There will be a downturn. It might be in a day. It might be in a year. It might be in a decade. We have no idea when it will come, but it will come.
I was talking to a VC yesterday who was an entrepreneur in the late 1990s, which we now commonly referred to as the Internet bubble. He was very successful as an entrepreneur and has continued to be very successful as a VC. A VC who has been around for a long time recently told him that you aren’t a real VC until you’ve been through at least one downturn. He commented that while knowing this, it’s hard not to be a cynic when things are going well and he wondered out loud if there was a way to balance optimism and cynicism as a VC. I had a quick reaction about continually being deeply rational about what one encounters, but it didn’t feel very satisfying to me as an answer.
We are in a very positive part of the startup / entrepreneurship cycle. Given that, there is a regularly occurring discussion about whether or not we are in a bubble, or this is a bubble, or is a bubble forming, or some other bubble thing. The conversations devolve quickly into “yes we are” and “no we aren’t.” This is often followed by justifications of positions with a bunch of random data to support the position, where most of the data is either inaccurate, narrowly chosen with huge selection bias, or a function of what the public market guys like to call “talking your own book.”
I have no idea if we are in a bubble or not. And I don’t care since, as an early stage investor, I play a long term investing game, because I have to. I can’t control liquidity or timing, especially when I initially make an investment. The market is going to move wherever it is going to move and is completely exogenous to me so timing it is irrelevant.
I’ve lived through several severe cycles – both positive and negative – as an investor. I’ve had successful companies created and built at all stages of the cycle. I’ve had failure at all stages of the cycle. There are great strategies for success in both the positive part of the cycle and the negative part of the cycle. And you can do completely stupid things that blow up your company in both the positive and negative part of the cycle. While the stage of a cycle has impact on a company, it’s only one factor.
As I pondered the cynic vs. optimist question this morning, I landed on a synthetic view that feels right to me. I was walking around my office looking at my physical book shelves, mostly for words to try to characterize what I was thinking about, and I landed on Andy Grove’s amazing book Only The Paranoid Survive. I bought the physical copy after reading The Intel Trinity (one of the business / history books I’ve read recently) which inspired me to go back and read – slowly and on paper – each of Andy Grove’s books.
Boom – that was it – I’m a paranoid optimist in a business context. As a human, I’m optimistic. I believe in good. I like good. I hope for good. I prefer good. I am hopeful about the future. I love the work I do. I love helping create companies. I love playing with technology. I love seeing amazing new ideas come to life. I love being alive. I hope to live a long time.
But I know that there is plenty of bad out there. I’ve experienced a lot directly in business, whether it’s bad actors, stupid decisions, unintended negative consequences, self-inflicted trauma, passive aggressive behavior, or outright deceit. I’ve made assumptions about what I think will happen only to have my assumptions be completely incorrect, or correct in my parallel universe to the reality that actually ensues. Some of this has been under my control or impacted by my viewpoint while some of it has nothing to do with me in any way, but is like the proverbial elephant that accidentally steps on and crushes the ant.
When I link this to the cynic vs. optimist dichotomy, I’m definitely not a cynic. But I’m not an unbridled optimist that can only expect more positive. And I don’t vacillate between cynic and optimist based on individual situations, companies, or the macro.
Instead, I ignore the macro. I recognize that I have no control over it. I try to use the experience and lessons from the last 30 years of being in business to guide me steadily through whatever part of the cycle we are in. I know the cycle will change and the companies I’m part of will have the opportunity to be successful regardless of the situation. But I also know they have the opportunity to fail. And that’s where the paranoia comes in. It’s a powerful calibrator.
When I reflect on Andy Grove’s leadership of Intel, it was through a series of intense up and down cycles – both within the semiconductor industry as well as the global macro environment. While he leads with the idea of being intensely paranoid, there’s a thread of clear optimism through his big decisions. When faced with brutal challenges, he dealt with them. When there was daylight in front of him, he ran incredibly hard in a positive way to cover as much ground as possible. But he always knew he’d face more challenges.
The next time I get asked the question, “How can you avoid turning into a cynic when things are going well and you know it won’t last forever” I now have an answer. Be a paranoid optimist.
We are in a cycle again where how much you raise is the story. It’s what the press likes to write about (e.g. Company X raised Y from A, B, and C). Now that everyone is overly focused on unicorns, the headline number on the valuation (e.g. Company X raised Y at a valuation of Z from A, B, and C) has crept into the story on big rounds.
