Does being a VC mean "trying to change the world?"

My friend Chris Dixon just wrote an interesting post titled It's not East Coast vs West Coast, it's about making more places like the Valley. It is very interesting and provocative, and as with all Chris's posts, it's a must-read. However, it honestly rubbed me the wrong way and prompted me to write the following comment:

Chris, I think it comes down to what being a VC really means. You seem to equate the VC mission with "making things that change the world." I believe this is a narrow and potentially dangerous definition, and actually highlights one of the biggest problems with the Silicon Valley venture scene. It also, in my experience, doesn't reflect the true dynamics of how large-scale West Coast VC works, which is a lot less sexy and entrepreneur-friendly than you indicate.

Should a good VC be working to fund ideas that change the world? Yes. Should they also be looking to back young companies working on important problems that are, say, built on top of something else and very useful but not transformational? I'd say so. There are lots of start-ups of value that will never be the next Google, Twitter, Microsoft or Apple, but that doesn't mean they shouldn't be funded and nurtured as any start-up should. If one were to apply the "change the world" mission to venture investing, the amount of capital being invested in such companies (or even that should be invested in such companies) is probably less than 20%. To me the key is making sure that those 20% or so get the requisite support and time to thrive from their venture backers, which is the much bigger issue at hand.

I'd like to think that I back worthwhile start-ups and am very entrepreneur-friendly without all that negative financial engineering you ascribe to certain East Coast VCs, but do most of my portfolio companies have a chance to change the world? Not in the way I define changing the world. And personally, I'm ok with this. I'm helping to create useful products, create jobs, and foster entrepreneurial excitement and possibilities. This is what venture investing means to me.

As it relates to large West Coast VCs, many of these firms are structurally bound to trying to change the world because they need those kinds of wins to return their funds. This doesn't make them paragons of virtue; it makes them rational. But buying this series of far out-of-the-money call options has an ugly dark side as well: if companies don't appear to have the potential to change the world (read: sell for $1 billion+, go public, etc.), they often get squashed and orphaned since they are no longer worth the VCs time. Now I'm painting with a broad brush here but you get the point. Does this dynamic help create a favorable entrepreneurial culture? Is this approach really making the world a better place? Not to me. Plenty of companies that would have made it on the East Coast will fail on the West Coast precisely because of the need to hit home runs to the exclusions of singles, doubles and triples.

Chris, I certainly agree that those investors who are heavily focused on metrics and traction are noxious and ill-placed as seed stage investors (they are really Series B, C and D investors). However, I would say that entrepreneurs who combine vision with pragmatism are more attractive to me than entrepreneurs who simply have vision. Might this pragmatism keep the starry-eyed entrepreneur from changing the world, and only building a really large, successful company? Yes. Is this necessarily an indictment on the NY VC reputation of wanting to understand plans for commercialization even in pre-revenue companies? I don't think so.

Thanks for penning this, Chris. You've raised some really important points that warrant discussion.

Roger

These were my $.02. I'd be interested in your thoughts, too.

Advice for CTO Founders: Don't Let Business Kill the Business

Founding a technology company is an amazing thing. I have met dozens of brilliant technologists with fantastic ideas, ideas requiring nurturing, mentoring and support. Too often, however, I have found CTO / Founders paired with business people who not only don't add value, but frequently detract from the value of the business. And from my perspective as an engaged seed stage venture investor, this makes them unfundable. This is not only sad but incredibly frustrating, because it is so easy to see how a great technology can be developed and commercialized if only - if only the CTO hadn't been impulsive and insecure and brought on a business partner too early in the game.

I am a business person, not a technologist. While I know I can add value, I also know when and how I can add value. It is generally a soft touch at the beginning of the development process, perhaps identifying 1-2 early alpha/beta customers to help flesh out use cases to be built upon over time. It is gently laying the foundation for a subsequent financing, helping the CTO set sensible milestones to be achieved that can demonstrate execution skill and release cycle management. It is helping with recruiting by leveraging my networks and experience in a particular domain. And it is most certainly not about me, it is about the CTO, the technology and the company. But I am doing this from the vantage point of an investor / Board member, not an operating executive. Because early in a technology company's life, a true operating executive is NOT what the company needs. In fact, they generally just get in the way.

