Tag: Venture Capital

Feb 25 2016

The Retrade

The retrades have begun. Since the beginning of the year, I’ve experienced four retrades – two early stage, one growth, and one late stage – and I’ve heard of a number of others.

If you’ve never experienced a retrade, or don’t know what I’m talking about, it’s the situation when you have a firm deal agreed upon or a term sheet signed and are proceeding to closing a deal, when the investor (or acquirer) decides to change the terms of the deal. And, in case you were wondering, it’s always to make the terms worse, not better.

This happens regularly in M&A deals especially with buyers who are buying thinly capitalized companies or ones who don’t care about their long term reputation. It’s very prevalent with buyers who over time get the reputation as bottom feeders and is often something floated during the diligence process to test the conviction of the seller.

However, for the past six years or so, I haven’t seen retrades from VCs or angels investing in companies very often. Occasionally a deal will fall apart in diligence, some famously so, but they rarely have been retraded.

This lack of retrades, however, is not the historical norm. When I started investing in the 1990s, I experienced a lot of retrades from VCs at many different stages. While a term sheet isn’t binding, part of the reason it tended to be long and complicated was to avoid the retrade dynamic and spell out all the terms of the deal explicitly.

In the late 1990s into the mid 2000s, I viewed the risk of a retrade as continuous background noise in any deal – investment or M&A. The notion of deal certainty became important to me and I started spending more time working with investors and acquirers who I believed had a very high likelihood of following through on what they said they were going to do. In contrast, once I found myself being retraded by someone, I noted it and had a higher bar for working with them going forward, since I expected there would be a future likelihood of a retrade if I did something with them.

By the late 2000s, I had stopped being emotional about the notion of a retrade. I viewed it as a normal part of business, which impacted an investor or acquirer’s long term reputation, but was woven into the fabric of things.

And then the retrades more or less stopped. From 2010 forward, the entire VC market shifted into a mode that many describe as “founder friendly.” Investor reputation mattered at both the angel and VC level. Retrades were a huge negative mark on one’s reputation and word got around. As more and more investors showed up, valuations increased, and time to close a deal shortened, there was little tolerance for a retrade, so they disappeared.

As we are now about five months into a broad market reset, both for public and private market valuations, the retrade has reappeared in private investments. The first indicator of it is that it now takes longer for a deal to close. I expect the days of transactions closing 15 days after a term sheet is signed are probably gone for a while. While some lawyers are breathing a sigh of relief, a deal that takes more than 30 days to close often starts to have a little bit of retrade risk. And, when a deal stretches out over 60 days, there’s a lot of risk around deal certainty – both retrade as well as a full deal collapse.

Recognize that I’m talking about investments, not acquisitions. I never saw the retrade dynamic go away with certain buyers and certain type of acquisitions. However, what’s notable to me on the investment side is that the retrade is happening up and down the capital stack.

Comments
Jan 2 2016

What’s Happening Today That No One Sees?

Amy and I watched The Big Short on Tuesday with my partner Jason and his wife Jenn. We were electrified as we walked out of the theater – all four of us loved it. Jason commented that it was a particularly impressive movie given the subject matter. I couldn’t stop saying “that’s the best explanation of what created the financial crisis that I’ve ever seen.”

I remember reading The Big Short in 2010 when it came out. I’m a huge Michael Lewis fan and gobbled it down in a day or two. As we walked to the parking lot, I commented that the big four actors (Gosling, Carell, Bale, and Pitt) in the movie totally nailed their roles. I particularly identified with Pitt’s character Ben Rickert (based on Ben Hockett) who lives in Boulder in the movie.

As we got into our car, Amy said, “What do you think is happening today that no one sees?” This was the underlying theme of the movie – there were some completely obvious things in hindsight going on at the time that no one saw, or wanted to see. A few did notice and made huge financial bets, in non-obvious ways – about what they saw and believed was going to happen. Their foresight and conviction paid off massively, but it scarred each of them in different ways that the movie dramatized extremely well.