While this makes for press release fodder and ego gratification, it’s of very little use to entrepreneurs. There’s no real story there. No understanding of the human dynamics behind the financing. No understand of what actually went down. No underlying metrics that drive the financing. No real perspective on how people thought about things and the choices they made. Just happy talk focusing on the dollar raised. Zero educational value around anything.
Recently, the gang at SalesLoft told the detailed story of their $10m financing. Kyle and his team went through Techstars Boulder in 2012 before moving back to Atlanta and being leaders in energizing the Atlanta startup community. Kyle followed the tradition of extreme openness about the financing process that I think Rand Fishkin started with his post three years ago titled Moz’s $18 Million Venture Financing: Our Story, Metrics and Future.
If you’ve never read Rand’s post on our financing, it goes through an extraordinary amount of detail about Moz’s business, the financing process, the terms, and the timeline. Rand did NOT run this by me before posting it – I saw it at the same time as the rest of the world. He did ask if it was ok with me that he’d be this transparent. I reminded him that I signed up for TAGFEE when I invested, it was his company, and he could write whatever he wanted.
After he posted it, he sent around the link to a few prominent people in the tech media. None of them covered the financing in any way. A few days later, I sent out a few emails asking folks I knew at these sites why they hadn’t written anything, since they so quickly write Company X raised Y from A, B, and C. I didn’t get responses from everyone I wrote, but the ones I got back said something like “Rand wrote too much – there was no story here once he put that post up.”
I found that fascinating. When I pondered it, I realized how divergent the media was becoming from what entrepreneurs were thirsty for in terms of substance.
Late last year, Danielle Morrill followed in Rand’s footsteps with an epic post about our $6.5m financing of Mattermark. In it, she talked a lot about the process, just like Rand did, along with disclosing all kinds of information about the business, the valuation, and what she experienced. I also wrote a post about the financing using Mattermark as An Example of How We Decide to Invest.
Interestingly, the media wrote more this time. I don’t know if it’s because Danielle is in the bay area (while Rand is in Seattle), or the story has broadened. But when I go back and read the media stories, they are still overly focused on the amount of the financing, rather than the story behind it.
Another company that did an awesome transparent funding announcement was Buffer (and app and company I love, but am only a tiny investor in via an AngelList syndicate) when they announced We’re Raising $3.5m in Funding: Here is the Valuation, Term Sheet and Why We’re Doing It. Data, data everywhere. And lots and lots of story.
Now, I’m not suggesting that every entrepreneur should write transparent funding announcements. That’s up to the entrepreneur. But I think it’s super valuable to read the ones that are out there. The amount of useful information to entrepreneurs who are building their companies, both for process, dynamics, and comparables, is enormous. And, while these funding stories are positive, the path to them is often a complete mess, such as Rand’s Misadventures in VC Funding: The $24 Million Moz Almost Raised or Danielle virtually stomping her feet in frustration when she wrote Mattermark Has Raised $2M in Our Second Seed Round.
In my book, this is a lot more useful to read than Company X raised Y at a valuation of Z from A, B, and C. Thanks to the entrepreneurs who are brave enough to put this out there.
Scott Maxwell of OpenView Partners had an awesome post up this morning titled The Truth About VC Value-Add. Go read it – I’ll still be here when you get back.
You may recognize Scott’s name – I wrote about him in my post When VCs Don’t Bullshit You.
The next person on the list of supporters is Scott Maxwell at OpenView Venture Partners. Scott and I were both on the Microsoft VC Advisory Board that Dan’l Lewin organized and ran. While we had never invested together, I felt like Scott was a kindred spirit. We both spoke truth to Microsoft execs, even though they mostly ignored us. I remember a meeting with the Microsoft Mobile 6.0 team as they were pitching us their vision for Microsoft Mobile 6.5. Both Scott and I, on iPhone 1’s or 2’s at the time, told them they were completely and totally fucked. They ignored us. A year or two later they had less than 3% market share on mobile. We had a blast together and as we went out to raise our Foundry 2007 fund, Scott made several introductions which resulted in two wonderful, long term LP relationships.
That’s how a friendship develops, at least in my world. You do stuff together, learn from each other, and then do things for each other. Simple.
Scott’s post is a great history lesson about the evolution of “value-added VC” behavior, especially around organization building by VC firms to “add more value” to their portfolio companies.
