Archives For VC Industry

Race to the Bottom

Matt Harris —  May 5, 2014 — 1 Comment
I don't always invest in commodity products, but when I do, I prefer not to lose all my money.

I’d like to think that the vast majority of the investments we make are in companies whose products and services are not commodities, and not subject to the brutal forces of commoditization.

In those cases, we are looking at markets where companies can win based on product differentiation, or where what they are doing is very hard and/or protected by intellectual property.  That said, the broadest definition of what we as venture capital investors do is invest in disruption, and certainly one of the vectors of disruption is through commoditization.  So while backing a company about to be commoditized is, well, stupid … backing a company that is doing the disruptive commoditizing can be exciting (despite some recent commentary to the contrary.)

Exciting, and terrifying.

Particularly terrifying if you don’t have a gameplan; without one, you may succeed at chowdering an industry’s margin structure without creating any value.  Through trial and error in this field of endeavor, I have found four general models that can work.

1. Be the lowest cost provider

One of the sneaky elements of our investment in Simple (fka BankSimple) was that, while the common perception was of a company leveraging awesome mobile-first design and zero fees to acquire and delight customers, the actual key was the ability to serve customers far more cheaply and hence more profitably than banks.  The customer acquisition stuff worked also, which was nice, but in fact the way to make money in the DDA segment (a commodity) is through disruptively low costs.

Another segment purportedly running this playbook is the “peer to peer” lending community (Merely writing that phrase makes me want to tear my hair out.  While it’s kind of delightful to imagine a multi-billion dollar hedge fund and a near-prime borrower as “peers”, it’s not exactly accurate.) I’ve seen a ton of charts detailing the “cost to serve” advantages of these companies.  My issue with this analysis is that, of the meaningful elements of the cost bar of a lending  business, at least three (cost to acquire, cost of credit losses and cost of capital) far outweigh cost to serve.

The one thing we know conclusively is that these lenders have a stratospherically higher cost of capital than their bank competitors, who leverage their nearly free deposits for liquidity.  Alternative lenders who can create durable advantages in customer acquisition and/or underwriting will create value; merely being low cost in terms of operations will not be sufficient.

2. Lock up differentiated distribution

In the relatively near future, most retail investors will have their money managed using algorithms that solve for market returns, properly allocated across asset classes, rebalanced tax efficiently and optimized for minimal fees.  This will be hideously disruptive for stockbrokers and other corrupt money managers, but will it create value for the disrupters?

There are a whole crop of new companies who are steadily building Assets Under Management using this new model.  The challenge is that the classic “cost to acquire vs. lifetime value” math is almost always upside down when you are providing a service that is, by definition, undifferentiated and focused on lower costs.  The winner(s) here will be those companies who get introduced to their customers for free, either through harnessing viral growth (has not yet happened in this category, though Robin Hood is showing signs) or figuring out a high volume channel.

3. Serve the previously unserved (and ideally previously unserveable)

Square has had a tough time in the press recently.  They have gone from a $10B IPO candidate to a lost cause/acqui-hire in a 3-4 months, on no news.  This says more about the state of financial punditry than it does about Square.

PayPal figured out something fundamental 15 years ago, which is that while most underwriting models start by saying “no”, it’s smarter to say “yes” to nearly everyone and then throttle usage on the backend.  In this way, you enable faster growth and accumulate the necessary “bads” to train your models, all the while managing losses through tightly gated credit limits.  High delinquencies, but low severity.  Square adapted this methodology to merchant underwriting, and in doing so enabled millions of merchants previously shut out of electronic payments to get in the game.  At various times in their lifecycle, they have been over-valued, but those who now dismiss them do so at their own peril.  Their recent moves, to tack back from their experiments with Starbucks and p2p remittance towards a more robust value proposition for small merchants, represent a doubling down on what made them special to begin with.

Merchant payments has never been a particularly interesting business.  Retailers fundamentally don’t care who provides their payments, and will ultimately largely view it as an embedded feature of a commerce system.  But Square’s landgrab in a previously unserved segment may provide them with sufficient escape velocity to make their optimistic investors look smart, particularly when combined with a legendary founder and a world class team.  And I’m enough of a contrarian to have their back now that the world has turned against them.