I like some time to pass before I look at history. While some people are good at reflecting on the past year and looking forward to predict the next year (one of the best in the VC world is Fred Wilson – read his posts What Didn’t HappenWhat Happened In 2015, and What Is Going To Happen In 2016), I’ve never been particularly good at a one year time frame. Instead, I generally like a ten year moving window to process things. So, the lens of 2005 (history) and 2025 (future) is the one I’m currently enjoying.

The Big Short is picking up major steam in 2005. The climax happens in 2008 and the denouement continues on until 2011. So, from a history window perspective, the time frame landed directly on my boundary. Subsequently, Amy and I went on a binge the past few days of other media around this, including the movie Too Big To Fail (which is really about what happened in the fall of 2008) and Inside Job (which covers a broader time range, but focused on 2005 – 2008).

As I sit here on January 2nd, 2016, I’m pondering “what is happening today that no one sees?” When I go back a decade, we were just making the decision not to raise another Mobius Venture Capital fund. My partners and I hadn’t yet created Foundry Group. Techstars didn’t exist. Venture Capital and entrepreneurship was dramatically out of favor. Early stage and seed capital was extremely difficult to find.

I remember having deep conviction that there was an enormous wave of technological innovation coming. I knew that many of the things that had been created in the Internet bubble were great ideas, but they were just – as Jerry Colonna and I like to say – a decade ahead of their time. Today, it’s pretty obvious that was correct. At the time, talking about this stuff was a conversation stopper of the sort that Michael Burry (played brilliantly by Christian Bale) seems to generate every time he talks to someone.

Unlike Mark Baum, who is based on Steve Eisman (and played even more brilliantly by Steve Carell), I’m not angry, cynical, and convinced the world is a giant, rigged, inside game. But I do believe that the vast majority of people have absolutely no idea what is really going on, especially those who are in the middle of whatever game they are playing.

While this comes out in The Big Short, it’s even more apparent when you watch (or read) Too Big To Fail. And, while watching Inside Job, you see people lying or trying to obscure the truth in almost every interview. You can’t fake reality – it always catches up with you.

In the mean time, I’m getting ready for the next season of Game of Thrones.

Comments
Aug 30 2015

The Twenty Minute VC Podcasts

I don’t listen to that many podcasts, but I like ones that are a short (< 45 minute) interview format. I can listen to one of these on a run or a drive to/from my office.

Until recently, the only one I was listening to regularly was the Reboot.io podcast. Jerry Colonna, the co-founder of Reboot.io is a dear friend and his interviews are often magical.

A few months ago I noticed The Twenty Minute VC by Harry Stebbings. I can’t remember which one was the first one I listened to, but I thought his style and interview approach was great. It was fast, started with an origin story, but quickly moved on to the present and then ended with a set of short questions.

Jon Staenberg, a long-time friend from Seattle who did an interview with Harry on episode 034, dropped me the following email at the end of April:

He seems like a good guy, want to be part of his podcast?
U good?
Ever in seattle?

I told Jon I’d be game. Harry responded immediately and we did a podcast together six weeks ago. I’d been listening regularly since Jon introduced us and heard several great podcasts, including mentions of me in 055 with Jonathon Triest and 059 with Arteen Arabshahi.

Last week Harry releases two episodes 065 with me and 066 with my partner Seth Levine. I had fun doing mine but absolutely loved listening to the one with Seth, especially around his version of the Foundry Group origin story.

Harry promises to interview our other two partners – Ryan McIntyre and Jason Mendelson – so he’ll ultimately have a triangulation (or maybe a trilateration) of our origin story.

In the mean time, enjoy the interviews with me and with Seth if you are looking for a podcast to listen to.

Comments
Aug 25 2015

A Venture Capital History Perspective From Jack Tankersley

In January, Jerry Neumann wrote a long and detailed analysis of his view of the VC industry in the 1980’s titled Heat Death:  Venture Capital in the 1980’s. While I don’t know Jerry very well, I like him and thought his post was extremely detailed and thoughtful. However, there were some things in it that didn’t ring true for me.