Before I dig in, I need to express two biases. First, whenever someone says “I’m a (adjective) (noun)” I immediately think they are full of shit. When someone says “I’m a great tennis player”, I immediately wonder why they needed to tell me they are great and it makes me suspicious. “I’m a deep thinker” makes me wonder the last time the person opened a book. “I’m a value-added VC” makes me think “Isn’t that price of admission?”
Second, I went through the scale up of the organizational VC firm in the late 1990s at Mobius Venture Capital. When we started Mobius, we were four founders and two EAs. At one point we were a 70 person organization, with 10 partners, 20 associates, two business development people, three recruiters, a marketing person, two incubators (anyone remember Hotbank?), a staff to run the Hotbanks, a big back office for accounting, EIRs, and some others folks.
It was a disaster. Now, you can argue that we were terrible at it. Or that we completely fucked it up. Or that our basic premises about what we were doing was wrong. Or that how we managed it was ineffective. Or that it would have worked great if only the Internet bubble hadn’t collapsed. Or probably 83 other arguments.
Regardless, it created a very deeply held belief that I share with my partners at Foundry Group that we wanted to run a VC firm that had none of this. We didn’t want associates. We didn’t want to grow. We didn’t want to build an organization. Instead, we wanted to be extremely close to the entrepreneurs and do all the work ourselves. It just occurred to me that we are bare metal VCs. That kind of fits with the word Foundry in our name.
So, my fundamental biases are (a) I don’t like the phrase “value-added investor” and (b) I have no interest in building a VC firm that looks like one that is configured the way many of the current larger VC firms are organizing themselves.
However, while it’s a bias, I have no opinion on whether it’s a better or worse approach. It’s a different approach. And that’s totally cool – there are lots of different ways to do things successfully. And there are lots of different ways to fuck things up.
In my opinion, Scott is one of the guys that is doing this effectively. I’m an investor in Scott’s funds and a very happy one. Scott’s also been thinking about this and working on it for over 15 years, now at two different firms, so he has a lot of run time with what works and what doesn’t. Many folks that are trying to incorporate “value-add infrastructure” into their firms would be wise to read his post carefully.
Now, if you are paying attention to my biases, you’d logically ask “So why did you co-found Techstars and why are you and your Foundry Group partners so involved?” Remember that it’s a different approach. We deeply believe that the way companies are created and funded, especially at the seed stage, is radically changing on a permanent basis. Techstars, at the very beginning, was based on this premise. It’s scaling magnificently around this premise and the iteration loop on learning is incredibly tight. And, while we are very close to it, Techstars is not “our firm” so we can help with our opinions, lessons we’ve learned, and belief system without having to run it.
Remember, there are lots of different ways to do something. However, there’s a huge difference between “doing something” and “doing something successfully.” The distinction is always worth paying attention to.
My favorite Mark Twain post, which I share with my close friend Phil Weiser (the Dean of CU Boulder) is “History doesn’t repeat itself, but it does rhyme.”
There is a lot of rhyming going on. If you want a quick taste, go read today’s Fred Wilson’s blog post Coming Up With A Better Name For NYC’s Tech Community.
If you know me, you know that it think that it is tragic to label things Silicon Blah. New York isn’t Silicon Alley. It’s New York. And Fred has been ranting about this since at least 2008 when he made a public plea to bury the name Silicon Alley.
Surprise. In 2015 there’s apparently a new effort in New York to rekindle with force the name Silicon Alley.
Here are some rhymes I hear on an almost almost basis.
Whatever.
I was at HBS the other day talking to a bunch of second year students about anything they wanted to talk about (we just did 90 minutes of Q&A). I just let them take the conversation where they wanted. The questions were great, but some of what they were hearing about venture capital was scary as shit. A handful of them had jobs in venture capital firms and we talked about how to be effective as a freshly minted associated. They had heard insane suggestions like “The market is hot – do as many deals as you can before it all crashes.”
Um. Yeah. What? Are you fucking kidding me? It’s not about doing the deals. If you do a bunch of shitty momentum deals as fast as you can, you are simply emulating what most VC firms (including the one I was part of) did in 1999 when we committed an entire $600 million fund in nine months. At one point that fund was up over 2x on paper (TVPI for those of you that like names for the different VC metrics.) 15 years later the financial performance (DPI) of that fund is a disaster. We didn’t get lucky and have one company that bailed us out. Too bad for us.
I told them it’s not about getting into the deals. It’s about building real value and then over time monetizing your investments. Having a strategy, being deliberate, and executing that strategy over a long period of time.