4. Change the game

This is the one in a million shot, and ultimately why most of us do what we do. Once in a career, maybe, you get a chance to back a team that is turning a commodity business into one that creates huge value for customers and for the company.

Merchant payments is a commodity?

 Well, what if you also have the cardholder information, and can disintermediate the visa/mastercard model by creating an “on us” transaction.

Remittances are a commodity?

How about turning cross-border cash transfers into cross-border commerce, and enabling immigrants to pay bills, top up mobile phones and create gift cards for free, instead of getting gouged on fees.

Factoring is a commodity that can’t scale?

What if you had comprehensive information on when the buyers would pay their bills, and could turn a risky transaction into a riskless transaction.

All of these are big bets, and none of them may pay off.  But the juice is surely worth the squeeze.

Job Creationism

Matt Harris —  December 15, 2011 — 5 Comments

I started my investing career doing leveraged buy-out deals at Bain Capital, working directly for Mitt Romney and his then small group of partners.  I left in 1997 to start my own venture capital firm, and part of my rationale was that I wanted to spend time creating jobs.

In the 14 years since then, I have learned many things.  Perhaps the first thing I learned is that 24 year old people shouldn’t start their own venture firms, but that’s another story.  One of the most important things I learned is that “creating jobs” is an extremely fraught concept.  As the scrutiny of Mitt’s career at Bain Capital begins to intensify, I’m reminded of my initial, naive take on this issue, and how far my thinking has come since then.  It seemed like the kind of unpopular topic that I should write a blog post about.

For the first 3 years of my venture career, until the spring of 2000, I did indeed “create jobs” right, left and center.  All of my companies were hiring anyone who had a pulse.  Fortunately, I was lucky enough to exit many of those investments before the music stopped, but by the summer of 2000, it was clear that all of us in the venture industry had created a few too many jobs, frankly.  I then spent much of the next 18 months uncreating jobs.  One of my CEOs at that time took to keeping a bottle of Jack Daniels in his desk, and at the end of each day of downsizing, we would grimly commiserate.  Bad times.

It’s actually a little strange that I was so intimately involved in all of those terminations.  Today, I probably wouldn’t be involved in firing anyone other than a CEO (god forbid) or a member of her senior staff, and then only if she wanted me there for support.  10 years ago I did more seed stage investing, and as such was more involved in the day to day details of my companies.  Even having said that, however, it still feels pretty self-aggrandizing to claim credit for “creating” any jobs.  I played a role in the maintenance of a healthy (or, a rational observer might claim, pathologically over-funded) early stage equity ecosystem, and I did my best to lend a helping hand as well.  But creating jobs?  I’m pretty sure the entrepreneurs did that, not the funders.

On a slightly more meta level, I have serious concerns about even the most rock star entrepreneur’s claim to job creation, on a net basis.  Let’s look at the newspaper industry (just in case I haven’t depressed you enough already.)  In 1990, the industry employed 460,000 people.  Today it employs 250,000, and is projected to shrink to 180,000.  The two companies who sucked all of the profits out of that business, Google and Craigslist, collectively employ about 25,000 people (Craigslist makes up 30 of that number.  Not a typo.)  So, did the heroes who founded and funded Google and Craigslist create 25,000 jobs, or did they destroy a quarter million jobs?

My point is this:  it’s all capitalism.  Bain Capital is a powerful motor in the capitalist machine, Village Ventures is a much smaller motor, but it’s the same machine.  It’s a big system that produces wealth for society in highly differential doses, and you either believe in it or you don’t.  Companies are naturally selected, if you will, through a process of vigorous competition, and there are definitely winners and losers.  You might even say that it comes down to the survival of the fittest.

I don’t side with the job creationists; I’m with Darwin on this one.

The End is Near (ish)

Matt Harris —  October 6, 2011 — Leave a comment

 

There is an article making the rounds (link:  here) forecasting a drought in late stage fundraising coming soon:  “When? Perhaps as early as three months from now. Surely no later than six.”  As I’ve have written before, I’m always impressed, but somewhat bemused, when people have sufficient confidence in their forecasts to use words like “surely”.  In this case, I don’t vehemently disagree with the author’s conclusion, but I disagree with his level of conviction.  This post lays out some reasons why he may be wrong … to be clear, they aren’t reasons why he IS wrong; I have no idea if he’s wrong or right.  I’m just pretty sure he’s wrong to be so certain that he’s right.

