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.

Tear Down This Paywall

Matt Harris —  September 8, 2011 — Leave a comment

I was speaking with a friend of mine, an incredibly talented New York Times reporter and great friend, about the NYT paywall recently. When she asked me if I paid, I responded with an indignant “no”, and proceeded to rail against the policy and the whole economic model of putting barriers between journalists and the readers who are interested in their work. When she followed up with a bunch of logical questions about why it was that I felt entitled to the content for free, etc, I ultimately admitted that I was a paper subscriber, and as such wouldn’t have to pay more for the web version. It became clear to both of us that my indignation wasn’t about the money, but rather a steaming sense of frustration that the whole paywall strategy was just wrong, and would hasten the demise of my beloved New York Times. After all, even if I hadn’t been a subscriber, I would still get to read the articles I was interested in if I got to them via Twitter or Facebook shared links. What the NYT had given up was the idea that they were the paper of record for me, my starting point online and a part of my identity; now, they were just one source among many, found through links curated by the folks I follow and respect.

I recently had a similar experience with Time.com, where I went to see an article about a state fair who had pioneered “fried bubble gum” (true story). The site launched a video ad at me and crashed my browser (the latest version of Firefox). I fired off a snarling, churlish tweet about how old media just couldn’t get out of its own way. What is interesting about these two anecdotes? First, that potentially I need some anger management therapy, but enough about me. What’s actually interesting is that someone like me, an avid consumer of media, in fact, I would even say someone who loves media, is so disgusted and annoyed by media’s efforts to make enough money to survive that I’ve aggressively turned away from what they are doing online. Someone who should be on the barricades fighting to defend the traditional media outlets is among the first of the rats to flee the sinking ship.

I guess it’s incumbent on me to propose an alternative, if I’m so certain that forcing people to pay or using interruptive advertising is the wrong answer. I’m not a media theorist, but it’s clear to me that I’m reacting against the thing that’s consistent about those two methods, which is that both will have the effect of reducing readership. The only media strategy that feels right to me is one that drives as much readership as possible. Given the low barrier to entry, there will always be free competition, and as a result even minor impediments to readership will have a significant impact. It could be that we’re talking about the equivalent of the buggy whip industry, and that attempts to restore it to previous levels of profitability are in vain. Maybe quality journalism ends up being supported by donations, like pro publica. But I hope not, and in the spirit of trying to help rather than just criticize, I have a couple of ideas:

Let’s think about what the New York Times (or ABC News, or NPR) produces. Quality journalism, yes. But perhaps even more importantly, the Times produces famous journalists and opinion leaders. It may not be as profitable as it was, but it is still the most valuable imprimatur in the news industry, and an incredibly powerful platform for a journalist to build a name. Does Tom Friedman help the Times? At this point, for sure. But he wouldn’t be Tom Friedman without more than a decade of prime space on the Op-Ed page. I’d be interested to know what the annual revenues of the Tom Friedman Corporation are now, and it’s disappointing that the New York Times doesn’t get any piece of that, having played a major role in creating the phenomena. Why aren’t they his publisher and speaking bureau? The Times could be the most powerful talent agency on earth, with its own factory for creating talent.

I agree that it’s not entirely crazy to charge for content. What is crazy is to put a “wall” up … walls keep people out. Throughout the media industry, the trend has been to lower up-front payments and make money on usage. Think of the gaming industry … most of the truly successful games are free, and make money from selling virtual goods. What can the New York Times learn from Zynga? Let people in the front door, let them share with their friends and then charge the most devoted users (over time) to access elements of the service that help them enjoy it more. Would people pay for access to and interaction with the journalists? Would they pay to attend events, or for additional photographs, or additional copy on particular topics that happened to be cut from the paper? Would they pay to get certain stories or sections early? I don’t know, but I’m certain the Times won’t ever find out by keeping people off their site in droves.

