By now you will likely have read Andy Dunn’s scathing post about Venture Capitalists in which he decries the industry’s masses.

I read Andy’s post with a knowing smile on my face. After all, I am no stranger to the publicly expressing the frustrations of dealing with the downside of this industry as I wrote about in 2006 when I was an entrepreneur.

But VC is like congress. It’s easy to hate it en masse yet many people love their local congressman.

Why?

Because they know him or her. They see how hard she does her job. They know her personally and know she cares about her constituencies even if she has to make tough trade-offs from time-to-time.

In the original version of his post, Andy writes

“This essay is dedicated to the great VC’s on my board who I am lucky to work with: Sameer Gandhi from Accel, Jeremy Liew from Lightspeed, and Kirsten Green from Forerunner.

I rest my case. “Hate the industry, Love my local guy.”

But many of the assertions in his post – while populist – aren’t exactly how things are in reality. So I thought I’d have my hand at a friendly counter point.

After all, I understand’s Andy’s frustrations with the industry.

And yours as well. I have felt them myself.

I wrote Andy first to be sure he wouldn’t be offended if I did. Luckily Andy is good natured

So let’s look at the main assertions

1. The industry is dying, except for the top 2%

“I don’t know the exact math, but I hear it again and again: the top 2% of firms generate 98% of the returns in venture capital.”

Unfortunately the first part of that statement is true. The second is not.

The top 2% do not drive 98% of the returns.

I have seen many slices of the data. The quickest I could find was from PitchBook. As you can see from the chart their data suggests there are about $25 billion of VC distributions per year in the US.

According to FLAG Capital there are 100 active VCs (as defined by making at least $1 million in VC per quarter for 4 consecutive quarters).

Their data looks at tech VCs. So for argument’s sake let’s triple the number of active VCs and call it 300.

 That would mean 6 firms drive $24.5 billion in returns.

Not even close to the case.

Most top tier VCs return about 3x invested capital and outlier funds (the best of a vintage) might return 6-8x. It’s true this was much bigger in the dot com era but I’ve studied the data and know that over the past decade these numbers are right.

So if you take 6 very strong performing firms of $250 million and assume they do 5x each that is $1.25 billion each, $7.5 billion in total or 30% of the industry returns.

But Mark, many of the great firms are $500 million and up! If you double your number that would mean 60% of industry returns. Not too shabby!

Yeah, true. But the larger funds usually have lower returns because they are often investing bigger dollars at later stages with less risk and therefore lower returns.

As you can see in this Cambridge Associates data, early-stage investing beat later stage investing in returns in 70% of the past 30 years.

It is true that every few years a fund exits that delivers smashing results because it has Facebook, Google or Twitter in it. But as an LP you can’t count on that any more than VCs can. You invest across many funds just as VCs invest across many companies.

The better way to think about VC returns is, do the firms consistently beat alternative asset clases on an IRR basis to adjust for the increased risk and lack of liquidity?

Here the data is not always kind to VCs.

But the top 25% do consistently beat the alternatives. The problem is the illiquidity because investors are often locked in for 7-10 years. The goal of an LP is to get into the top decile. But picking today’s top 10 does not pick the next year’s 10.

Take for example Accel. When it went to raise its fund 10 years ago the rumor was that many LPs were disappointed with recent returns and did not re-up. Yet their next fund had Facebook in it. Doh.

And I believe that Accel has consistently shown its ability to be in the top decile in the last decade.

But the funds that every LP wishes they were in – USV & First Round Capital – not to mention Foundry Group, Spark Capital, Floodgate, IA Ventures, Founder Collective, K9, True Ventures, PivotNorth, SoftTech and many others either that didn’t exist 10 years ago or were just sprouting. Neither did Andreessen Horowitz.

So the reality is that yesterday’s winners are no guarantee of tomorrow’s success and today’s emerging managers might just be tomorrow’s best investors.

The industry isn’t dying. It is changing. And reinventing itself. And some firms will go under. And others will emerge. That’s normal. It’s  a market, after all.

In 2000 our industry had more than $100 billion in LP money. By 2009 had reduced to around $15 billion in capital from LPs. In 2013 it is expected to be around $35 billion.

Not. Dying.

Why?

Compare the state of play in 2013 versus 15 years ago. 33% of the world is on the Internet on average of 3.1 hours / day. There are 138 million smart phones in the US alone and … wait … 99 million tablets. Insane.

2008 App ecosystem on iOS = $0. 2013 = $25 billion of which Apples stage is more than $8 billion at > 90% gross margin. Credit cards = less friction = more purchases = cha ching.

2. The best VCs don’t try to help entrepreneurs

I’ll admit that I do know one VC firm who’s strategy is not to call their entrepreneurs and not to be involved in operations. But I seriously only know one. They believe that stock picking is the most important function they can play. They are also less than 10 years old.

But the people whom I consider best in this industry are quite helpful indeed.

Let’s look at some great companies.

Facebook. Is it right that VCs had no involvement in persuading Sheryl Sandberg to join the fledgling company? Not according to my sources.

Google. If you read Ken Auletta’s piece it makes it clear there was active VCs involvement in the early days. It led to hiring Eric Schmidt. And Coach Campbell. And to finally admitting that ads weren’t evil so that Google could copy the model of the fast growing Overture.

Twitter. There have been a lot of management shuffles at Twitter. But in my mind there is no doubt that placing Dick Costolo at Twitter was the most positive thing Twitter has done to become a long-term success. Hard to imagine that Dick joined “organically” or that his becoming CEO also was organic. My guess is both had heavy VC involvement.

Amazon. I’ve heard directly from top executives that Jeff Bezos (in my opinion the most talented person in the tech industry) has received his fair share of VC coaching in the early years

Tumblr. Nothing was more heart warming than the photo of David Karp hugging Bijan Sabet after the sale to Yahoo! And hard for me to imagine the Fred Wilson and Albert Wenger weren’t instrumental mentors to David.

After all, many people love their VCs but hate the industry.

According to Andy

Dear Dumb VC, it’s so painful to sit in meetings with you and hear your vision for what the company should do and what’s going to happen in the industry.

Just so you know, Dumb VC, the top 2% never do this.

They’re too busy using their superb judgment getting into great deals and bowing out graciously from the ones they don’t want to back.

Not in my experience, Andy.

The best VCs I know take 11pm conference calls. Meet with their teams on weekends. Broker critical introductions since entrepreneurs are often younger & newer to industry whereas the best VCs often have great contacts across decades and many deals.

In my mind, the best VCs actually deliver outsized returns by “leaning on the scale” not by “deal sourcing.”

I had dinner last week with somebody you would consider one of the best known names in our industry. I asked him what he’s learned as a VC. He said,

“I prefer to do Enterprise A rounds and Consumer B rounds.

On the enterprise side, I know every buyer of technology in this industry. So I can make a huge difference in the company’s trajectory. And I’ll know in 18 months whether we have product / market fit. But we can have a huge impact on that.

With consumer deals you can’t manufacture consumption. So I prefer to watch what works first and pay a higher price to get in when it’s proven.”

This rang true with me. Great VCs create the fabric of their success by backing the best entrepreneurs they have access to and then helping them to lean on the scales.

This happens at acquisition time, too. The best VCs know the buyers and can help guide and manage the process.

3. VCs Spend Too Much Time Deciding

Yes. This one is probably true. And for a good reason. Even though I know this sucks when you’re an entrepreneur and just want the money deposited tomorrow so you can get back to running your businesses.