One of the critical underpinnings of his argument is the data suggesting that venture capital investing is outpacing fundraising, ie, that VCs are investing more than they are raising, and that therefore their coffers will run dry soon.  I think this misses a few fundamental dynamics at work.  The first is that late stage venture capital investing is no longer just a game for venture capitalists.  If you look at the largest deals of Q2 2011, you find these names:  General Atlantic, Tiger Global, Goldman Sachs, Credit Suisse, Great Hill Private Equity, JP Morgan and Harbourvest.  I guarantee that none of those firms’ prodigious fundraising success is included in the venture capital fundraising totals, and yet they took leadership roles in financings totaling over $1B in the second quarter alone.  This list doesn’t include the increasingly active corporate players like Google Ventures, Visa, SK Telecom and J&J, to name but a few; 10% of the dollars invested in the industry in Q1 2011 came from corporates, the most since 2001.  It also doesn’t include the mutual fund companies like T. Rowe Price, international players like DST or the other non-VCs who are investing through Second Market and Sharespost.  Based on the high and increasing activity levels of this long list of investors whose activities are showing up in the “dollars invested” category, but not the “dollars raised” category, I’d be shocked and worried if there wasn’t the gap that the author is so concerned about.

The other primary point is that the stock market is looking shaky, and that therefore, before too long, venture fundraisings will follow:  “Another worrisome omen is that venture funding tends to lag behind stock market moves by a quarter or two.”  The market bottom during the (first) credit crisis was Q1 2009, so I went and looked at what the large financings were in Q3 2009, to see if this lag did indeed affect investor psychology.  I would say, not so much.  In Q3 2009, Twitter, at that time pre-revenue, raised $100MM at a $1B valuation.  In addition, two companies that ultimately went bust raised $350MM in aggregate:  Solyndra and Canopy.  If that’s the kind of incisive due diligence that we should anticipate in Q1 2012, I’m not sure entrepreneurs should be too nervous.

And so, my urgent message to entrepreneurs is this:  the end is nigh!  Unless it’s not.  Run your company sensibly, raise money prudently, focus on hiring great people and delighting your customers, and read fewer hysterical blog posts.

I have a friend who lives high up in a building, and has a terrace, and likes to set off Chinese paper lanterns late at night. The aerodynamics are such that the wind flows up the side of the building and carries these lanterns directly upward. Watching a fleet of these soar is inspiring … it’s amazing to believe that such a fragile construction of paper and plywood, filled with flame, can actually fly.

I was with him once at a beach house owned by a friend of his, in the Dominican Republic. He thought that seeing these lanterns fly out above the ocean would be magnificent. The first one he lit flew directly sideways, actually hit a woman’s head 40 feet away, and then careened into the building. Thankfully no one caught on fire, but everyone was pissed. Turns out that when you are launching fragile and combustible objects, it really, really matters which way the wind is blowing.

That experience (seeing a woman nearly burn to death and multi-million dollar beach house nearly go up in flames) reminded me of our first fund. We raised a $43MM seed stage fund in 2000, and proceeded to invest relatively quickly in over 70 companies. Shockingly, that fund looks like it will actually make money, based on some outsized exits (Optasite, @Last, Glycofi, Pump Audio) and some unrealized winners (Everyday Health, Newforma, GetWell Networks). This compares to the median fund from the vintage, which is worth $0.83 on the dollar. That notwithstanding, like most seed stage investors, we were doing the equivalent of launching a fleet of Chinese lanterns. From 2000 through 2005, the wind was against us, and a lot of those lanterns were extinguished or went in bad directions.

If you are a seed stage investor, there are three categories of good outcomes. The first is that the company gets purchased without needing new capital, and you make a quick return. The second is that you raise a next round at an uptick, and then sell, and you make a quick return. The third is that you raise a series of follow on rounds, at accelerating upticks, and you sell the company (or go public) for a very meaningful return. All of these things depend on picking great companies who make real progress, but I would submit they depend more on the environment, ie, which way the wind is blowing.

Right now, and for the last few years, we have had ideal conditions in the consumer web sector for this kind of investing. A group of eager acquirers focused on talent and willing to pay up? Check. Tons of investor interest in the sector, willing to pay up for companies with traction? Check. A Cambrian period of innovation coupled with low cost company building and marketing tools so that early demonstrable momentum can be achieved on short dollars? Check.

