimes they do.  Why?  It seems to me that a B round investor needs a compelling value proposition to win over the founder and the A round investor.  Maybe with Yahoo and B round investor SOFTBANK it was the Japanese connection?  Sometimes it is intros to tier-1 carriers, or tier-1 OEMs.  Sometimes, even a top 1% B round company still needs help with good old fashioned company building.  Depends on the company, but top 1% entrepreneurs have their pick of investors at all stages of venture equity financing, as well they should.

So, I remain stage agnostic, and trying to focus on the top 1% early and late, particularly in data storage, wireless and nexgen advertising.  Neither early nor late is easy.  There is no free lunch.

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Traffic to this blog has been light.  Maybe I need to buy some AdWords.  It is possible my content is no good, but I need to drive more eyeballs first to figure that out.

Redpoint Schadenfreude Off the Mark

If you do a Yahoo search or Google search on Redpoint Ventures, you will find articles questioning the venture firm's ability to keep raising money: SiliconBeat: Redpoint Ventures raises $400 million, despite mediocre results

Well, I will share my two cents on how they keep raising money:

1. Redpoint's founders were among the best in the business at their prior firms and have the track record to prove it.

2. Redpoint's partners are on the short list of investors sought by leading Internet and consumer entrepreneurs, which will pay off in the form of "supernormal" returns in the future.

Redpoint must have rubbed a few journalists the wrong way when they launched in 1999.  They were pretty bold back then.  It sounds like some of the pundits hold a grudge.  In the trenches, what I am seeing is that the best entrepreneurs are not holding a grudge.  They are lining up to work with Redpoint.  So, the limited partner community is as well.  I suspect they will be rewarded.