As I said, I’m not a media theorist (I’m not even a media investor). I’m sure these ideas are specifically wrong, and maybe even broadly misguided. But I remain convinced that raising the price of something, through charging directly or making access more annoying, when that something is perceived as more and more broadly available, is the road to ruin.

[This blog post was deeply informed by conversations with Jonathan Glick, at whose feet I have learned more about the media industry than is probably good for me. Having said that, if I got anything wrong here, the blame is all mine.]

I was on a call with a senior guy at one of my portfolio companies recently, and asked him what the background noise was. He explained that he was at a “Daily Deal” conference. Of course I replied “WTF?”, and he explained that he was one of 500 attendees at the conference, and that it was one of 4 or 5 conferences entirely focused on the Daily Deal phenomena that were taking place this year. Thankfully, he was there as a vendor and not a YADDO (Yet Another Daily Deal Outfit).

If you’ve ever sat down and tried to calculate the lifetime value of a customer against your acquisition cost (and if you haven’t, you should), you will recall that the single most impactful cell in the spreadsheet is the assumption about how many times the customer buys (or, if it’s a service, how long they stay loyal). In the academic literature, and among the consulting firms that study these matters, it is a settled issue: loyal customers generate well over 100% of the profits of almost all businesses.

A long time ago, when I was doing some work in the telecom field, I recall pawing through vast reams of customer data to evaluate the different profitability profiles of different customer segments. Most of our conclusions were nuanced, subtle and open to refutation; the only one that was blindingly obvious was that customers acquired through promotional marketing techniques didn’t stick around long, and therefore were unprofitable. This led to a different kind of segmentation, what you might call behavioral segmentation. In other words, we found that people divided into two buckets, Loyalists and Switchers. There were all types of Loyalists, some who stayed because of inertia, some who were brand ambassadors and truly loved the company, etc, but there was only one kind of Switcher: the bad kind. Bear in mind that this was a telecom company, one of the only types of vendors for whom promotional marketing even stands a chance of working, in that the recurring nature of the service and the high switching costs should create at least passive loyalty. Imagine this math for a pizza place in a large urban area … a disaster.

There have been many critics of the daily deal model, who focus on how unprofitable the initial transaction is for the merchant. If we go back to our lifetime value spreadsheet, that critique gets at the cost of customer acquisition cell, which I will agree is important. Far more important to me, however, is the likelihood (or inevitability) that the customers acquired in this method will have low levels of loyalty, and will readily switch to competitors when the next deal shows up. Groupon’s mobile app “Groupon Now” is the apotheosis of this … by using it, the consumer is assured to get a deep discount on anything they purchase, thereby guaranteeing that they will never be a profitable customer for any merchant, ever again.

Another of the critiques of the daily deal model is the opacity of it, on the part of the retailer. The customer doesn’t even present a payment card, just a piece of paper, so the retailer gets little or often zero data about them. I would submit, however, that they get the most important piece of data they need, which is that the person is inherently a Switcher, or (more likely) has been trained to be a Switcher by Groupon, Living Social, etc. They’ve just walked into the establishment with a sign on their forehead reading “Unprofitable”. It’s kind of like the attractive young assistant who has an affair with his boss, eventually convincing her to leave her husband and marry him, only to be surprised a few short years later when she turns around and leaves him for another man. By cheating on her husband with you, didn’t she tell you all you needed to about her tendencies? Groupon merchants are “stealing” customers away from their competitors, don’t they think that the irrefutable infidelity of those customers will reoccur?

Let’s take this to its logical extreme. Imagine everyone in the US armed with a smart phone and some daily deal company’s version of Groupon Now. Every purchase we make takes into account which nearby vendor (or online vendor, depending on the category) is running the deepest discount. Retailers have margins ranging from 2% (grocery) to 19% (restaurants). If you slice even 25% off the average bill (vs. the 75% they give up now to Groupon), they are all dead. If you slice 25% off 25% of the customer bills, for a 6-7% hit to margins, most are dead and all are hurting. The only answer: raise prices across the board to compensate for the impact of the Switchers. This further drives the average consumer into the arms of the discounters, in a cannibalization race to the bottom, creating a Nation of Switchers.