How long will this go on? My friend and very talented investor Shana Fisher has a framework where she points out that from 1995-2000, anyone randomly investing in early stage made money, from 2000-2005 anyone randomly investing lost money, and from 2005-2010, anyone randomly investing made money. I don’t love the next step in that sequence.

My personal view is that these conditions will continue for a while at least. Some of the dynamics involved are secular, rather than cyclical. Further, there are some folks who have leaned into the seed stage model and made an art of it, in a way we never did. First Round Capital comes to mind. Actually, come to think of it, they are the only ones who come to mind…

For our part, we moved onto more traditional early stage investing. Our latest fund is $135MM in size, we typically lead Series A rounds with $2-3MM, and we are focused on building a manageable number of high impact companies where we own an average of slightly over 20%. That requires us to get in early, which is why we have a tight sector focus on financial service and media, areas where we can get comfortable on little data and where we can sell our way into competitive deals based on our ability to help. The wind will always play a role, but hopefully we are launching rockets, not paper lanterns.

Orthogonal Feedback

Matt Harris —  March 7, 2011 — 3 Comments

source: http://rmstar.blogspot.com

I was meeting with some entrepreneurs last week, a terrific young team with an interesting company, and we were discussing their business. About halfway in, I said “Okay, let’s assume that most of this works, and you get some traction. What far fetched ideas do you have to truly create a massive company here?” The team slyly looked at each other and came out with some really interesting stuff. I joined in and had some extremely random ideas that, if they pursued them, would send them in very different directions. Some of it was pointless, and maybe all of it will get thrown out once the excitement of the meeting wears off, but I hope not.

I wish I did this kind of thing more, and I wish more investors did also. Obviously most entrepreneurs come to meet with VCs to get money, but most VC/entrepreneur meetings don’t end up with a check being written … as an example, we invest in far less than 1% of the companies we meet with (most of reasons have to do with our strategy, not the quality of the company). Given that, entrepreneurs should get something, at least. Most often what they get is a sense for what the market is looking for, eg, “mobile payments are really hot right now.” Hearing that once is modestly useful; hearing it a dozen times is distracting and annoying.

I think most VCs focus on sharing that kind of market feedback because they think that’s what’s expected. VCs are not necessarily supposed to have ideas, after all. In my experience, though, most VCs do have interesting ideas, if only as a function of sitting in meetings with smart, hyper-creative entrepreneurs all day long. If you live in a tinder box, you can’t help but have a few sparks once in a while.

[As an aside, if you're wondering why VCs don't typically start companies given my claim that they have good ideas, I think there are two reasons, if you'll allow me some vast generalizations. First, VC ideas are often riffs on an existing play, albeit hopefully novel and not incremental (in my lexicon, orthogonal in some way). Second, the real difference between VCs and entrepreneurs is that entrepreneurs are execution machines, and VCs ... not so much. And finally, there are some former VCs who've done well, most famously Mark Pincus, but I'm also bullish on Matt Warta, Dan Allen and others.]

So this is my new resolution: that each entrepreneur I meet with walks away with one or two new ideas that at least serve to stretch her thinking a bit. If they get that much from each of the investors they meet with, I’m certain the fundraising process will eventually lose its bad name.

Tired of Self-Hating VCs

Matt Harris —  February 22, 2011 — 15 Comments

This post was stimulated by a tweet i read over the weekend, by a VC I won’t name because I don’t know him, and he has a very good reputation for being a nice guy. His tweet read: “I’m really not sure I like VC’s”. My reaction to this missive went from, at first, a knowing smile, then to mild irritation and finally to downright anger. Anger, not at him, but at myself. Anger at the fact that this kind of radical and broad based self-deprecation (and by “self” I mean all of us) was amusing, old hat and totally unexceptional to me, and to all the rest of us who practice venture capital.

I have a clear sense of why this is. The origin story of the VC as black hat is based around the archetype of the entrepreneur as philosopher king, and the VC as necessary evil. It is a story that is perpetuated by every entrepreneur who was told “no” by a blue-shirt-and-khakis-wearing weenie like me, and by every angel investor looking to build a brand. It is a story that is fueled every time a VC checks his/her blackberry in a meeting, or says something inane or just fails to return an email. I get it, and I’m sure I share in the blame for the lasting power of this narrative by my lack of social skills or by the response time implications of my clogged inbox.