So why do inexperienced (as entrepreneurs), ultra-skilled CTOs fall into the trap of engaging a business partner too early? Fear? Lack of confidence? Camaraderie? Perhaps all of the above. Many CTOs I know are not that comfortable with the business end of business, directly engaging with customers, speaking with investors and managing business operations. These weaknesses can be addressed in a variety of ways, ranging from engaging part-time, outsourced help to bringing on experienced advisors to help out early in the company's life. These are not revolutionary suggestions, just not necessarily those acted upon by first-time CTO / entrepreneurs. Selecting value-added angel investors and advisors can also help with the camaraderie issue, as they can provide advice and counsel during the solitary period of hard-core coding and product development. A full-time business partner is definitely not required at this point in the company's life.

But sometimes, too often, the CTO falls back on hiring a friend or someone to whom they were introduced that sells them on their value-added. They might give them too much stock, and even have that stock not subject to vesting provisions. And if this business partnership doesn't work out, the CTO / Founder, the engine of value for the company, is stuck in a bad, bad place. Fire the business partner, and the stock they've granted is off the table, stock which is needed to attract and retain talent that can actually help build value and sustainability of the business. Keep the business partner, and the business itself might be rendered unfundable, because quality investors will not put money into a venture with a weak business partner in conflict with the founder. Try to get the founder to negotiate a reasonable exit for the business partner, and this can take years off the founder's life. By the time this point has been reached, the focus has ceased to be the technology and the product, but on organization. And this is one thing that should NOT be the focus of the CTO / Founder during the company's development phase.

So my advice to CTO / Founders? JUST SAY NO TO BUSINESS PARTNERS BEFORE YOU HAVE A REAL PRODUCT THAT IS READY FOR PRIME TIME. And for gosh sakes, spend the time to find the right one. You've spent your entire career working towards this moment. Give it the justice it deserves and don't act impulsively when seeking to address business needs. Your technology brains got you this far; use some of them to make yourself stop, breathe and think. Seek advice from a mentor. Solicit trusted advisors help with interviewing. And if you do feel you've found the right person, by all means make their stock contain standard vesting provisions to guard against a bad fit that takes significant amounts of stock off the cap table.

I don't want to see any more of you with crappy business guys ruining your great ideas, ok?

Thoughts on Taking Venture Money

My (highly intelligent and experienced) friend Chris Dixon just posted on the importance of VC brands. He makes many good points and you should read his perspective. But the issue Chris raises begs a more fundamental question: whether or not to take venture money, and if so, from whom?

There are many variables that come into play. Are you a seasoned and successful entrepreneur? Do you have a functioning product with demonstrable traction? Does your team include a strong founder-technologist with a strong reputation? Taking venture money early is simply not an option for many, if not most, start-ups. If you are a guy like Chris who has already made top institutional investors money (Bessemer, General Catalyst) from a prior start-up (SiteAdvisor, sold to McAfee after 14 months), getting venture backing for your next company (Hunch) is not much of a struggle. But this is the exception and not the rule. And while raising money as a seasoned and successful serial entrepreneur from legacy backers isn't difficult, it is generally a wasteful time-suck pursuing venture money early in the game. This is not the same as "Don't talk to VCs." Absolutely not! VCs are invaluable sources of input, contacts, and pitching experience for the new entrepreneur. These are opportunities not to be missed. But to spend enormous amounts of time trying to raise first-round money from venture investors is almost always a mistake.