Many entrepreneurs come by with great pitches and say, “I’m hoping to have term sheets in the next 30 days.”

If this happens to you as a VC – you’re too late to the deal. Shame on you. Get to the entrepreneurs earlier next time.

If you don’t really know the entrepreneur through many meetings, debates and encounters – it’s really a crap shoot the fund them.

That’s why I wrote this.

Per Andy,

“I should be building the company, you should be deciding quickly whether to invest or not.”

If anything a “Dumb VC” would decide quickly without knowing the entrepreneur. In my opinion Dumb VCs are too worried about being in “hot” deals so they chase the hottest new trend, the fanciest, best known entrepreneur or the party round that has so many other great names attached to it that they feel they can’t miss this one.

The unfortunate reality is the most partners at VCs firms see hundres of deals every year and invest in 1-2 of them. After 6-7 years they therefore have 7-10 board seats, which is about all most VCs can effectively manage.

A priori many deals look attractive.

Post hoc it’s obvious who the winners were.

Ask any VC who’s been in the industry 10-20 years and they’ll tell you that often those that looked the best when they wrote the check didn’t turn out to be the best. And vice versa.

So caveat emptor to those that feel rushed into deals.

Some of the most bizarre sounding deals end up being huge winners. Some of the most obvious companies and talented entrepreneurs end up not working or burning through too much capital.

VCs are wise to go slowly.

Even though that may not be what entrepreneurs want.

4. VCs shouldn’t call their entrepreneurs once they invest

“Dear Dumb VC, now that you’ve invested, leave me alone! Did you know that the 2% never call their entrepreneurs?”

I’ll just leave it to entrepreneurs to decide on their own on this one.

I call often. So I must be dumb, I guess.

My view … it is my job to be a sparring partner. I want to challenge the founders view.

Why?

Because being an entrepreneur is a lonely job. You have to make tough decisions with few inputs and little history from which to base your decisions. CEOs can rarely express their uncertainty and doubt to others.

So the VC’s job is to challenge. Cajole. Debate. Offer contrasting views. Play Devil’s Advocate.

And then step back.

And let the entrepreneur decide the course of action. Even if it is different than what you would have decided.

Fred Wilson talks about this in his post about Tumblr.

I seriously know exactly one VC whose policy is not to call their entrepreneurs. One.

5. VCs often don’t use the products of the companies in which they invest

Agree whole heartedly. I never understood investing in companies in which you didn’t really understand their products.

I blog. I create videos. I use analytics. I use social media. I IM and DM and SMS. I Instagram, Cinemagram and Path. I Quora. I Trello and Salesforce and DropBox and 500px.

I try to live a “day in the life of” the users.

It’s hard for me to imagine investing in companies in which you don’t use and understand the products and markets.

6. VCs should never be late

Hard to argue with this. Nobody should really ever be late to meetings because it’s disrespectful of other people’s times.

But I’d be lying if I didn’t say I wasn’t habitually late. But I have been since I was a kid. No excuse, but it turns out to be one of the most common traits of people with ADD as I found out when I read Delivered from Distraction.

I wish I were better. I struggle. I try to make it up with humor, kindness, apologies and by giving more time at the end of the meeting.

Many VCs are in fact late. Many entrepreneurs are, too. So are corporate executives.

I have found that being on time versus being late is a personality trait more than a power play.

What I hate more than anything is when people are late and then cut meetings off early. If an entrepreneur was told they have 45 minutes they should get 45 minutes.

In a perfect world everybody would be on time. In reality, that is seldom the case.

The best entrepreneurs don’t get too worked up about this. They understand that it just is. It’s hard for me to imagine that an entrepreneur who was waiting to see the CEO of their largest potential customer would leave if that customer were 20 minutes late. You might be bummed, but you’d bite your lip.

So what I’m really hearing is, “VCs piss me off. So when they’re late the piss me off even more.”

Fair enough.

I pitch a lot of LPs. I have to raise money, too. Many are late. Many don’t return my emails on time. Many don’t commit when I want them to.

I have walked a mile in their shoes so I’m a lot more tolerant about it these days than I used to be.

7. You suck if you don’t have 2+ $1 billion exits.

Ergo I suck.

I work with partners who have seen 15 such exits. My partner Yves will have 3 in our last fund alone and possibly 4.

Me?

Zero.

But I became a VC in 2007 and wrote my first check in 2009 – 4.5 years ago.

So $1 billion exit is unrealistic for me.

And as John Doerr has noted, “your lemons ripen early” so I like to say that if I had a ton of exits it would be because I haven’t done my job as well as I would have liked.

Most great companies start to really shine in years 7-10.

I believe I have some great investments. And some that are proving more challenging. And if you call any founder I’ve backed – good and bad – they’ll tell you I don’t quit easily. I’m on their side good times and bad.

I am seeing some companies like Maker Studios and DataSift where the growth has been faster and more impressive than any companies I ran. And while all companies have challenges – I am inspired by their progress to date.

In Summary

I was an entrepreneur previously. I know the frustrations.

I am now a VC. Not yet for as long as I was an entrepreneur.

I spend significant amounts of time with VCs now that I have gone to the Dark Side. I have more empathy than I once did.

I see the hours and hard work put in by my peers. I see how much time they spend on the road away from their families. I see them on conf calls at any hour – even from vacation.

It’s hard being an entrepreneur and making money.

It’s hard being a VC and making money.

In reality neither side is evil.

It always reminds me of my time as a CEO. Everybody always thinks they can do your job because they’re doing the hard work while you get to fly off to conference, speak with the press, go to fancy board meetings & dinners. They think it’s easy – until they have to do it.

VC is a bit like that, too.

From one of you. Now on the other side of the table.

BTW,

I think a more humorous attack our industry’s behavior was done by this hilarious video done by my friend Dorrian on YouTube recently

Dunce photo by PaperDoll Dreams on DeviantArt

On Tuesday Los Angeles will elect a new mayor. And while Eric Garcetti is leading in the polls by 7%, according to recent articles a victory is not certain.

LA needs Garcetti. He would be the first tech mayor of our city. He understands our issues as a community and vows to help keep LA Tech on the map.

From his opponent I have heard crickets in the past year.

Why does it matter?

And how can you help?

If you live in LA please turn up to vote on Tuesday. In a citywide election every vote really DOES matter.

If you live in LA (or even if you don’t you can help amplify) please consider Tweeting the following:

“I support the tech industry. I’d love to see a mayor in Los Angeles who does, too. http://bit.ly/Tech4Garcetti #EricGarcetti”

Why it Matters

Look at the impact that having a tech savvy leader in a city can make. Consider Bloomberg in NYC or Ed Lee in San Francisco. They both have presided over big tech booms in their respective cities. They understand that job growth and therefore overall city well-being depends on it.

While a mayor of any city doesn’t have unilateral power and certainly the mayor of LA has unique challenges not faced in other cities, having a champion of business in office will help to continue to raise the profile of the city when people make crucial choices about where to grow jobs.

Consider the case of LegalZoom, one of our cities great startups. In 2010 the City of Los Angeles started trying to crack down on tax receipts of Internet startups allocating them to the least favorable gross-receipts tax bracket taking up their city tax by 500%.

The result? LegalZoom moved from Hollywood to Glendale. Doesn’t sound like a big deal if you know local geographies – it’s only a 20-minute or so move.

But more damning is that LegalZoom decided to open its next big center of innovation in Austin, Texas, along with 600 new jobs and a $21 million office purchase according to this article.