But the biggest way in which I contribute to the persistence of the “VC as evil” meme is by nodding knowingly when it is mentioned in my presence. There is a way in which, by agreeing that the phenomenon is real, I implicitly place myself outside of it … “yeah, VCs are jerks, but I’m obviously one of the good guys.” Just the other day, I was speaking with a successful angel who is considering raising a fund (I know, you’re *shocked* to hear that), who characterized that decision as “going over to the dark side”. I laughed. Here’s what I should have said: “Screw that.”

And that’s my take on this notion from here on out: Screw that. The worst VC in the world spends his or her entire working life providing jet fuel to the entrepreneurial economy. That’s what we do, even in our darkest hour … that is literally the only tool in our tool chest. Remind me what’s so bad about that? Of all the professions in the economy, what is so “dark” or “evil” about injecting cash into high growth companies? I’m clearly missing something. Every venture capitalists I know does three things all day long: figure out which entrepreneurs to back and wire money to those entrepreneurs; work like hell to help those companies; and pitch limited partners that they should give him/her more money to rinse and repeat that process. Again, personal foibles and the occasional jackass aside, I think we can agree that these are activities that are massively net positive to the world.

Now, like any insider in any field, I could talk at length about how far short of the ideal I and my compatriots fall. But how unusual is that? If you want to hear something chilling, you should go out for drinks with some medical residents, and hear them talk about the foibles and failings of overworked young doctors. Or discuss food hygiene with a chef in an honest mood. Or watch “Waiting For Superman” to learn about the delta between the perfect and the real in the teaching profession. Here’s a quick newsflash: human beings are deeply flawed. The bottom 20% of any field is depressingly pathetic. That fact does not make medicine, cuisine or teaching worthy of wholesale mudslinging, and the same should be true of venture capital.

The other day, my 2.5 year old daughter asked me what I did for work. I said that Daddy helps people start companies. I’m pretty sure she didn’t understand what I meant, but it felt good to say it. I’m proud of what I do, and I think she’ll be proud of me, too, someday (though I’m pretty sure she’ll always be willing to swap me for Dr Seuss.)

First, read this post.

A couple of my close friends, Mark Solon and Roger Ehrenberg, have tweeted this article with the endorsement MUST READ. I’m as much (or more) of a fanboy of Steve Blank as anyone, and I think the world needs more straight talk and demystification of the VC/entrepreneur relationship. Having said that, this seems like such an obvious point that to make it feels more like sloppy demonization than analysis. By these lights, customers are not your friends, partners are not your friends, employees are not your friends and your lawyer isn’t your friend (even if it’s Ed Zimmerman and he’s gotten you drunk on $350 bottles of wine.) If you are expecting someone, in a business context, to do something against their own fiduciary duty and self-interest, then you are in for a rough ride in this world, whether you raise venture capital or not.

Mark and Roger, you are both colleagues and friends. If I have a company in trouble (which I never do, of course), can I count on you to lead their next round at an uptick, based on our friendship? NO? Well, hot damn, I thought we were friends.

All ur commentz are belong to uz

Like most professionals who give some thought to their online profile, I’ve spent some time on Quora in my fields of interest. I’m not a ninja at it, like Suster and increasingly Ehrenberg, but a man’s got to sleep sometime. In response to a question I thought was hilarious [Would it be terrible to pitch a VC with a preso done in all lolcats?], I posted a facetious but well-meaning and not totally ridiculous answer ["just make sure you bring a pen to sign the term sheet. done."].

If there was any point to my response, and I’d like to think there was, it was a form of applause for a question that gently exposed the ridiculousness of the form of the “pitch”, and encouraged entrepreneurs to laugh at VCs and themselves a little bit. My response got voted up and received a couple of positive comments, but was then deemed “not helpful” and thrown into the oubliette. With some mild chagrin (the stakes here are very, very low), I looked into this and found that it was a Quora staffer who stuffed my answer in the memory hole.

It was with some self-righteous pleasure then that I found the following piece, criticizing Quora for this very practice. It was with much greater pleasure that I noted the killer quote from Molly Ivans, which goes into my bag for later: “The strongest human emotion is neither love nor hate. It is one person’s desire to f#ck with another person’s copy”.