But suddenly so much of the focus is about getting into the deals. Venture Investing Just Had Its Biggest Q1 in 15 Years, Says PwC Report. $13.4 billion in Q1 in 1020 deals. Some other statements, all obvious stuff based on what everyone is seeing on a daily basis. But the headlines, and the focus, is all about input. Now, I haven’t read the PWC Report so they might have a deep analysis on the exit math, and then input / output dynamics that justify $13.4 billion in Q1 as a reasonable number. Or a segmentation analysis that shows that $7 billion of it is actually a substitution effect for what would have otherwise been public money going into IPOs, so really it’s only $6.4 billion going into venture capital.
History doesn’t repeat itself, but it does rhyme.
Now, don’t misinterpret what I’m suggesting. The easy sound bite “Feld thinks there is a bubble.” But that’s not even close to what I am saying. I have absolutely no idea whether there is a bubble. I have no idea where we are in the current part of the cycle. I have no idea what the dynamics of the cycle are.
But it’s easy to see the rhymes. And they are super helpful in understanding, and reinforcing, the best way to execute an effective strategy. But only if you are looking for them, thinking critically, and acting accordingly.
Don’t be the scorpion in the famous scorpion / frog parable. And always remember that history doesn’t repeat itself, but it does rhyme.
I got the following question the other day.
“If you get a chance, I’d request you to write a blog post about various business decision related conflicts or misunderstanding that might occur in a partnership and how you folks at the Foundry Group resolve it. My partners and I grapple with such challenges quite often.”
Every VC firm is different so to answer a question like this, it’s important to remember that the answer is one specific to Foundry Group. Never forget that VCs Are Like D&D Characters.
When my partners and I started Foundry Group in 2007, we created a set of deeply held beliefs that we carry around with us every day. Some of them are about our strategy and some are about our behavior.
One of our deeply held beliefs is that “We will address and resolve all conflict between us directly, clearly, quickly, and openly.”
This is easy to say but very hard to do. It means that there will be no passive aggressive behavior on anyone’s part. We won’t carry around things that bother us. Instead, we’ll put them on the table to discuss. We have to have a strong basis of trust, which we’ve extended to the notion of “business love.”
It has to be ok to be upset, to disagree, to be sad, to be disappointed, and to be unhappy. These are normal emotions. Things don’t work, they can be confusing, frustrating, or downright miserable. A partnership has to be a safe place to be open about these emotions, especially when they are being generated by someone in the partnership.
The deeply held belief is nice, but unless there are tactics and consistent action to back it up, it ends up being meaningless. There are three things we do to make sure we execute on this deeply held belief.
Weekly Time and Space for Discussion: We have a set time on Monday’s – between 11am and 1pm – where the four of us meet every week. Unlike many firms that chew up an entire Monday of “partner meeting stuff”, we do it over lunch. As part of this we have a chance to touch base with each other once a week. This is like flossing your teeth – it gets rid of the easy stuff.
Regular Dinner / Offsite: We have a full day offsite at least quarterly and as often as monthly. We spend at least an hour on the question “How are each of us doing?” In this case, “doing” means “emotionally doing” and covers what is on our mind, how we are feeling, what is stressing us (professionally and personally), and how we are doing with each other. Sometimes the discussion is balanced between the four of us; other times it ends up being focused on one person. We always end these days with a long dinner together, which allows us to spend more time on our collective relationships.
Be Direct: I wrote about this in a post last year titled Brutal Honesty Delivered Kindly. In all of these discussions, we are direct. We are kind to each other and never gratuitous in our comments, but always speak the truth. And when someone is wrong, he owns it.
Fundamentally, it’s about communication. Without the deeply held belief, we don’t have a clear context for how the communication works. But the combination of the deeply held belief and regular practice over the past eight years, has resulted in a highly efficient, trusted form of conflict resolution. Sure, we screw up plenty, but it’s easy to recognize, acknowledge, and course correct when we do.
I was on an airplane for the first time for business in a while and when I woke up from my nap I found my self staring at CNBC on the DirecTV seat back display. I never watch CNBC so I was attracted to the talking heads, who were silent since I didn’t have earphones in. I kept thinking I was watching ESPN with all the sports metaphors, blinking lights, constantly changing headlines, and tightly coifed and good looking men talking at me in rapid fire.
