IA Venture Strategies - Working to Build a Better Venture Mouse-trap

As was ably covered by Dan Primack in PEHub, I am starting a new venture fund. However, as my friends and venture colleagues know, I am extremely down on what the venture industry has become. To be clear, it is less an issue of structure (management + incentive fees in a GP/LP structure) and more an issue of size. It is clear to understand how motivations get skewed when venture firms effectively become asset managers, where the management fees alone are sufficient to make the partners rich and investments must become increasingly large and non-venture like. Growth capital is not venture capital in my parlance. Venture capital means funding "ventures" - taking on early-stage risk - and actively helping companies execute their plans and achieve their potential. I have a theory that the largest a true venture fund can be, which means, having a seed-stage investment charter together with a "life cycle" approach to investing (leaning into winners, deploying larger amounts of capital in Series A and B rounds, if necessary) is around $300 million. But I digress...

I decided to start my fund after determining that many of the deals I was seeing were both strategic and thematic, strategic to my trading company and thematic in that they all had a common thread - helping to manage and extract value from massive, often real-time data sets - "big data" in jargon. Rather than prosecute them as an angel, I felt a fund structure would better enable me to "size up" in particular deals and to cast a wider net across the big data domain. I wanted the fund to be small ($25 million stated goal, but with the ability to go a little higher) and I wanted it to be different than most venture funds I know, who have raised money largely from pension funds and endowments. I really wanted the fund to be an extension of my activities as an angel, where I frequently build syndicates of value-added angels and select venture firms to help de-risk the portfolio companies and create a network effect across a particular domain. This approach has helped me win deals from conventional venture firms that couldn't (or wouldn't) bring such a syndicate to the table and generally had terms that were more oppressive than those I offered (less about valuation, more about participation and specific protective provisions). So how to create a fund that achieved my value-added investor objectives and offered the network effects I was seeking...

My answer was to raise money from "non-traditional" investors, e.g., strategic firms and individuals with knowledge of and deep interest in the big data domain, focusing on verticals with particularly acute data problems. Further, my explicit goal was to bring such strategic LPs to the table as part of a "big data ecosystem" I am creating among my Limited Partners, my venture portfolio companies, my trading company, and leading academics and thinkers in the field. Big data problems are, by their nature, big, and substantially benefit from collaboration across a wide array of domains. For instance, this is why there are several open-source database projects currently in operation, because the problems are growing at such a rapid rate and are so complex that discrete teams are often not best equipped to tackle the issues at hand.

So investor engagement, and not just money, is a ticket to play in this game. Funny thing is, they want engagement. They know that the value of the insights on the edge can impact their operating businesses to a far greater extent than any normal investment they could make. Their early involvement can also help to "de-risk" the portfolio companies, giving them early access to real customers with a strong motive to help out. My trading company also acts as a strategic partner, helping to evaluate the technologies of these big data opportunities and, on occasion, to become an early customer as well. Also, the LPs are excited about the network effects of participating in this ecosystem and sharing ideas with the other members of the community. Finally, they are interested in seeing the filtered deal flow and possibly helping with due diligence, becoming an early beta-tester and even a paying customer. It is really an institutionalized form of what I've been doing for the past five years, except with a unique array of people sitting around the table due to their operating companies and ability to test and deploy the tools, technologies and analytics being developed by the fund's portfolio companies. Neat stuff.

I am also extremely excited to be doing this fund in New York City. I have found NYC to be a great place to base my investing activities and couldn't think of a better place to start my fund. Proximity to Wall Street, big Media, the Pharma industry, several major insurers and health care providers, and a short flight to the Defense complex down in Washington D.C./Virginia. Fertile commercial ground on which to launch a big data fund. I already have three deals for the fund, one in the predictive analytics space (closed), one in database architecture (term sheet) and a NYC-based incubation of a new intrusion detection system. I couldn't be more excited to be working with my early companies and syndicate partners. I am also looking forward to working with those domain-expert angels and venture firms as partners in my portfolio companies. I've always believed in having the right people around the table, and having a venture fund won't change this one bit.

FRC's Exchange Fund: VCs are from Mars, Traders are from Venus

Both the blogosphere and the Twittersphere have been abuzz with First Round Capital's new exchange fund idea. Here are a few extract's from Josh Kopelman's post on the new program: 

This exchange fund was created to allow First Round Capital entrepreneurs to contribute a small piece of the stock they own in their company  -- and share in the upside of all the other companies.

When I was an entrepreneur, I remember the feeling of having all my eggs in one basket -- and it is our hope that this fund will remove some of that stress.  Now our entrepreneurs can get the same diversified portfolio that our limited partners get...

I totally get what what Josh and his partners are trying to do, and think it is both intellectually interesting and proposed with only the best of intentions. But as a practical matter, I just hate the idea.

It might be a cultural issue: I come from a very different world than Josh. He is a (very successful) serial entrepreneur and venture investor. I am a former Wall Street business head who managed groups of extremely aggressive, super high-performing originators and traders who has evolved into a venture investor. Words like "share in the upside" and "diversification" are not words with which I am familiar when it comes to the heads of my teams. In fact, they sound like communist rhetoric to the ears of someone use to the hurly-burly "Pay me for what I do" mantra of Wall Street.

Now, I'm not suggesting that "It's all about me me me" is a good thing. In fact, I think it's a bad thing - to a point. I think the root of my discomfort is with the fact that I want my entrepreneurs laser-focused and all-in, especially as they are working to establish traction and prove out the business model and value proposition. The last thing I want them to have (and I want them to want to have) is diversification. I want them to have the insane confidence my desk heads had, where they wanted to be paid for the value they created in their own businesses, and didn't want to share in the upside of (or, more importantly, have their rewards dragged down by) the performance of other units. Further, I encouraged them to cooperate with other desks and business units when it made sense, but not because I compelled them to do so but because it made long-term economic sense for them to share with others. Forced sharing isn't really sharing. It's coercion. So regardless of whether one has direct economic exposure to the group one is sharing with, the motivations are clear: if it works to benefit my business, I will share. Otherwise, I won't waste my time.

The way I've worked to relieve stress in my entrepreneurs is after they have gotten the business up and running, a scalable model is in place and the growth engine is humming along. At this point I have supported buying a small portion of the entrepreneur's stock, either as part of a financing round or where insiders with deep pockets and demand purchase the stock directly from the entrepreneur. While the amounts involved will not dis-incentivize the entrepreneur from still driving as hard as they always have, they can often be life-changing by reducing stress and really enabling them to focus their energy on the business (even after it is successful). This is my preferred way of handling the "diversification" issue. Until business stability is achieved and rapid growth has taken place, I want the entrepreneur to feel stress - positive and necessary stress, in my opinion. 

Is Josh right or am I right? Reasonable people can disagree. But I am personally fascinated with the idea because it is so completely opposite of the behavior I would want to see in my entrepreneurs.