Now, on the merits of this question, I think Quora is wrong, or at least a little off, and will probably tack back to letting the community judge the strength of answers, and letting a little humor creep into things. But that’s actually not the point of this tempest in a teapot. The point is this: if I’m sitting at Benchmark, wondering how my Quora investment is performing, I’m now thinking “Finally, we have some controversy over there! Maybe now the normals will start paying attention.”

We’ve all seen this movie before. It happened with Zynga and Scamville, with Groupon and that retailer who went out of business from an over-abundance of customers (I swear they actually planted that story), with Twitter and their downtime (and more recently Tumblr), and so on. Each of these minor crises, at the time, is touted as the moment each company “jumped the shark”. (The reference, of course, is from an infamous Happy Days episode.) And after each stumble, these companies emerged stronger and kept growing. Arguably, the press and buzz that resulted from each incident actually improved each company’s trajectory.

Here is a chart that helps to illustrate my point:

This is the Google Trends data showing the incidence of search and news relevance of: “Facebook”, “Jump” and “Shark”. During the period which this company has gone from zero to global domination, at an increasing pace, vocal segments of our society and the media have been clamoring for our attention with news of its demise. Whether it’s transmission of personal data, or a failure to penetrate China, or failure to crush Foursquare, or whatever the shank du jour happens to be, there is always someone there to claim that it signals Facebook’s downfall. Of course, there are valid critiques of Facebook and its business model, but the company is not going away, and all of the hysterical predictions to the contrary merely point to its ongoing prominence.

What does this mean for entrepreneurs? As a noted hip hop artist cum super angel once said, “those who have a propensity to hate [for any reason, or no reason], are going to exercise that propensity [regardless of what you do to either draw or defuse their wrath].” (NB: I paraphrase slightly). It seems trite, but it is no less true, to say that it is your success that draws these critiques and therefore it is truly a good sign. Nonetheless, it is sometimes disconcerting to your investors, board members, employees, partners and customers, and you will have to react … just don’t over-react. Make sure what you are doing is 100% clean as a whistle and makes good business sense. If it isn’t, or doesn’t, fix it quickly and with no embarrassment. If you’re confident, just keep keeping on. Your growth will continue, your critics will find more and more casus belli, and your customers will be as happy as ever.

Power vs. Influence

Matt Harris —  November 19, 2010 — 2 Comments

Earlier in my career I worked at a large private equity firm (in my view, one of the great ones: Bain Capital), and for the last 13+ years I’ve worked in early stage venture capital. Those two ways of investing, ie buyouts vs. early stage venture, have lodged in my mind the subtle distinction between power and influence.

As a general matter, private equity or buyout firms purchase 100% of their portfolio companies, while venture firms purchase minority positions (though over time and across syndicates, venture capital ownership in aggregate often exceeds 50%). In one sense, the difference between 25% ownership and 100% ownership is just a math difference, particularly when you consider the various “control provisions” many VCs put into their terms, in practice the difference in governance style is (or at least should be) radically different.

I was reminded of this distinction twice yesterday. The first was in a conversation with a search and HR consulting firm, whom I greatly respect. This particular firm works nearly exclusively with private equity funds, but in this case was interested in working with one of our portfolio companies. It slowly became obvious to me that the firm thought they were in my office to make the sale, ie, that I was positioned to decide to use them for a search at one of our portfolio companies. I hastened to make it clear to them that they were in the wrong office, and that the team at the company would make the decision, and at most I would have input, or influence. The second conversation was with an outside director candidate, where similarly I had to make it clear that while my opinion mattered, ultimately we were looking to the management team to lay out a strategy for building an effective board, with our guidance.

I would contrast this with the typical process at a private equity firm, where quite literally the management teams at the portfolio companies work for the private equity folks. That’s a fine arrangement, and probably appropriate for more mature companies, but that would be a terrible outcome for an entrepreneurial, venture-backed company. Any entrepreneur who wants a “boss”, in that sense, is probably not the right person to execute the kind of high risk, high growth innovation that is the underpinning of a successful venture.