I sent out a few emails to mentors of mine who had been VCs in the 1980s. As I waited for reactions, I saw Jerry’s post get widely read and passed around. Many people used it as justification for stuff and there were very few critical responses that dug deeper on the history.

Jack Tankersley, a long time mentor of mine, co-founder of Centennial Funds, and co-founder of Meritage Funds, wrote me a very long response. I decided to sit on it for a while and continue to ponder the history of VC in the 1980’s and the current era we are experiencing to see if anything new appeared after Jerry’s post.

There hasn’t been much so after some back and forth and editing with Jack, following is his reaction to Jerry’s piece along with some additional thoughts to chew on.

It is good that Mr. Neumann begins his piece in the 70’s, as that era certainly set the table for the 1980’s. You may recall I got into the industry in 1978.

The key reason for the explosion in capital flowing into the industry, and therefore the large increase in practitioners, had nothing to do with 1970’s performance, early stage investing, or technology. Instead, it was the result of two profound regulatory changes, the 1978 Steiger Amendment, which lowered the capital gains tax from 49% to 28%, and the 1978 clarification under ERISA that venture capital investments came within the “prudent man” doctrine. Without these changes, the 1980’s from a venture perspective would not have happened and the industry would have remained a backwater until comparable regulation changes stimulating capital formation were made.

Secondly, the driver of returns for the funds raised in 1978 – 1981 was not their underlying portfolios, at what stage, or in what industries they were built. Instead, the driver was the 1983 bull market. The Four Horsemen (LF Rothschild, Unterberg Tobin, Alex Brown, H&Q and Robinson Stephens) basically were able to take any and everything public. Put a willing and forgiving exit market following any investment period and you get spectacular returns.

So contrary to the piece, it wasn’t VC were good at early stage technology, it was that they had newfound capital and a big exit window. For example, my firm at the time, Continental Illinois Venture Corporation, the wholly owned SBIC of Chicago’s Continental Bank, had many successful investments. Some were Silicon Valley early stage companies, such as Apple, Quantum, and Masstor Systems.  I handled CIVC’s investments in the latter two (in fact, I also “monitored” Apple as well).  Take a look at the founding syndicates of each:

Masstor Sytems (5/1979)     Quantum Corporation (6/1980)
CIVC $   250,000     CIVC $   200,000
Mayfield II $   250,000     Sutter Hill $   790,000
Continental Capital* $   250,000     KPC&B II $   775,000
Genstar** $   275,000     SBE+ $   700,000
S & S*** $   225,000     Mayfield III $   500,000
    BJ Cassin $     75,000
Total $1,250,000     Total $3,040,000

*Highly regarded private SBIC, **Sutter Hill Affiliate, ***Norwegian Shipping Family, +B of A’s SBIC

What is striking about these syndicates is that nobody had any meaningful capital, which forced syndication and cooperation.  CIVC’s only “competitive” advantage was its ability to write a check up to $1 million. In this era, the leading VC firms such as Mayfield, Kleiner, and Sutter Hill (all shown above), rarely invested more than $1 million per company.

When we syndicated the purchase of the Buffalo, New York cable system, we literally called everybody we knew and raised an unprecedented $16 million, a breathtaking sum in 1980. As dollars flowed into the industry, cooperation was replaced by competition, to the detriment of deal flow, due diligence, ability to add value and, of course, returns.

CIVC had a number of highly successful non-technology investments made in the late 1970’s timeframe, such as:

  • LB Foster: Repurposed old train tracks
  • JD Robinson Jewelers: The original “diamond man” (Tom Shane’s inspiration)
  • National Demographics: Mailing Lists
  • American Home Video: Video Stores
  • Michigan Cottage Cheese: Yoplait Yogurt
  • The Aviation Group: Expedited small package delivery
  • JMB Realty: Real Estate Management company

None of these companies fit Mr. Neumann’s definition of the era’s venture deals and each generated returns we would welcome today.