Garcetti worked with LegalZoom, ShopZilla, Hulu and others to try and change the tax ordinance to support the emergence of our biggest tech companies in LA city only to be stymied by the head of the office of finance, Antoinette Christovale as outlined in this article. The 600 under-employed people of Hollywood who could have worked at LegalZoom but are now in Austin thank you. As does the mayor of Austin.

Growth companies beget more growth companies.

And we need a tech visionary in the bully pulpit in the mayor’s office to make sure our issues are heard & known.

In digital video between Maker Studios (where I am an investor), Machinima, Zefr, BigFrame & FullScreen we have added around 1,000 jobs in the past 3 years and this should continue, as video becomes an important part of the infrastructure of the Internet.

In our city we have leaders in finance (ZestFinance), art communities (DeviantART), commerce (NastyGal, JustFab, ShoeDazzle, LittleBlackBag, Beachmint), Internet infrastructure (Gravity, Factual), AdTech (Burstly, Rubicon, Shift, GumGum, Steelhouse, GradientX), Software (Cornerstone OnDemand), Mobile (Scopely, TextPlus, SnapChat, Whisper, Tinder), Business Services (j2, LegalZoom, Inside.com, DocStoc) and many others too numerous to list (and I’m sure I forgot some important ones).

Thousands of jobs.

We can continue to innovate in LA or watch our jobs and our engineers move up North. We can try to reinvent Hollywood film and TV (Hulu, Epoxy.tv, Blayze, Chill, TasteMade) or we can watch it migrate out of our city.

Garcetti understands this and having a vocal and visible leader amongst us is so important to win at the margin. To attract LP money to local VCs. To attract companies to locate and stay in LA. To encourage Google, Facebook, Twitter, EA and many others to plant more seeds in town and grow the local tech scene.

The Facts

I have watched Garcetti up close. He is a smart, dedicated public servant who gets tech.

1. Smart: He was graduated from arguably our top-rated high school (Harvard Westlake), B.A. from Columbia, Rhodes Scholar at Oxford and studied at London School of Economics.
2. Dedicated Public Servant: Garcetti has been a member of the LA City Council since 2001 and was a three-time president.
3. Gets Tech: Garcetti knows our industry’s issues and can promote jobs and fair legislation. While his opponent tours around with Magic Johnson, Garcetti has been at virtually every major tech gathering in our city for the past 18 months as well as dropping knowledge on Reddit.

He is also a bilingual Jewtino (his dad’s family is Mexican / Italian and his mom’s is Jewish). Can’t get much better in a city like Los Angeles, hey?

So please vote. This isn’t a presidential election where our vote is neutered. This is a citywide election where every vote counts.

Be heard.

And let’s elect a mayor who knows that building a vibrant tech community is the key to LA’s continued growth and innovation.

My internal compass has always steered me strongly toward the belief that founders who can scale with their startup companies are better to back that founders who eventually need to hire a CEO.

I have talked about this publicly a great deal – how I prefer “missionaries” over “mercenaries.”

But lately I’m more swayed by the wise words of Reid Hoffman.

“Founder is a state of mind, not a job description”

We all love the mythical stories of our great founder heroes who drove startups from scratch and led their businesses many years later: Bill Gates, Larry Ellison, Jeff Bezos and so on.

Very few founder CEOs go into the job ever expecting to give up their seat. It’s your baby. Your idea. You took the biggest leap of faith. It becomes an extension of self rather than a job.

So give up the CEO role?

Fuck no.

But it’s actually not that simple.

Jonathan Strauss took this issue head on in a blog post that I believe every startup founder should read on “Replacing Oneself as CEO.”

“After 3 and a half years of fusing my self-worth with the success of the company in the crucible of startup survival, it was impossible to tear them apart without pain.

But while my first reaction was disappointment and failure, it was almost immediately washed away by a wave of relief.

I knew change was inevitable, but I had no idea how stressful and exhausting maintaining my internal reality distortion field had been until they gave me permission to turn it off.”

I can’t imagine many founding CEO’s who don’t read Jonathan’s words and know exactly what he means.

I saw this first hand. The confidence, energy, passion and humor that are hallmarks of Jonathan became muted in the pressures of needing to show financial successes to match one’s enormous product vision and ambitions.

I told Jonathan (and believe) that this would be the best year of his professional life. He gets to return his focus and energy back to what got him so passionate in the first place – product – while now having a seasoned leader and enough capital to fulfill his vision.

I spoke with TechCrunch TV recently about the decision to give up the CEO seat, the stresses of the job and my perspective of the situation as an investor. You can watch it here.

I have never felt prouder of the team & product at awe.sm (please visit to check out our latest & be ready for our next big product announcement due out in next month or so) and yet we just brought in a new CEO to the company, Fred McIntyre.

How could these statements live in the same sentence?

*******

An Awe.Sm story

I first met Jonathan nearly 4 years ago. I know because I marked the occasion with a blog post on how to have a great VC meeting. I wrote about Jonathan’s visit (but never named him by name until now) because it was so memorable. His vision for social analytics and tracking the conversion funnel was better than any I had heard at the time (or since).

He talked about how we were going through a period of time in which people were measuring “likes” and “followers” but not the real value of social media conversion by tracking what actually converts into business and that few people understood the catalyst of what drove a successful campaign in the first place. It is what he set out to build and he had huge initial success in landing big clients like Disney, Zynga, Gilt and TopSpin.

I funded Jonathan’s first $500,000. For the entire first year after I funded the company he refused to take a salary and I had to admonish him to make sure he paid his expenses. He worked his ass off and delivered an amazing technical infrastructure to support a “big data meets social analytics” platform that could be used by any developer.

Yet our initial customer success didn’t translate into big revenue growth and we faced issues such as:

• Do we support developers, end-users or both?
• Do we price for volume of consumption or for enterprise integration with other platforms?
• Do we have a heavy-touch implementation and support or a lightweight one by integrating with products that white-label us?
• Do we optimize for “social sharing tools” or merely for back-end analytics?

The decisions were endless, the choices not obvious and the VC involved a pain in the ass. The financial pressures of running a startup started to hit Jonathan. I saw it first hand.

I have a very public seed stage investment policy  and awe.sm was definitely in the bucket of amazingly talented founders with a great product that hadn’t yet proved product/market fit.

So I wrote another check to extend our runway another year. The second check was $400,000 out of a $500,000 round. And I forced Jonathan to start paying himself.

Our product really started to show its strengths in attribution as we were able to prove publicly that Twitter was driving more traffic than people had acknowledged but it wasn’t showing up in referral logs due to what is known as the “last mile problem.”

We had inbound M&A requests from some of the biggest names in tech. We did a gut check and I asked Jonathan what he wanted to do. He knew that I didn’t want to give up on his journey but I would if that’s what he wanted.

He told me he couldn’t give up when there was so much more to prove. He remained as committed to the company vision as when we first met.

We had VCs show interest in funding awe.sm and settled on Foundry Group and raised $4 million ($1 million more from me).  It was great to get some new ideas around the table and to have some money to execute on our plans with more resources than before.

Yet with major advances in our product infrastructure we still hadn’t proven we could scale sales. It was really hard to look at the situation and know that the answer was that Jonathan needed help and that what he really needed was a boss. The board was unanimous in our opinion of this including outside director Ian Rogers who has served as Jonathan’s mentor and friend.

We knew what was right for the company and wanted to see the company succeed more than protect Jonathan’s short-term ego hit. Jonathan shared that experience in his blog post so I won’t repeat it.