Between a headline about Carly Fiorina exploring a run for president and Zebra Technologies equipping all NFL players with tracking devices I noticed one about companies who were raising prices to inflation proof their business. At least, that’s what I thought it said since it flashed up there quickly between a headline about “Steel is on Fire” and then a video of Warren Buffett walking around without a headline so I had no idea why they were showing him.
The inflation proofing headline stuck in my head. We’ve had a very long period of low to no inflation, at least based on the way the government calculates it. While my cynicism around government math and how inflation is calculated is substantial, there isn’t much question that since 2008 capital has been extremely cheap. Fred Wilson wrote a great post titled The Bubble Question a while ago where his punch line was:
It is the combination of these two factors, which are really just one factor (cheap money/low rates), that is the root cause of the valuation environment we are in. And the answer to when/if it will end comes down to when/if the global economy starts growing more rapidly and sucking up the excess liquidity and policy makers start tightening up the easy money regime. I have no idea when and if that will happen. But until it does, I believe we will continue to see eye popping EBITDA multiples for high growth tech companies. And those tech companies with eye popping EBITDA multiples will use their highly valued stock to purchase other high growth tech business and strategic assets at eye popping valuations. It’s been a good time to be in the VC and startup business and I think it will continue to be as long as the global economy is weak and rates are low.
But I think cheap capital is only half of the equation. The other half is ever increasing labor costs across all aspects of the wage chain. When I was in business school in the 1980s, we talked a lot about the productivity paradox. The premise was that computers and automation would drastically improve productivity, making labor less important as tasks were automated, resulting in lower cost of labor.
As the technology industry rapidly evolved, the notion of non-productivity kept coming up. Nicolas Carr’s HBR Article “IT Doesn’t Matter” was probably the capstone piece around this and how companies could take advantage of the commoditization of IT, rather than how IT was a transformative input into companies and societies.
Suddenly, in 2010, technology was disrupting everything and the technology industry was booming. By 2013 everyone was talking about a bubble, even though the companies being created this time around were substantial. Once again, wages for IT employees and computer scientist were skyrocketing and suddenly coding schools were popping up everywhere, to the point that people are now saying that Computer Programming Is a Trade; Let’s Act Like It.
Capital remains incredibly cheap, so it’s flowing into wages. But that’s only at the high end of the market around technology jobs. At the other end of the spectrum, we have the famed jobless recovery with the elimination of massive numbers of jobs that previously existed, especially in industrial and Fortune 5000 companies. While this is happening, we have an entirely new class of entrepreneurs, or self-employed, being created by companies like Uber.
Yeah – this shit is super complicated and it plays out over a long period of time. In fact, it might only be really possible to understand what is happening in hindsight. But the combination of cheap capital and expensive labor has created a very powerful economic dynamic which right now is driving massive innovation across virtually every industry sector around the world.
We know that extremely low cost of capital will not last forever. We know that eventually there will be real inflation again. And we know that wages can’t increase endlessly. I wonder what happens to the allocation of capital, entrepreneurship, and the impact on society when capital gets expensive again?
I know many entrepreneurs who feel that VCs have played them, gamed them, deceived them, or bullshitted them. But this doesn’t only happen to entrepreneurs. VCs play this game with VCs all the time.
One of our deeply held beliefs at Foundry Group is that there is no value in bullshitting anyone. We screw up a lot of things, make plenty of mistakes, and often look back and say some version of “oops.” But we never bullshit each other or bullshit anyone we work with.
Seth, Jason, and I had an awesome dinner with one of our LPs last night. In addition to being an incredibly supportive investor in us from the beginning, this LP has become an extremely close friend. He’s someone we trust with anything and listen to carefully whenever he has feedback. And we always enjoy being together – a lot.
As I was walking home after dinner, I thought about the person who had introduced us to this LP. His name will be familiar to plenty of you – it’s Fred Wilson. This LP is also a long time investor in Union Square Ventures and was one of the first people Fred introduced us to when we started raising the first Foundry Group fund in 2007.
In 2014, it’s easy to reflect on what has happened over the last seven years and feel good about it. I’m fortunate to have three amazing partners, an awesome team that I get to work with every day, a hugely supportive set of about 20 LPs, and hundreds of entrepreneurs who we love to work with, and whom I think respect us and appreciate us a great deal.