For many years preceding 1999, the 1982 vintage was known as the industry’s worst vintage year.  Was this a function of “too much money chasing too few deals” as many pundits claimed? Not really; it was a result of an industry investing into a frothy market at higher and higher valuations in expectation of near term liquidity, and suddenly the IPO window shutting, leading to no exits and little additional capital to support these companies.

Mr. Neumann’s post also misses the idea that it was a period of experimentation for the industry, This time period saw the rise of the industry-focused funds and the advent of the regional funds. Many of the industry funds were wildly successful (in sectors such as media communications, health care, consumer, etc.), while none of the non-Silicon Valley regional firms were long-term successful as regional firms. Some regional firms, such as Austin Ventures (in Austin, TX) did prosper because they subsequently adopted either an industry or national focus. The remainder failed as a result of the phenomenon of investing in the best deals in their region which typically were not competitive on a national or global scale. Just imagine doing Colorado’s best medical device deal which was only the 12th best in its sector in the world.

Some additional observations include:

  • Many of those quoted in the article such as Charlie Lea, Kevin Landry, Ken Rind, and Fred Adler, were all very well known in the industry. However, none were based in the Silicon Valley and are probably unfamiliar names to today’s practitioners. I knew them all, because we all knew each other in this era.
  • “By January 1984, investors had turned away from hardware toward software.”  This isn’t true. Exabyte, one of Colorado’s hottest deals, was formed in 1985; Connor Peripherals (fastest growing company in the history of technology manufacturing, four years to $1 billion in revenue) raised its first round in 1987.
  • “By 1994 the big software wins of the 1980’s were already funded or public.” This isn’t correct either. A good example is Symantec
  • “Ben Rosen, arguably the best VC of the era”. While Ben may well have been among the best, in the early 1980’s Ben was brand new to the industry. He was a former Wall Street analyst with no operating or investment experience, who became a VC by teaming up with operator LJ Sevin. Even many newcomers with little real experience were quite successful.
  • Silicon Valley firms also did many non-tech deals. Sequoia followed Nolen Bushnell from Atari into Pizza Time Theaters (and according to legend, did well). I well remember being in Don Valentine’s office as he waxed poetically about his new deal, Malibu Race Track. Unfortunately Reed Dennis of IVP did not do as well in his Fargo, ND-based Steiger Tractor investment!
  • “Venture capitalists’ job is to invest in risky projects.”  This statement is scary to me. We should be risk evaluators, not risk takers.  We should invest where our background and instincts and due diligence convince us the anticipated return will far exceed our evaluation of the risk. There are five key risks in any deal:  Market, Product (a/k/a technology), Management, Business Model, and Capital. Taking all five at once is crazy. Most losses happen when you combine Market and Product risk – take one, not both, and take it with a proven entrepreneur.
  • “The fatal flaw of the 80’s was fear”. I strongly disagree. Instead, it was the result of virtually no liquidity windows after 1983. As mentioned, the industry also experimented with new strategies such as industry focus funds and regional focus funds. Some worked; some did not.  Also in the 80’s, the megafunds were created (at the time defined as $100 million plus); the LBO sector outperformed venture through financial engineering; asset gatherers, such as Blackstone, were created. The biggest Wall Street crash since the Great Depression (October, 1987) shocked us all.  “They don’t talk about the 80’s”; if true, maybe it’s because the period cannot be simplified.

The 1980’s proved there is more than one way to “skin a cat”. Early stage technology may be one; but it is not the only one and may not be the best one, then or now. My advice to a venture capitalist, then, now or later, is simple:  Do what you know, do what you love; build great companies and over time you will succeed.