But we did offer Jonathan his second gut check. We knew we had a valuable product that an acquiring company would gain greatly from and a world-class engineering and product team that would be valued by a buyer. If he wanted to sell we would enable it, but if given the choice I preferred to see the team fulfill their dream and I never lost confidence that our market was there. Nobody has stepped in with as complete of a vision as awe.sm has.

Jonathan went through a reflection period and chose to continue the journey. We have spend the last 6 months working on our next generation product and as one of the main beta testers I can tell you it’s the best stuff we’ve put out to date so I was very pleased with his decision to fight on.

We set out to find Jonathan’s “co-founder.” Somebody who had lived with the marketing consequences of trying to track online conversion from websites, google, mobile and social.

We found Fred McIntyre who had worked with Ian Rogers in the past and therefore we had a strong connection with his past skills, drive and determination. He has joined the team as CEO and shown an immediate desire to “live the company” in the way that founders did. To be a founder in state of mind.

*********

My Own Journey – And Replacing a CEO

I actually don’t talk about it publicly much but I am one of those people who gave up the CEO role in my first company so I know the emotional roller coaster it can be.

I had never even considered it, it wasn’t an option. But I was part of a networking group called YPO, which has a subsection called “forum” in which a small group of your peers meets monthly to discuss life. Topics range from aging parents, marital strife, infidelity, disease, stress, life’s true mission, giving back – you name it. I was staggered to hear people talking so openly.

I wish the tech community would found its own version of YPO Forum. It might help us better prepare for the enormous pressure & stress of being a founder, it might help us realize when there are people with serious depression in our midst (and try to spot people considering suicide), and frankly it might just be a great outlet for all of those insecurities you can’t tell your team, your co-founders and your VCs.

In my case it was the encouragement to hand off the role of CEO of BuildOnline before the company was eventually sold.

I had stayed for 6 years. I loved the entire journey – good and bad – and the employees and customers. But I was also in a rut where I felt I had lost the ability to be innovative and I had lost a bit of the passion & fun that came with the early days that were more existential and involved more intellectual challenges and less managerial ones.

The truth is I have never enjoyed running team meetings, managing processes & procedures and deciding HR policies, promotions and org structures.

There is no better article on the topic than Reid Hoffman’s post about giving up the role of CEO at LinkedIn.

“CEOs need to derive satisfaction from the nuts and bolts of building a company, not just building product and articulating the vision.  They need to be passionate about leadership, management, and organizational processes as the company scales.”

In this day and age many people will tell you that you can have your cake and eat it, too. You can simply hire a COO to do these things while retaining the CEO title but focusing mostly on product.

I have previously written why I don’t believe in the COO role at early-stage startups.

Reid weighed in eloquently on this topic.

“[to be CEO you need to] devote substantial time to time consuming things like running meetings and other business process. You can’t just do the exciting stuff like making the final call on product and speaking at conferences, while shuffling off everything else to the mythical COO who loves doing all the dirty work and doesn’t want any of the credit

… I had thought about the COO option, but I knew that the company needed someone who felt like they “owned the ball.””

Mythical COO who loves doing the dirty work with no credit. Kind of like a mythical Vice President of the United States who wants to be behind the scenes but doesn’t want the top job.

Therein lies the dilemma.

The best people almost always want the top job if they’re going to put in the real work effort. Of course there are exceptions – the most obvious one being Sheryl Sandberg.

Reid’s admission of his interests sounds like something I would have written myself verbatim

“I’d rather be solving intellectual challenges and figuring out key strategies, not debating which employees should get a promotion, or configuring project timelines.”

So Reid set out to hire a CEO. His first attempt was Dan Nye who had some success but apparently one key missing ingredient. Reid believes that you need a CEO who is also passionate about product and he later found that person in Jeff Weiner.

Jeff joined early enough to feel like a “founder” even though he wasn’t there at the “founding.” He was as passionate about the product as Reid and became the biggest eater of the LinkedIn dog food. He had founder mentality.

This seems to be the exact situation at Twitter. While Dick Costolo wasn’t there at the founding it seems clear that he has become the reasoned voice of the growth of Twitter. And while it was another team entirely that sparked the product adoption that is now Twitter, there is no doubt in my mind Twitter would not be its current success without Dick at the helm driving product, user engagement, capital raising and revenue growth.

Again, captured eloquently in the words of Reid Hoffman

“Being there at the start isn’t the only path to being a founder.  “Founder” is a state of mind, not a job description.”

So true.

So I look forward to watching the next awe.sm chapter unfold. To watching Fred lead our sales, marketing and implementation efforts and driving the recruiting & financing of the company. And watching Jonathan to continue to build on the product vision that started 4 years ago from his desire to fix a large part of the Internet’s inefficiencies.

No.

The one word the best entrepreneurs never accept.

I said it.

Now let me walk you through a broader story because avoidance of the word in and of itself will seem cliche. Stay with me.

When I was little I had a role model for entrepreneurship – my mom. She was a natural leader. She was president of the UJA in Sacramento. From this I saw civic involvement and leadership first hand.

She was a nurse but was never graduated from a 4-year college. Still – she can do the NY Times crossword puzzle better and faster than I. Even today.

She was a hustler. And a ball buster. And a natural sales person. She was never afraid of the word “no” even to the point of embarrassing me.

My youth was filled with her arguing with vendors if they tried to pull a fast one. As my wife will tell you – arguing is cultural – you grow up with it or you don’t. I did. It’s very Jewish. For better or worse. She’s learned to embrace it in me. If a maitre d’ tries to seat me at a table in huge traffic flow or a corner she knows not to bother sitting down.

My mom bought our family’s first computer and encouraged me to learn it at 13.

She opened 2 businesses – a bakery and then a restaurant. I worked in both before leaving to work in a software company at 17. I never knew a world in which you weren’t supposed to work and make money. Even though my dad was a doctor and in retrospect I probably didn’t need to earn my own money. My mom always taught me it was my responsibility to do so.

When I was younger my mom taught me something I never forgot

“You don’t ask, you don’t get.”

It’s simple. I know. But it amazes me how many people don’t really get it.

2 stories.

One.

When I lived and worked in London my wonderful assistant was Deborah Halliday, who was raised a very “proper” British young lady. Her brother played rugby for the English rugby team and went to Oxford. That’s kind of like having a brother in the NFL in the US.

If there was any society in which being a hustler was out of step with the norm is was England. Yet I was a foreigner so I got away with being different.

I used to ask Deborah to book my travel plans in France and Germany were I went 1-2 times / month. There were online tools to book this stuff but the Internet booking sites were early.

I would tell Deborah, “I found this hotel near the Champs Elysees for 170 Euros. But I don’t want to pay that much. Tell them I’ll stay if they’ll give it to me for 120 Euros.

“What? You want … what?”

“Mark. You can’t do that! You can’t just name your own price.”

Me. “Of course I can. Tell them you found a hotel down the street for 100 Euros but I prefer to stay at their hotel. Haggle. See what you can do.

Deborah. She was mortified. Bless her cotton socks. I put her outside of her comfort zone.

Me. “Deborah. You don’t ask, you don’t get! What’s the worst they can tell you? “No?” If so, we’ll call back an hour later and pay 170 Euros. It’s not like they’re going to tell you ‘no’ in an hour. You might as well try!”

Classic Mexican Road strategy.

Here’s the thing. They NEVER said ‘no.’ Such were the times. They weren’t fully occupied.