But is wasn’t always this way. In 2007, when we set out to raise our first Foundry Group fund, early stage tech VC was in the shitter. No one believed that you could make any money as an early stage VC and when we went out to raise our first fund, we heard over and over again that we were on a fools errand. The prior fund that I had co-founded – Mobius Venture Capital – had blown up after having a very successful first fund in 1997. The collapse of the Internet bubble was not kind to us and by 2005 it was clear that our second fund – raised in 1999 – was a disaster, and our third fund – raised in 2000 – was off to a very rocky start.
In early 2006, my partners at Mobius and I decided not to raise another fund. In 2007, several of us (Jason, Ryan, Seth, and I) set out to create a new firm.
I thought I had a lot of VC friends and supporters from the last decade of my life as a VC. I quickly learned that it was easy for these so-called friends to say “I’ll help” and very hard for them to actually follow through.
When we started raising our first Foundry Group fund in 2007, I called many of the VCs I knew and asked them for introductions to their LPs. While some of them said they would help, I only recall three who actually made any serious introductions.
Fred Wilson at Union Square Ventures was by far the most helpful. Fred introduced me to all of his significant institutional LPs. We had been friends for a long time and had worked together on several companies. I had deep respect for Fred and I think he felt the same way about me. There was no hesitation on Fred’s part – he made real introductions, advocated strongly for us, and was unbelievably supportive. Over 33% of our capital ended up being from the same LPs who invested in USV. I will never, ever, ever, forget this. Fred can ask me for help on anything he wants for the rest of his life and I will always be there for him.
The next person on the list of supporters is Scott Maxwell at OpenView Venture Partners. Scott and I were both on the Microsoft VC Advisory Board that Dan’l Lewin organized and ran. While we had never invested together, I felt like Scott was a kindred spirit. We both spoke truth to Microsoft execs, even though they mostly ignored us. I remember a meeting with the Microsoft Mobile 6.0 team as they were pitching us their vision for Microsoft Mobile 6.5. Both Scott and I, on iPhone 1’s or 2’s at the time, told them they were completely and totally fucked. They ignored us. A year or two later they had less than 3% market share on mobile. We had a blast together and as we went out to raise our Foundry 2007 fund, Scott made several introductions which resulted in two wonderful, long term LP relationships.
The last person who was helpful was Jack Tankersley at Meritage. When I moved to Boulder, Jack was one of my early mentors. He was a partner and co-founder of Centennial Funds and he and Steve Halsted basically created the VC industry in Colorado in the early 1980s. Jack was extremely helpful in coaching me on how to create a new firm and made a number of introductions, one of which became an LP. I appreciated the energy he put into this immensely.
There were at least a dozen other VCs who said “I’d be happy to make some introductions for you.” Very few of them did, and the ones that did made introductions to junior people at LPs who quickly blew us off.
My partners and I are forever appreciative of Fred, Scott, and Jack’s help. And, after 90 meetings in the first three months of fundraising, which resulted in 20 immediate rejections and no obvious path to a fund at the end of the first quarter, our appreciation for these three people grew. As we started to have momentum in the second quarter, Fred and Scott really stepped up and advocated for us. By September we were oversubscribed and did our first close with our final close in November. We’ve never looked back.
The wonderful dinner last night with the LP Fred introduced me to reminded me of this. But more importantly, it reminded me of how often VCs bullshit each other and entrepreneurs. And, in the situations where they don’t, how incredibly powerful it is.
Fred, Scott, and Jack – thank you.
I woke up to an article in Daily Camera today titled Small Business Administration trying to bring SBIC funds to Colorado.
There are so many things wrong in the article I felt compelled to write about it. This isn’t a knock on the writer (Alicia Wallace) – I like Alicia and think she does a good job. Rather, it’s an example of the difference between signal and noise in any kind of reporting around the VC industry.
I’m an investor in over 40 VC funds around the world (mostly in the US) and three of them are SBIC funds. Each of the SBIC funds were raised in the 2000 – 2002 time period. On paper, only one is in positive return territory as a fund, but the SBIC leverage is a substantial negative factor for the LP investors in that particular fund. And, in the other two, I don’t expect to ever see any of my capital back because of the SBIC leverage. Furthermore, I don’t believe any of the GPs in any SBIC-backed fund would ever take money from the SBIC again.
So I’m speaking from at least a little experience – albeit indirectly – with the SBIC, as I’ve never been a GP in a fund that had SBIC leverage.
The article starts off saying that “Matthew Varilek has traveled across the state, proselytizing the potential benefits of the Small Business Investment Company Program.” As a partner in one of the most visible VC firms in Colorado and an LP in many of the Colorado VC firms, I’ve never heard from Matthew or anyone from the SBIC. Matthew, if you really want to have a deep discussion about why the SBIC program isn’t effective for VC funds anymore, feel free to give me a shout. I’d be happy to meet with you.