The fact is, there is really no sense in which any of my CEOs work for me. From a user experience perspective, most of the time it presents as though I work for them … most of my job consists of helping them meet their objectives, rather than the other way around. (Though, of course, by helping them meet their objectives I sneakily achieve mine, which is to own good-sized chunks of valuable companies.)

While proudly acknowledging that I don’t have any real power, I do think in most cases I have a reasonably amount of influence. I guess, to paraphrase WHEN HARRY MET SALLY, I am the dog in the scenario above. Management teams clearly have the prerogative to go against any opinions I may have, and all of my good ones commonly do that. But it is the case that the stakes of doing so and consistently being wrong about it grow higher over time. Hopefully, in addition, I’ve gained some level of influence just by having a degree of credibility with regard to certain aspects of building companies in my lane (financial services industries).

Lest anyone read this as a venture capitalists currying favor with entrepreneurs (not that I’m above that…), I should admit that my strategy here isn’t just about being a good guy and empowering management teams as a value in and of itself. I do it because I think it’s more likely to make money. Ultimately, my view is that power and accountability go hand in hand. To the extent to which I, as a director and venture capital investor, am making decisions at or for one of my portfolio companies, I am taking on accountability for the outcomes. To the extent to which I take on accountability, I am removing it from the management team. My view is that accountability shared is accountability lost, and a lack of accountability is the first step on the road to ruin.

The End of Management

Matt Harris —  August 23, 2010 — 2 Comments

An important article appeared in the WSJ over the weekend called “The End of Management”. [apologies in advances if they kibosh the link; trust me, it was epic]

The basic thesis is that given decreases in coordination costs, the costs of scale have begun to outweigh the benefits of scale, calling into question the entire idea of the corporation.  Interestingly, the subtitle is “why managers should act like venture capitalists”, but I’m more interested in the implications of the piece for the venture capital industry itself.

The fact is, the venture industry has matured, and matured in a somewhat of a mediocre way.  Economic theory and history would suggest that the industry should consolidate around a few large firms.  In fact, the dominant trend is the opposite … many large firms are losing “customers” (both investors and entrepreneurs) and shrinking/going away, while the firms taking market share are relative newcomers (see:  the Book of Dixon and the Book of McClure).

The unfortunate facts of the case for large venture firms are that scale has gone from being a significant advantage to being a crippling disadvantage.  The same problems that beset large corporations (bureaucracy, principal/agent mismatches, the inability for small wins to move the needle, the inability to pick a focus and win a particular segment) are plaguing large venture firms in spades.  The benefits of scale (deep pockets, brand name, the experience of having lived through cycles, robust compliance/regulatory/back-office infrastructures) are real, but are less important in an era where those things can either be obtained through relationships, bought on a variable cost basis or built quickly and cheaply.  Or, somewhat cynically, be systematically discounted and disparaged by more nimble competitors, such that they at least appear not to matter.

One interesting example of this is the question of experience.  Fred Wilson has a thought provoking post about the impending adolescence of the current burgeoning crop of start-ups.  He notes one fund he is an investor in who has called down 40% of the fund in the first 6 months.  Anyone who was in the business in 1999 knows the kind of frenzy that drives that type of activity, and fears it.  Fred can get away with this type of avuncular commentary, but this kind of talk from a GP at a mega Sand Hill Road firm would be treated as condescension and “not getting it”.

At Village Ventures, when we got started in 2000, it was the era of the mega-funds.  Our thought was that there was a way to get the benefits of scale without the costs by creating a platform of shared services and a forum for sharing experience and resources, and offering that to smaller funds, who could be nimble and focused.  10 years later, we have 15 firms on the platform, with almost $1B in capital under management, and a strong track record of performance.  We’ve made our share of mistakes but I still think the idea is right.  I continue to think that ignoring all of the benefits of scale is a mistake, and that there are ways to harvest them without the sclerosis of being too large (Fred’s wisdom about pacing and reserves being one example).

The most interesting thing about the article, and about the current trends in venture capital, is that they hold the potential to be secular trends, not just cycles.  The skeptics (usually me) tend to see such phenomena and say “ah, just wait until Sacca et al raise their $500MM funds, so they can ‘participate more fully in the pro rata rights they are creating’ … and then raise a hedge fund so they can buy at the IPO as well”.  I don’t think that will happen, and if it does, that will be the road to ruin for them as well.  For my money, in any of the digital disciplines, small funds are here to stay.