She began to love it. It was liberating. I taught her to make it a game. I would challenge her to see how cheap she could get rooms. I can still hear her giggle at how ridiculous it was in her mind’s eye. And yet how eye opening it was that you could have almost anything you wanted. If you just asked.

Story two.

Fast forward. My son Jacob. He’s now 10. When he was 7-8 my wife used to sit down with him to do homework and train him the importance of getting it done early and well. Luckily I have such a terrific and organized wife. Or Jacob would be screwed.

They sometimes did homework at Le Pain Quotidien. And if Jacob was good he could get a treat.

Tania once took him up to the counter to pick out a treat. He pointed at a chocolate cake and told Tania he wanted a piece.

“No, honey. That’s a whole cake. You can’t have a piece. It’s not cut. Why don’t you find something else?”

Jacob, “Of course I can have a piece. Just ask them!”

Jacob has IJ. He knows to ask for what he wants. He is respectful. But he has an inner compass that in stead of saying “ok” to adversity he says “why not?”

She had him ask the lady behind the counter directly. She said, “no problem.”

My wife smiled and couldn’t wait to tell me the story.

My wife thinks Jacob’s an over negotiator but she secretly loves it. I always take it as a compliment.

Both stories have something in common. Not being ashamed to ASK. As I tell people almost weekly, “What’s the worst that could happen? That they would say, ‘no’?”

And I mean it. I promise you that 95% of the people I meet are afraid of people telling them no. They are personally embarrassed by it. Or insulted. Or view it as failure.

I’m told “no” all the time because I often ask for more than others do and therefore you need to be willing to hear “no.”

I was on a flight last year from DC to LAX. I had a business class seat due to status of flying a lot and my family was in economy. I felt bad and was planning on rotating.

But when I sat down I asked if my family could upgrade since there were 3 open seats. I assumed the answer would be “no” but I figured I had nothing to lose.

The flight attendant said “ok. but you’ll have to pay a small upgrade fee and I can’t move them until after take-off.” But move them she did. And she decided it wasn’t really important to make me pay since the seats were unoccupied.

Score!

We had also just been upgraded from London to Baltimore.

2 times in a row – unreal. My wife was a bit incredulous (but grateful). I simply pointed out that our kids learned a more important lesson than the downside consequence of their expecting to always sit in business class (which isn’t going to happen!).

They learned to ask, “why not?”

You don’t ask. You don’t get.

And here’s the thing about “no.”

I know first hand just how chicken people are about hearing it. I’ve sat through so many meetings where sales reps didn’t ask for the order. I’ve been pitched by hundreds of entrepreneurs who never actually asked me whether I would invest. Very few people do.

Here’s an experiment for you.

Hold interviews with tech people, marking people, ops people, finance people – whatever. They always finish the interview with a “thank you” and barely ask next steps.

Any great sales person will ask you at the end of the meeting, “So, how’d I do? Who else have you spoken with? How do I stack up? What do I need to convince you of to get an offer? What is the next step in the process?”

Great sales people are trained to “ask for the order.” If you interview a sales person and they don’t ask for the order, be worried.

I like to flip things on their heads. I like to ask in reverse in interviews, “If we did get aligned to offer you this role, do you plan on accepting? What other offers do you have? What do we need to do to win? What steps do you still need before you decide to go with us?”

I want to know. And I have nothing to fear in the answer.

My favorite (not!) is dealing with lawyers (or VCs) who say, “as a firm, we never do a, b, c.” Let me tell you now that often this line is BS. But my standard response is, “I don’t care what you normally do. I think it’s right for our situation. So unless you explain to me logically why it doesn’t make sense at our company, my assumption is that it’s a good idea.”

In summary, I recommend some honesty with yourself. “Asking” is a skill that can be practiced and learned but you need to be self aware.

How comfortable do you feel with asking for the order? How confortable do you feel with asking awkward questions or asking for things that are out of the norm, “Could we have your room for 120 Euros so we don’t have to stay down the road?”

If you don’t find it within your confort zone – practice in small ways for asking for slightly unreasonable things just to get used to it. It’s a skill you’re going to need as an entrepreneur.

After all – you don’t ask, you don’t get.

For the past 5 years or so Google, Facebook and a handful of tech industry giants have been quietly buying scores of early-stage startups for their talent. And to keep up with the Jones’s it seems that Yahoo! has now employed the same strategy.

And who cares, right?

A couple of tech giants throw millions around in either cash (for which they have hoards) or part with some publicly traded stock. And a few teams of super talented, educated and bright entrepreneurs make a few mill. in their 20′s. What could be more capitalist than that?

It has even gone so far that we now have evocative headlines in the tech press such as “Buy or Die,” which is what got me thinking about this post.

We’ve been here before – trust me. Every era has its own amnesia for M&A gone wild.

In the end, it doesn’t really matter. It’s not some big tragedy on a grand scale. But the press (and I suspect many of the senior execs of these companies) don’t really explore the corrosive downside of these acquisition.

So I thought I would.

Buy. Or Die.

Really?

If I don’t commit to millions of dollars of acquisitions I will … die? I’m supposed to believe that my best innovation can only come from scores of startup founders who just made millions and have now become CVOs at my company? (Chief Vesting Officers)?

Meh.

The Aqui-hire Business

Many buying companies price these deals on the basis of $1 million per engineer on the team for an early-stage deal. And they might give a premium if the team has been around a longer period of time, has built some hard-to-build proprietary technology or has some customer traction.

Usually the location of the engineers matters great so having offshore engineering makes acquihires unlikely.

Let’s assume an early-stage company around for 2 years with limited traction. It is probably purchased in the $5 – 15 million range even if you see higher numbers in the press.

Almost certainly the startup would have raised some capital. Let’s assume $2 million in seed money.

If the money comes from professional investors it usually has a “liquidation preference” meaning that their money comes out before the founders or common stock. (If you don’t know venture economics – there is an overview here.)

While at initial glance this sounds unfair, when you think about it – it doesn’t. If you give $2 million for 20% of a company ($8 million pre + $2 million investment = $10 million post-money valuation) that has no product and no customers and it turns around 3 months later and sells for $5 million it would hardly be fair for investor to get $1 million back (20% of the proceeds). That’s why liquidation preferences exist – downside protection.

After the liquidation preference the founders (probably 1-3 people) are likely to get 90% of the remaining proceeds and the staff – those engineers that the acquiring company so desperately wants – would ordinarily receive a very small proportion.

I talked about the math of this in this post, “Is it Time to Learn or to Earn.”

Mark – doesn’t the acquiring company mostly care about the super innovative founders? Those 1-3 you’re talking about?

If they do then they’re naive. And most buyers aren’t. Most founders stick around for their lock-up period (1-2 years) before going on to found their next company.

Think about it – they were the ones most willing and most able to take risk in the first place. They founded their last company with no money in their pocket. Now they get to go out and try again with $2 million in their pockets plus the credibility of having just gotten a big W.

Most founders stay the least amount of time they can.

I know the buyers try the best to believe that [insert well known founder name here ... David Sacks, Max Levchin, Dennis Crowley, Keith Rabois] will stay and help lead their company in a totally new direction. But evidence suggests otherwise.

So the buying company usually wants to pay $0 for the company. And wants to structure a huge payout for the employees that will remain. That way investors (dead money for the buyer) and founders (flight risk) don’t get all the spoils while the faithful staff who will stick around get nothing.