This is not going to happen. Retailers know the value of loyalty, and will team up with companies like Foursquare and others to focus on rewarding loyalty, not switching. In two years, we will look back on those Daily Deal conferences with a rueful smile.

Intentionality

Matt Harris —  May 31, 2011 — 1 Comment

It never ceases to amaze me how frequently startups manage to beat large companies. I was in a big bank the other day, and couldn’t help but be impressed by the resources they had at their command. They have a massive customer base, huge profits, thousands of people and a well known brand. They could, if they wanted to, build a hundred versions of what, for example, our company BankSimple is building, test each of them on a separate population of existing customers and then spend $100MM to launch the best version internationally across all of their channels (branch, TV, direct mail, online, mobile, etc). If it failed, it would be a non-event; if they saw any sign of uptake, they could pour the gas on to that channel and that segment and build the momentum from there.

I don’t say this to pick on BankSimple. (In fact, quite the opposite, because those guys are going to light the world on fire this fall with their product, and I expect barely a whimper from the incumbents.) Most venture-backed companies these days create advantage more through execution than through intellectual property. They create equity value as much or more through inspired design than revolutionary technology. BankSimple falls into that category, and they are hardly alone. The phenomena does beg the question, though, of how and why big companies let this happen.

I have a theory, and it revolves around intentionality. Big companies have habits; they basically have to. Massive scale requires some degree of standardization, which engenders rules and regulations, which ultimately groove into immutable habits … habits of action and habits of the mind. Big companies do things without thinking of them; that’s just the way they do things.

Young companies do everything intentionally, not least because in many cases they are doing things for the first time. They may not (and I believe should not) step carefully, but they step mindfully. The logo is as it is, the brand is what it is, the office layout is what it is, all of the elements of the business are what they are because a small group of people deliberately intended them to be so … not because of inertia, or policy or precedent. Again, they may be wrong, or require changing, or grow outdated, but they are almost never casual and almost always done with great care.

If you run your business with intentionality, and add to that a fetish for measurement and a willingness to break glass and change things quickly that aren’t working, you have a massive advantage over your incumbent competition.

As Balzac once said, “Behind every great fortune lies a great crime.” In the past few weeks, we have been treated to scandalous-if-true stories about the founding of Facebook and Twitter. Allegedly, Facebook was founded by the guy who stole the idea from a set of Olympian twins, ripped off a wood-chip dealing fraudster for his first $2k of investment and then screwed the college buddy who provided him with additional growth capital. Twitter was the bastard child of a devious founder, who convinced his early investors that it was worthless so he could look like a hero for buying them back at cost, only then to reveal the true glory of the product and, oddly, not even let most of them invest back in later when they tried their damndest to do so. Oh, and he also fired the real founder and, in an Orwellian turn, pretends the guy never existed in press interviews.

Now, I have no idea if these stories are even partially true. Frankly, I don’t care, and am pretty sure anyone who isn’t actually involved shouldn’t care much either, beyond gossip value (though perhaps “gossip value” is an oxymoron). There will be those who insist that the veracity of these claims goes directly to the moral fiber of the founders, and hence perhaps the culture of these companies, and that therefore we all have to know the truth. I think that take is bullshit, and that’s the thrust of this post.

If I had to pick one adjective that describes all radically successful founders, it would be this: transgressive. That trait is what it takes to start a company that attempts to redefine an industry, or, like Facebook, redefine large parts of society. It is not a polite thing to do. It is audacious, disruptive and preposterous on the face of it. Founders have to be persistent (bullheaded), persuasive (flexible with the truth) and visionary (delusional).