Next, there is the wonderful PR quote about the SBIC that says “Since the program’s inception, SBIC “success stories” include the funding of companies such as Apple, Costco and FedEx when they were burgeoning small businesses.” The SBIC was instrumental in the creation of the venture capital business. The Small Business Investment Act of 1958 helped catalyze many of the VC firms created in the early 1960s. When I first heard about VC firms in the late 1980s, and my first company (Feld Technologies) started writing portfolio management software for some Boston-based VC firms, many of them had funds with SBIC leverage, although even by the late 1980s this was changing and many of them had shifted away from the SBIC. If you want to see a fun quote on it, read A History of Silicon Valley which quotes:
“ …many venture capital pioneers think the SBIC program did little to advance the art and practice of venture investing. The booming IPO market proved the model of investing in new companies, as some SBICs cash out at attractive levels. SBICs did give a boost to early venture firms, and some like Franklin “Pitch” Johnson, profiled below, thought the new law made the US “see that there was a problem and that [venture investing] was a way to do something… it formed the seed of the idea and a cadre of people like us.” Bill Draper, the first West Coast venture capitalist, has been more blunt: “[Without it] I never would have gotten into venture capital. . . it made the difference between not being able to do it, not having the money.” Many believe SBICs filled a void from 1958 to the early 1970s, by which point the partnership-based venture firms took off. The US government, however, lost most of the $2 billion it put into SBIC firms.”
So, while Apple, Costco, and FedEx benefited, the PR would be more credible if the SBIC was trumpeting iconic companies created after 1990 or even 2000, especially where the lead investors (rather than follow on investors) had SBIC capital.
Peter Adams, head of Rockies Venture Club, is quoted a few times. I like and respect Peter, so this isn’t aimed at him, but rather at the clear lack of understanding of the capital dynamics around VC funds.
“It looks really great on the surface,” said Peter Adams, executive director of the Rockies Venture Club, a nonprofit aimed at connecting investors and entrepreneurs. “Then when you dig into it, there were some problems.” Adams, who has been involved in many of the meetings with the SBA and members of the investment community, said the greatest concerns voiced by investors and venture capitalists involved management team qualifications, investment track records and the addition of debt to the equation. No. 1 for us is they want a management team with multiple people that have track records in venture capital and have worked together as a team before,” he said. “I can see where they’re going with it, but the VC industry in Colorado has been fairly decimated through the economic downturn.”
Peter is right about the context, but has two fundamental things wrong here. First, the VC industry in Colorado wasn’t decimated through the economic downtown. It was decimated because of lack of performance between 2001 and 2009, just like much of the rest of the VC industry around the US. There’s nothing special about Colorado in this mix, and it has nothing to do with the economic downtown. This dynamic has been reported thousands of times so I don’t need to go through it again, but we don’t have to look back very far to hear the drum beat from the media, LPs, and everyone else about how “VC is dead.” And if you’re curious, it wasn’t too long ago that Silicon Valley was also dying.
The other problem here is the need of the SBIC to invest in “a management team with multiple people that have track records in venture capital and have worked together as a team before.” Any VC firm that fits this qualification is unlikely to have difficulty raising money in today’s environment, and subsequently has no need for the SBIC leverage. And, more importantly, the only firms that will look for SBIC leverage are one’s that don’t have this, which is a classic adverse selection problem.
Then there’s this:
The recession also then plays into requirements that the management team members have been involved in a meaningful number of successful exits during a four- to six-year period. “From 2008 to 2013, that was not a good time for exits,” Adams said.
Huh, what? At Foundry Group, our significant exits (at least 10x capital returned) since we raised our first fund in 2007 include AdMeld, Zynga, MakerBot, and Gnip. We’ve had plenty of other exits, but these are the big ones. One of those companies, Gnip, is Boulder-based and another from our older funds (Rally Software) also generated a greater than 10x return for us. Techstars (which we helped start) have also had a steady stream of significant exits, including local Boulder companies like Filtrbox, GoodApril, and SocialThing. And then you’ve got plenty of Boulder / Denver monsters on paper – some in our portfolio (like SendGrid and Sympoz) and others like Zayo, Ping, Logrhythm, and Datalogix. Finally, if you look across the country, the exits have been awesome the past three years.