And precisely because buyers usually prefer to have limited money go to investors – investors almost always have the ability to say “no” to transactions in the terms of their funding documents (aka “blocking rights”).

And that is the tension in the acquihire – what is the purchase price for the company, what is the “earn out” if the acquired company hits some performance targets and what is the amount of money set aside for staff retention? And will investors allow a deal to happen in the first place.

The numbers you see announced in the press for deals are hardly ever right.

OK, Mark. We get the mechanics. But what is so corrosive about this?

Why Acquihires Hurt the Acquiring Company

How about if we look at it from the “rest of company” perspective.

You have been at Google, Salesforce.com, Yahoo! for years. You have worked faithfully. Evenings. Weekends. Year in, year out. You have shipped to hard deadlines. You’ve done the death-march projects. In the trenches. You got the t-shirt. And maybe got called out for valor at a big company gathering. They gave you an extra 2 days of vacation for your hard work.

And that prick sitting in the desk next to you who joined only last week now has $1 million because he built some fancy newsreader that got a lot of press but is going to be shut down anyways.

What kind of message does that send to the party faithful who slave away loyally to hit targets for BigCo?

I’ll tell you what is says.

It says if you want to make “real” money  - quit.

Go do a startup. Get some famous angel or seed money. Get yourself in a big demo day competition. Woo the press. Hire legions of young, impressionable graduates from the top engineering universities. And then come back and sell me your company.

I know many rank-and-file employees. I’ve had the chats with them. You rarely meet people who don’t resent the scores of entitled acquihirees of their company.

Does Yahoo! et al really have to keep up with the Jones’s to build its future?

For the 200 new employees they’ll get through acquihires do they unleash 2,000 unhappy existing employees? Sure, most won’t quit. Because they know that it’s not a slam dunk to start a business and get acquired. But the most talented of those 2,000 will.

What if the $100 million you’re going to spend trying to win this alleged “war for talent” in stead went into big retention plans to keep your most talented employees.

You can’t “Roll Out the Red Carpet When Your Best Employees are on the Way Out the Door” as I wrote in this post. So why not announce big, hairy audacious goals on recruiting the best mobile talent with sign-on bonuses and retention plans? And reward your existing top 10% of employees handsomely.

I’ll bet the ROI would be higher than acquihires.

Acquihires and Venture Capital

I’m a VC. I know I’m supposed believe in acquihires to bury my investments that aren’t working.

I would never discourage any teams of people I’m working with against early acquisition if they felt it was in the company’s best interests.

But that’s not how you make money in the venture capital business. You make money by backing winners that build real businesses.

I look for entrepreneurs who set out on their journeys to do exactly that – build big businesses. Change industries. Not looking for quick flips.

And on many occasions I have passed on deals where it was clear that the founding team was over-optimizing the deal structure to focus on a quick exit.

When I have great teams with products that are taking longer to show traction than they or I would like I usually spend time trying to figure out how we can build a better business versus selling early.

I don’t blame entrepreneurs who go for an early exit when it comes up. To the contrary. On many occasions where I’ve met with teams of people in whom I’ve never invested I’ve encouraged exactly that – an early exit at a “small” price. Because if you’re business isn’t working or isn’t likely to work it’s obviously better than running into a brick wall or over-capitalizing yourself.

And of course many small acquisitions work for the buyers when there is a clear strategy for owning the asset or a clear alignment with the team you’re acquiring.

But as a repeatable strategy for large companies to try and compete with each other it still strikes me as a wasteful strategy. And few in the press are willing to call this out.

Sarah Lacy did. It’s why I love reading her writings – she’s one of the few remaining journalists in the tech sector (along with Kara Swisher and a few others) who have been around long enough to have earned their critical eyes or cynicism.

She wrote this excellent piece last year called, “The Acqui-hire Scourge: Whatever Happened to Failure in Silicon Valley”

And I thought I’d finish on a quote from Sarah,

“Allowing entrepreneurs — and their investors — to save face by saying they were “acquired” instead of failing is nice, but it’s a bit like the pre-schools where everyone wins a trophy for showing up.”

Note: image from PandoDaily, clicking it will take you to the article in which I found it.

Anyone who reads this blog frequently will know that I am a big believer in low-cost video content and specifically the power of YouTube as a content creation & distribution platform.

Our industry just took one big step towards legitimacy with the hiring of renowned media exec Ynon Kreiz to run Maker Studios. The industry finally has one of their own at the helm of the largest YouTube network.

This followed an investment late last year by Time Warner in the company in a round totaling $36 million, led by Rachel Lam, head of their investment group. This has been a very welcome addition.

And this month we announced that Maker Studios, where I am an investor and board member, crossed 3 billion views. And for the record, that’s per month not total in aggregate!

So if Time Warner + Ynon Kreiz + 3 billion views / month isn’t legitimacy, I don’t know what is.

I frequently hear critics saying, “yeah, but you can’t monetize on YouTube.”

While I will admit that there are still issues in building a profitable business on YouTube alone given the YouTube vig plus talent payouts – I can tell you first hand that big businesses are being built, brands are significantly more interested in large media buys, audience loyalty and brand building are taking place and at volume this looks like the making of the next generation of online media to me.

If you want to understand my thesis behind Maker you can read this article that outlines the trend, but in summary:

• People watch 5.3 hours of TV / day. They read less than 30 minutes. You can’t change media consumption patterns easily. The future of the Internet is video. Full stop.
• Production costs have fallen more than 90%. Distribution costs have, too.  This is classic “Innovator’s Dilemma” market conditions.
• My estimate is that the top 5 YouTube networks will do > $200 million net revenue in 2013 (after Google’s share)
• These same top networks – Maker, Machinima, Zefr, FullScreen, BigFrame – and the like have create nearly 1,000 new tech / media jobs in LA in the past 3 years alone.

The news that Ynon Kreiz is joining to run the company as Executive Chairman was first reported by Peter Kafka at AllThingsD (and later picked up by Variety, AdWeek and several other traditional media outlets.

Ynon Kreiz is a force of nature in the media and tech sectors. He created Fox Kids Europe and took it from scratch to worth North of 1 billion Euros in value and was ultimately sold as part of a $5.3 billion deal to Disney. He became a VC at London-based Benchmark Europe (now Balderton) and then CEO of Endemol, a large multibillion media company best known for creating & owning global franchises for Big Brother, Deal or No Deal and other unscripted television.

Ynon & I first discussed Maker in early 2012. Dana Settle (Greycroft) & I had led the first round of investment in the company in 2010 and we were looking for smart media investors to join us as investors in the company. We had a series of meetings with Ynon and thought he’s be a great addition to our team.

Ynon had decided that YouTube would play a major role in the reshaping of the video business and he wanted to figure out how to be involved. He initially started by becoming an investor in the company along with many of the good & great of our industry including Shari Redstone, Elisabeth Murdoch, Jon Miller & Robert Downey, Jr.

Ynon immediately began working with the founding team: Danny Zappin, Lisa Donovan and Ben Donovan and he established a really strong rapport as somebody who had the media chops and executive relationships but was grounded in the economics of low-cost video production & distribution.

The founders had been responsible for gaining staggering scale in the past 3 years, having been trail-blazers in building a network of talent and an unrivaled understanding of the YouTube ecosystem. They figured out how to motivate talent to work with the company, how to stitch together a network where everybody gained by being supportive of each other and they figured out how to make the economics work.

Like every group of founders they had a great team around them like David Sievers, Shay Karl, Kassem G and Nice Peter (who produces my favorite show on YouTube – Epic Rap Battles of History).