Comments
Aug 10 2015

The Beginning of the End or the End of the Beginning

I was in a conversation last week with a friend who asked “do you think this is the beginning of the end?” We were discussing something totally wacky that had just happened that clearly could be viewed as an indicator that we have crested the peak of this economic cycle. Then, earlier today, I was on the phone with one of my favorite lawyers and he made a joke about a deal I’m doing as harkening back to the late 1990s. He asked if I thought it was an indication of the top of the cycle. We had a good chuckle (probably PTSD gallows humor from 15 years ago) and I suggested that they slow down the hiring of the associates at their law firm so they wouldn’t have to lay off so many in the inevitable downtown.

Somewhere in between these two conversations I told someone that I thought this was actually the “end of the beginning.” And, tonight at a wonderful dinner, I made the statement to the friend that we were having dinner with that I thought the next 30 years were going to be incredible.

I think we are at the end of the beginning of a dramatic shift in how our species deals with existence. Depending on who you believe, we are either 30 years from the singularity (Kurzweil) or only 15 years away (Vinge). The new science fiction coming out is doing a remarkable job of helping us set a context for the different aspects of what we’ll need to deal with. Some of it will be just as off as Philip K. Dick can be while some will be just as accurate as Philip K. Dick can be. If you are a fan of Philip K. Dick, like I am, you know exactly what I mean. And if you aren’t, I suggest you start with Do Androids Dream of Electric Sheep?

Humans have serious issues with exponential curves as we want to make everything a line. But a lot of the stuff around us is happening exponentially and we don’t realize it. As a result, we’ve dramatically underestimated the impact of technology on – well – everything. And, since so much of it is exponential, it compounds at an incomprehensible pace. When we look outside at concrete, steel, and glass going up slowly, it lulls us into a sense of normalcy.

The machines want us to feel this way.

Think about it for a brief moment. Suspend disbelief. Wind the clock forward 100 years. Do you think, as a species, we will still be struggling with the things that vex us today? Will we still be arguing about the same stuff? Will physical instantiation of things have the same meaning? We will still be eating Cocoa Puffs?

We are at the end of the beginning. It’s going to get wild. Buckle up.

Comments
May 20 2015

Cynic or Optimist?

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.

Comments
Apr 23 2015

The Paradox of VC Value-Add

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.

Comments
Oct 28 2014

What’s Old Is New Again

I know I’m getting old. I remember in 2007 when the idea of a super angel appeared, where successful entrepreneurs were suddenly angel investors making 10 or more seed investments a year. This was a “new” innovation that was celebrated with much fanfare.

Between 1994 and 1996 I made 40 angel investments with the money I made from the sale of my first company. I was referred to as an “angel investor” – I didn’t get the super angel moniker back in the 1990s, but I was often referred to as promiscuous.

Every day I’m reading about a new thing in the startup world. Big corporations are splitting in two or spinning off divisions that are being funded by VC firms. The amount of VC investment each quarter is growing, with us now in the $10 billion / quarter zone, rather than the $10 billion a year zone. Strategic investment is in vogue again, with virtually every large public company trying to figure out how to fund startups. Hedge funds are once again allocating big money to private companies and lots of cross-over public company investors are trying to get large dollars into private companies pre-IPO.

What’s old is new again. As we know from BSG, “All this has happened before, and all this will happen again.”

There are definitely new and interesting things happening this time around. If you haven’t noticed AngelList, you are missing what I think is one of the most interesting phenomenons around. And I’m deep in another one, Techstars, which has helped spread the mentor-driven accelerator model around the world.

Every cycle has a different tempo. We are in a very positive part of the current cycle. But it’s a cycle, and we know that by definition we are likely to have too much, and then a correction, and then too little. Welcome to life.

This part of the cycle always makes me uncomfortable. I love innovation, but when things that have been done before get talked about as though they are new, and no one bothers to try to remember what happened, why it happened, and what went off the rails, that’s uncomfortable to me.

Don’t live history, but study it. Remember it. And make better decisions and choices the next time around.

Comments
Jul 31 2014

When VCs Don’t Bullshit You

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.

Comments
Jul 28 2014

Why The SBIC Doesn’t Work For Venture Capital Anymore

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.

Comments