It keeps going. There’s talk about the “angel cliff” (e.g. we need funds to invest between angels and VCs – nope, been there – remember “gap capital” – not so effective) and the SBA rules and regulations (which I believe are toxic and inhibiting to a successful VC fund.)
One of the other problem is SBA and SBIC’s behavior in governance of the fund. The paperwork is silly and the overhead is non-trivial. The control over distributions and negative incentives to hold or distribute capital often generates bad decisions when companies go public. And at least one close friend who is a partner in an SBIC fund has now found a new LP to buy out the SBIC so they could actually invest capital in their winners, rather than be limited by the SBIC’s constraints on the amount of capital you can invest in any particular company.
The SBIC could be a powerful force for good in the venture capital industry. But it has to approach things very different and based on my experience with the SBA over the past decade, I don’t see it happening unless there is real leadership somewhere in coordination with leaders in the VC industry. I’m certainly willing to help, if only someone bothered to reach out to me.
UPDATE: It turns out my partner Seth Levine had met with Matthew a while ago. Seth said “Your blog was right on and much of the type of thing I related to Matt and some senior guys he brought in. The gist of my conversation with them was pushing them to consider a different model – that the current one basically led to lowest common denominator GPs and sub-optimal returns. Plus the SBIC leverage could be crushing. I don’t think they have a ton of flexibility around this but they at least listened to the feedback. I’m going to see a bunch of them in a few weeks – I agreed to help judge a business plan competition they were hosting. Like you I’m not a huge fan of the program as it has existed but I give the new guys some credit for both reaching out and trying to be proactive about thinking through this.”
UPDATE 2: Matthew Varilek reached out to me and we are setting up a time to talk.
Almost exactly a year ago I wrote a post Your Words Should Match Your Actions. It was a generic rant that resulted from me watching a couple of VCs blow up their reputations with entrepreneurs I know because of how they treated them.
This morning I ended up on an email thread about this. I’m going to anonymize it, but you’ll get the point. The two people (who I’ll call “Entrepreneur” and “VC”) are both very successful, extremely smart, and very visible.
Entrepreneur: Thread below is 2+ years old, but resulted from VC asking me similar questions. Interestingly, when I (a year later) pinged VC about my new company, not even the courtesy of reply from him. Bad mojo. 🙂
Me: Welcome to the “assholeness-VC-factor.” Hey – I’m important – give me info. Oh – you are now raising money – fuck off.
Entrepreneur: I’m amazingly appreciative to short, polite “no thank you’s”. I don’t know whether VCs think that’s too much work, or whether they want to leave open the possibility of the “must have been caught in my spam filter” excuse when the startup becomes a rocket in 2 years?
I then went on a more serious rant explaining what I think is going on.
It’s worse that that.
In my book Startup Life (that I wrote with my wife Amy) I said that one of the key things that has made our relationship work is that I realized “my words had to match my actions.” After about decade of telling her she was the most important person in my life, and then being late to dinner, canceling things at the last minute because something else came up, or taking a phone call without even looking at who was calling when we were in the middle of a conversation, she’d had enough and our relationship almost ended.
My biggest behavior change 14 years ago was to focus hard on having my words match my actions, and my actions match my words. Simple to say, really hard to do.
Of course, it also works in a business context. I’ve learned, and deeply believe, that it’s the essence of being authentic. You can have any style you want – these two things just have to match up.
Sadly, many very successful people simply don’t understand or appreciate this. They put huge amounts of energy into developing a public persona. It could be PR, it could be speeches, or writing, or systematic campaigns over a period of time about themselves and their businesses.
But then their words and their actions don’t match up. Over and over again. It can be subtle or overt. It can be mild or jarring. It doesn’t matter – if they haven’t internalized the idea of their words and actions matching up, there is a long negative reputational effect.
And, as our email exchange demonstrates, it lingers. I have heard the same thing about that VC and I’ve experienced it personally. Yet his public persona is “entrepreneur friendly”, “very accessible”, “incredibly smart”, and “highly capable.” Yet, he completely blew you off, after asking you for something when you were a powerful and well-connected executive at a large company. Stupid behavior on his part.
Oh, and in addition, this VC missed a chance to invest in what is now a rocket ship. And the entrepreneur didn’t go back to him for the Series B because he got blown off the first time, so the VC missed two chances to invest.
Do your words match your actions? If you don’t know, ask yourself at the end of each day “did my words today match my actions.”