If you’re in the mood, you might enjoy some of my favorites:
* Moses (Snoop Lion) vs. Santa Claus
* Mr. T (DeStorm) vs. Mr. Rogers
* Babe Ruth vs. Lance Armstrong

But the founders also recognized – as many great founders do – that they were going to have to build out an experienced management team to become the billion company everybody believes this can be.

The first move was to bring in digital media veteran Courtney Holt as COO. He has proven to be one of the most knowledgeable & competent senior executives in the online video world. And he has truly been a pleasure to work with. He joined when Maker was a small, chaotic organization and helped bridge our talented creative team with the outside world of investor, brands, partners & press.

Another major hire was Ryan Lissack who joined as CTO. Ryan was not only a senior engineer at Salesforce.com (he ran mobile and also ran content management) but was also my cofounder at Koral and lead architect at BuildOnline. Needless to say I think Ryan is one of the most talented engineering leads in LA but I’d stack him against anybody in the Valley, too.

So it should be no surprise to anybody that Maker is not a talent only company. It is a “talent first” company but one under-pinned with a serious multi-million dollar investment in technology that has helped fuel our growth and will continue to provide tools & support for our talent.

And anybody who read Danny’s transition letter to the company would note that he gave one shout out to Mike D (Michael DiSanto), who is now moving to the Bay Area to help run the tech practice for Bingham.

“Without you none of this would be possible. Thank you.”

It’s true. I had written about Mike before but hadn’t disclosed his name. He is the anonymous lawyer I talked about in this post who talked me off a ledge at a particularly vulnerable moment on a past transaction.

He was not a lawyer at Maker Studios – he was a behind-the-scenes leader.

To the credit of Danny, Ben & Lisa – they never aspired to be the CEO’s of a rocket ship media & technology company. They always said to us, “we believe we are best positioned to lead this company through the important stages of growth and we would like to do that. At the right time we would like to work with you to bring in the appropriate leader to help us build this company to the next level.”

Dana & I took a chance on the founders early on. But they built the company into what it is today. And we are unbelievably proud to see the company grow from small, crappy offices above a taco shop in Venice to a production home in Culver City with 70,000 square feet and more than 50,000 individual content contributors.

Danny and Ynon in a way will switch roles. Ynon started as shareholder, board member & advisor and switches to full-time executive. And Danny switches to major shareholder, board member & advisor. I look forward to continuing to work with him in his new capacity – as a peer.

Ben & Lisa have always held enormous talents and I look forward to working with them as they help grow the company, increase & improve production quality, build out vertical networks, form partnerships with major brand advertisers and develop new sources to monetize both on and off YouTube.

Ynon was the obvious choice to help the founders take the company to the next level since he had the trust of the founders, the investors, the senior management team as well as YouTube and most of the large media players in Los Angeles and internationally.

And that’s why the online video space and YouTube ecosystem has taken one more leap toward its rightful place as next generation video platform. The media world now has its own leader running the largest YouTube multi-channel network startup. And the fact that a successful executive who could choose to run a traditional media company has chosen Maker as his next big bet is telling.

If you want to read some other articles I have written on the topic of online video and what I believe will shape the future, there are linked below.

1. The Future of the Digital Living Room
2. Hollywood vs. Silicon Valley and Who Will Win
3. 10 signs Internet TV is Ready to Disrupt the Industry
4. My Video Interview with Jon Miller
5. Why Middle Tail Content Means Big Business
6. New Online Video Trends
7. Why I Invested in Maker Studios in the First Place

Yesterday I wrote a post about “proprietary dealflow for VCs.”

In the article I discussed the downside of raising capital at a too high of a price and referred people to a previous article I had written encouraging founders to raise “At the Top end of Normal” as opposed to stratospheric prices.

In the comments section Siqi Chen wrote a great question

“Whenever I hear advice about pricing a round too high for the next round, I can’t help but think: well, if the choice (ceteris paribus) is between

a) doing what is effectively a down round preemptively when I don’t have to, by underpricing my current round in this market vs

b) accepting the market price along with some risk of taking a down round in the future, if I don’t hit my milestones, why would I ever choose b)?”

Since it is a great question with a subjective answer I wanted to broaden the reach of my answer beyond the comments section. I would love it if other people would weigh in on the comments section below if you’ve had experiences with down rounds.

The Damaging Psychology of Down Rounds

There is an important psychology that exists in investments. I don’t make the rules so don’t shoot the messenger. But psychology DOES play a big role in investment decisions. Even when investors themselves might not realize it is at play.

The rule is, “Always be over-subscribed.”

What does that mean?

It’s far better to be raising $1.5 million and get $2 million in interest (or perceived interest) than to be raising $1.5 million and only manage to get $750,000.

“What’s wrong with them that they couldn’t raise their money?”

Damaging psychology. People want what they can’t have. They want what they must work to get. So if you’re not a sought-after commodity investors may avoid you.

I know it shouldn’t be like this. They should either believe in you and your business or not, but I promise you I’ve seen this type of behavior repeatedly over the past 15 years.

And what’s worse than being under-subscribed?

A down round. That’s why.

But why?

Well, a down round is even more complicated than having no demand for your investment round.

First, a down round sends a signal that something is wrong with your company. Something didn’t go to plan. And no amount of explanations, “we raised in a frothy market. We know that. You’re getting a great deal when we’ve made huge progress.” or whatever simply won’t erase the “something is wrong” psychology.

But here’s the kicker.

As has been pointed out by Dan Primack based on FLAG Capital data, there are fewer than 100 “real and active” tech VCs in the country. If we count seed funds and large angels maybe that number goes up by 2x?

Point is – it’s a small industry. Everybody knows everybody. And we think of it like a Prisoner’s Dilemma played in multiple games. Whatever I do now it going to affect my future deals.

Often that is a good incentive because it keeps VCs from screwing people over since a bad reputation or bad working relationships could cost you deals in the future.

But in this case it works against the founders. Many VCs would prefer to avoid having to cram down other VCs by investing at a lower price or even if it’s not a cram down they prefer not to invest in a down round that forces the VC to take a “write down” on their valuation sheets they should their LPs.

And most VCs are over-whelmed with deals. So given the choice of pissing off your VCs (and you) they simply give you a polite response and move on to the next deal (with less hair on it).

What can you do if you’re already in this situation?

I’ve written about this before. I always tell entrepreneurs, “Clean Your Own Shit Up First.” (before fund raising). It’s the one post where my wife actually complained I went too far in trying to come up with an authentic image to represent the post.

So what do others think? Have you been involved in companies with a down round? Has it been easier / harder than I describe?

Do you think there’s a case for not raising at too high of a crazy price either for psychology reasons or for restructuring reasons?

Love to debate in the comments.

Image courtesy of Daniel Moyle on Flickr.

When I was new at Venture Capital I was trying to figure out the business. It was a fun period for me because everything was new and I was curious.

• What kind of deals should I be doing?
• What stage? What price? With which other investors?
• Should I focus on geographies or industries?
• Should I trust my instincts for founders and products or should I be more focused on the market size or business plan?

One of the major calibration pieces for me was where to find deal flow. As a VC you want to feel like you have “proprietary sources” of deal flow. Otherwise you’re a stock picker, which in this business isn’t a good thing.