Please don’t take this as a defense of actually criminal, or even unethical, behavior. We would never work with a founder who was guilty of what we considered an actual ethical lapse, and surely if all of the allegations regarding Twitter and Facebook are true, those founders have a lot to answer for. When I’m checking references on a founder, I definitely focus about integrity and ethics. It’s incredibly important to me that I can implicitly trust the people I’m in a foxhole with.

Having said that, I’m painfully aware that the world is full of gray areas. So what I always pursue, in addition to positive character references, is 100% alignment. To be honest, if an entrepreneur I really respected came to me and offered to buy me out for 1X my money, and said he was going to carry on with the project without me, I WOULD ALWAYS SAY NO. Always. I don’t get paid to return 1X to my investors, and I never want to sell when one of my founders is buying (though occasionally I do buy when they are selling, for other reasons.) Further, when I’m doing these reference calls, I occasionally hear things that seem bad, but I interpret as good, eg: “John had a bad habit of promising things to the client that didn’t exist, then scrambling like mad to backfill those capabilities”; “When Jill wants something, she can be pretty hard to deal with until she gets what she’s after”; or “Seth asked a lot of his people, and would occasionally burn some of his weaker performers out.”

You should know that all of this comes from a guy who is married to an entrepreneur, and started a firm with one (different people, thank g-d). I am a charter member of the cult of the founder. Of the 10 guys I lived with in college, nearly all have started a company or been on a founding team. Perhaps the best part of my job is getting to spend time with people who do 10 impossible things before breakfast, ie, my portfolio company CEOs. But we should be honest about what it takes to change the world. It takes more than chutzpah. It takes Balzac.

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.

The first task of a revolutionary is figuring out which buildings to burn down.

In that same sense, the first task of an entrepreneurial firm is to figure out what of the existing order to keep, and what to challenge. This is first in a long series of posts (possibly as many as two) riffing on the analogy of entrepreneur as insurgent and traditional big company as the corrupt regime in power. This will eventually be turned into a book, which you can pre-pre-order by sending me $100 right now. i take Paypal, Facebook credits, Zipmark, Dwolla, Venmo, Waspit, etc.

In the event that anyone is offended by the analogy or glib tone of this essay, and feels inclined to point out that it is an insult to liken an entrepreneur, who risks merely her time and treasure, to an Egyptian, Tunisian or Libyan revolutionary, who risks everything … mea culpa. As to tone, I am a dealer in snark, and when all you have is a hammer, the whole world looks like a nail. As to the analogy, I am gobsmacked by the courage of these young iconoclasts in the middle east, and thrilled by the way they take courage from each other; I can’t help but be reminded of the daring entrepreneurs I am lucky enough to work with.

The essential triumvirate in any insurgency includes the insurgent (entrepreneur), the regime (incumbent big company competitor) and the people (customers/users). The goal of the insurgent is build a movement that leverages his own strength against the regime’s weakness, all in the context of the hopes, dreams, wants and needs of the people. There are many stages to this thing, but the first stage involves getting into the fray and becoming relevant. that inevitably entails some mayhem, and hence this post: if you’re a revolutionary, out on the streets in the early days of an insurgency, which buildings do you burn down?

The initial temptation is to tear it all down, and build a utopia unconstrained by the baggage of the past. This is almost always a mistake. In particular, it’s a mistake not to at least dig deep into the current structure of how things are done, and then when rejecting elements of it, do so from an informed perspective. Even companies that represent radical new ideas leverage existing behaviors and habits. Think of twitter, a company i think we can all agree asked users to engage in a brand new human activity. What are the options you have when you “receive” a tweet? Basically, you can reply, reply all, forward, ignore or delete. Twitter uses its own vernacular, and certainly the fact that it is semi-public is a departure, but it fundamentally builds on heuristics that are deeply familiar from email (and, before that, corporate voicemail). Where possible, don’t destroy or take on those conventions and institutions that you can co-opt and leverage. You may damage the regime, but you’ll also damage yourself, in that you will certainly not delight the people. You don’t burn down the hospitals.