So where to go? Strategic angels. Small venture firms and "super angels." Entities, be they firms or individuals, whose charter is to take pre-revenue risk at a fair price and help these nascent companies succeed. At the seed stage it is critical, absolutely critical, to build the right investment syndicate. Getting money from mom, dad and friends is ok, but is not going to deliver the value-added of a strong seed-stage syndicate of professionals who may be tough on valuation, but bring a discipline and culture of support to the venture. Angels and small firms, just like brand-name VCs, can be due diligenced fairly easily. There are a finite number of these people and firms, and they can be tracked down through either VCs, online research or smart networking quite easily. But as is the same with venture firms, warm introductions are critical to getting the right meetings and being taken seriously. Fair or not, reality is that the best of these investors get bombarded with deals, and need to impose filters to effectively manage inbound traffic. And the most powerful filter is receiving a deal from a trusted source. So if you are a start-up seeking seed funding, I'd create my target list of angels and small firms/super angels and work my rolodex like hell to get the right introductions. Otherwise, you are fighting an uphill battle.

Let's say that you've gotten that seed funding, something in the $250K-$1.5MM range, that has helped you prove out the business model, win early customers and generate some revenue traction. And let's say that you are in a capital-efficient business, where you don't need $20MM to ramp growth, but something in the $2-$5MM range. While it may make sense to take more money down the line, this amount is likely sufficient to build a very valuable business at scale (but perhaps not the $100MM+ business that we all dream of). Where should you get this Series A money? The "big brand" firms with huge pools of capital? Medium-sized firms? Small firms? Not an easy question, with virtually countless permutations. That said, t I do think there are three factors all entrepreneurs should keep in mind when making this decision.

1. Size of fund
2. Deal partner
3. Domain expertise

Size of fund: In general, the larger the fund, the larger the required exit in order for an investment to be worthwhile. A fund with assets north of $500MM is going to be hard-pressed to invest $3-$5MM in a company and be ok with an exit less than $100MM, assuming they own 20% of the company. The payoff simply doesn't move the meter. They want to "lean hard" (e.g., put more money into and shoot for a mega-exit) on winners, because nominal dollar returns to pay back the fund are critical. This is where alignment of motives breaks down. ROI is not the measure, it's dollars returned. This creates a problem for entrepreneurs who may want to accept the $60-$70MM exit (which, incidentally, is many times more likely to occur than the multi-hundred million dollar exit), but where the VCs have a blocking position and can force such a deal to be turned down. So it's important to understand that taking money from large, "brand name" firms (and the two generally go hand-in-hand) often means that you are "going for it" - no sub-$100MM exit for you. It will either be a home run or you'll be stuck for a long, long time. As long as you go in eyes wide open, then ok. But this is a material barrier to those running capital efficient businesses who want to preserve the optionality of exiting across an array of scenarios.

Deal partner: As mentioned above, having the right deal partner is critical, regardless of whether you are talking about the seed round, the A round, B round or beyond. A strong deal partner can help materially de-risk a business through sound mentoring, prudent board leadership and valuable connections. The brand of the deal partner is far more important than the brand of the firm. While having a brand name firm might help in future fund-raisings (unless they choose not to invest - then you're screwed), it pales in importance to a great deal partner. Deal partners become great because of what they do, not who they work for, so raising the next round with a great partner, even if they're not at one of the "elite" firms, does not in my experience represent a barrier to fund raising. And if the deal partner has good chemistry and a positive attitude towards working with the first-money in seed investors, so much the better. Then everyone can be pulling in the same direction. It is a powerful combination.

Domain expertise: An extension of the deal partner concept. Certain firms have experience at certain things. Those firms most active in your space and close to the end-users you want to sell to should be the highest on your hit list. They have the benefit of "pattern recognition," having lots of data about firms like yours, how they might stumble and ways in which the growth plan can be better executed. They are also likely to have great contacts on the recruiting front, absolutely essential to building a Series A company in rapid growth mode. And while your deal partner is the one you work with most closely, having others in their firm able to help out with introductions, occasionally sit in on strategic Board sessions and to identify key recruits will prove invaluable over time.

While there are always exceptions, these are the factors I've found most important in helping entrepreneurs achieve their business and strategic goals. Good luck, and be careful out there.