The second category of institution that you can choose to destroy are those that do represent a chance to win favor with the users, but will engender negative consequences from outside the immediate ecosystem. One of the portfolio companies we are very excited about is BankSimple. This is a company that operates in a heavily regulated industry, and is therefore properly cautious to remain within the bounds of what is considered kosher by the regulators. It would be enormously liberating to ignore these constraints, and in fact you could build a retail banking experience that would be absolutely kick-ass if you dispensed with things like Know Your Customer, fraud management and NACHA compliance (I won’t go into it but it’s not something you want at a Superbowl party). You can’t, and shouldn’t. You would hurt the incumbent competitors in the short term, and the customers would be wildly in favor, but forces larger than you would come down hard. You don’t burn down the US Embassy.

Next come the special interests, which exist any society … the privileged classes, the industrialists and landed families who own the factories and the real estate. These are people who have done well by the old regime, and will probably root against you, but who you need, as they control the means of production and have legitimacy (at least some) in the eyes of the people. The answer here depends how radical you want to be. One of our companies, Quirky.com, is clearly revolutionary. Quirky permits designers and investors to collaborate to create products, which Quirky then manufactures and sells. This type of crowdsourced innovation is new to the world and incredibly exciting, and is destined to disrupt the traditional relationships between consumer goods manufacturers and their distribution channels. Why, then, is Quirky also working with traditional retailers like Bed, Bath & Beyond? There is some good analysis here, but the basic answer is that it doesn’t usually make sense to try to innovate all the way up and down the chain when you can leverage some parts of the existing infrastructure. Quirky, at least, has decided not to burn down the office buildings.

Then you have the hard choice regarding the existing justice system. Do you set everybody free? “Free” is kind of a magic word these days, in entrepreneurial circles. The prevailing wisdom is to charge nothing, build a user base, and then “monetize” them. Similarly, when a society’s jails contain both real criminals and good people deemed enemies of the state, it is tempting to let them all free, and figure you can sort out the criminals later. But both of these things are very dangerous to the market dynamics. “Free” is a tough genie to put back in the bottle (also works if you substitute “hardened criminal” for “free” and “jail” for “bottle”.) One of our most exciting companies is called Extreme Reach, which is taking on a dominant incumbent in the video distribution business. It was tempting, at the outset, to compete on price. Instead, Extreme Reach built a technology that let them compete on quality, service and flexibility, maintaining the prevailing price structure. As they now rapidly take share, I can tell you that it’s awfully nice to be getting paid while doing so. There are many, many compelling counter-examples on the consumer side, all of which have built massive audiences by starting out, and largely staying, free. I would say, in general, that revolutionaries do burn down the prisons.

What do you do about the state controlled media? This, after all, is where the people have been getting their information for decades. Can you afford to destroy it, rather than co-opt it and use it for your own purposes? I think this one is increasingly clear. New movements demand new media, and can leverage the hell out of it. Examples here are too numerous to name, both in the insurgency world and the entrepreneurial world, but suffice it to say that getting a seat on Oprah’s couch is now less valuable, for most companies, than a retweet by Chris Sacca. Definitely burn down that state-run TV station.

Finally, there are those elements of the ideology that aren’t just wrong, they are representative of all that is wrong, the root of all evil. They may be lovely, or useful, or valuable, but they just must go, if the revolution is to have any legitimacy. One of our companies, On Deck Capital, has built a platform to enable lending to small businesses. In the last 3 years, they have lent over $100MM to Main St small businesses, with exceptional credit performance. The thing I love most about their model is that they basically ignore the FICO score, that antiquated and creaky credit scoring methodology that was one of the prime causes of the credit crisis. Both in reality, and in the realm of perception, you can’t build a “new” system that relies on emblematic elements of the old. Down with FICO; Up with On Deck! You burn down the secret police building, you burn down the torture chambers, and you burn down the presidential palaces!

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.)