I sorted out pretty early that lawyers were a great source of deal flow. Why? Because entrepreneurs often went to lawyers at their earliest stages to get their company registration done. Entrepreneurial lawyers like Don Lee, Dave Young or Ted Wang are  good at sussing out which entrepreneurs are high potential. They are likely taking losses on their first project with the entrepreneur so they select carefully. I’m not saying that lawyers were my screening process – simply that they knew about deals early on and they had voted with their time and pocketbooks so I knew I had a degree of filtering.

Of course I went through normal other channels of deal flow. I spent time on college campuses. I tapped my friends at big tech companies (Salesforce, Google, Oracle). I asked for intro’s from entrepreneur friends. I attended events. I did speaking gigs. I hustled.

I eventually stumbled on to the best source of high-quality deal flow imaginable – blogging. The sheer number of relationships I’ve built through being public, transparent and being willing to engage in comments and through social media has enabled me to get to know entrepreneurs even before they launch their next company.

There is one source that was always problematic for me – intros from investment bankers. This is no criticism of the investment banking industry (although I’m sure some will read it this way) for which there are very useful purposes. But as a source of deal flow it is last on my list. [no, I'm not talking about SVB, Comerica, Square1 and the like. They are venture bankers not investment bankers. Big difference.]

Before I tell you the reasons I’m concerned about investment banking intros, I should start by saying I think bankers are enormously helpful for entrepreneurs in raising money

• When you are trying to raise “strategic money” since these people are often hard to reach and they are often more used to being approached by bankers
• When you are raising a large, later-stage round given by this time you’ve likely got a fairly large business to run
• International money. Same as strategic – hard to reach, hard to get to know easily

I think the issue I have always had with investment bank pitches was best summed up in this article about Y Combinator in which Paul Graham apparently made the following quotes

“There are two things that people grumble about Y Combinator that are actually compliments,” he told me.

“One is that Y.C. start-ups are overvalued. The only way for a company to be overvalued is if there’s someone willing to pay that price. So what they’re saying is: Going through Y.C. causes companies to raise money on better terms than they would have otherwise. We wouldn’t have the barefacedness to make that claim ourselves!”

Therefore one goal of Y Combinator appears to be “get the highest price and best terms.”

Fair play.

They have an investment in each company so I can understand that goal. And they have access to some of the most talented technology entrepreneurs so this is a worthy goal for them.

As an early-stage investor that is not always aligned with my goal, which I would express as, “pay the right price for the stage & risk in a way that is fair to the founders yet preserves our ability to grow into our valuation at the next financing event.” As far as “terms” go I’m 100% aligned to have the most vanilla, founder-friendly terms I can.

But I think there is a down side that I see in startups that raise artificially at prices above what a normal market might value. It makes it extraordinarily hard to raise the next round of capital.

And I’m seeing this even at some really well run startups.

I have always advised startup companies against letting valuations get massively ahead of market norms. I normally advise “Raising at the Top End of Normal.”

The other Paul Graham quote from the article is this:

“The other thing they say is that they can’t tell on Demo Day which are the good start-ups. Well, it’s not because the good start-ups look bad; it’s because the bad start-ups look good! Which means we’re doing our job.” 

Recap: Our goal is to find investors who pay the highest price and to help make sure that investors can’t tell whether they’re getting a good deal or a bad deal.

Hmmm. Lucky me.

So I stand by my well-read Quora post of why I don’t attend demo days. I reiterate as I did back then – it’s not a Y Combinator thing. It’s a Demo Day thing. I don’t think they serve investors well. I feel like I’m attending theater rather than looking for deals.

They are terrible predictors of success for investors. We are judging how well you are coached on stage. Do you have good quips? Good vocal variety? Or as the article on Y Combinator suggests, “is your accent too heavy?”

Meh.

I prefer to get to know companies over time.

I know this will read like a criticism of Y Combinator and I’ll get in usual trouble for that, which I reget. Because my nuanced views will be read wrongly. I wish Paul & team could see my views in why Demo Days are not right for me as more of my style than anything I think is wrong with them. And for the record, GRP has funded YC alum.

I view Y Combinator as a sort of Harvard Business School or Stanford in that I know the best young people of our generation want to go there. So I know that the people graduating will have a higher proportion of great talent than other places. I know they will continue to produce great successes and that they have a team of great thinkings and leaders running their program.

I also know that there are people close with the program like Sequoia that get access to the companies early and therefore have a proprietary advantage over somebody like me.

It is not my proprietary deal flow.

I haven’t built Y Combinator. So if I’m the guy in the audience feeling the power of that great baritone projection with that beautifully designed product and if I am able to fund that company without a prior relationship with them, I’m guessing it falls into Paul’s category of “a bad startup looking good.”

Otherwise, “why I am so lucky?” to get access to it when so many other investors who know the companies on a more proprietary basis have picked over it, spent more time with them and chosen not to proceed?

Or maybe I’m paying the highest price? Hardly a reason to get excited about winning a deal.

As the saying goes, “If you don’t know who the sucker at the table is, it’s you.”

Bad companies that “look good.”

And so it goes with bankers.

They are designed to help good companies to get access to investors but also help to make bad companies look good. They do this because they have amazing skills at writing business plans. They know how to build pitch decks. They have blackbelts in Powerpoint. They tell you how to tell your story. They know the VCs so they know what interests them.

Real life entrepreneurs are messier. And that’s how I like it.

I like to see how they got introduced to me. How good they were at follow up. If they made a mistake how they recovered. I like to see their responses to hard questions – even if I don’t care if they have the “right” answer.

I like to watch how they respond to set-backs and adversity. I like to see how they improve their products when there are obvious holes. I like to debate with them how they will land customers and how they deal with the press.

I judge based on their ability to attract their fellow teammates and what choices they make. And I listen to the reasons their co-founders quit their well-payed job to join them.

I like to hear their passion for the idea. I love complexity. And non-conventional ideas. I love when other investors “don’t get it.” I love businesses that don’t lend themselves well to VC Panels at conferences or Demo Days.

If I’m willing to commit early and be out on a limb then I want to know if I can get a better price. If I wait for traction I know I have to pay up. That’s OK, too. I want to know that if I commit it’s not going to be a party round. I hate party rounds. I generally don’t like to work with founding teams to over-value “collecting logos”

I know that the simple view of this is that I want “cheap” prices, which isn’t true. I have enough investments that people can diligence to tell you that I’ve been fair on price.

But when your banker is pushing me, telling me

“We’re expecting 3 other offers, so move fast”

or

“You’ll have to top “x” price to win this deal”

You’ll understand why I have no enthusiasm. My value add in this deal? Ability to move fast and pay the highest price?

And my reward for doing this? I get to watch 2-5% of my investment immediately squandered on a banking fee for the introduction.

Lovely.

To all my banking friends … I’m not a hater. Your skills are much appreciated later in our business. I would gladly work with you on a $50 million late-stage, complex financing. I would welcome you in an M&A process. I value your insights into industries and your unrivaled networks.

But for A-round deals please understand why I don’t want to take the meeting.

And given how easy it is to meet VCs through introductions I also wonder what’s wrong with your startup teams that given the unprecedented amount of transparency and access now in our industry – why they chose to hire a banker. Might there even be some selection bias in the companies in which you’re pitching me?

To the investment bankers in the comments who argue, “Entrepreneurs have more valuable things to do then raise money. They have a business to run!”

I think that misses the point.

The process of raising capital IS part of running a business.

It’s where you get to test your ideas in the marketplace of people who see many similar ideas.

It’s where you meet people who have broad networks and even if they don’t invest in you may prove very helpful in your future.

It’s part of a process where you learn which investors YOU like so you can decide with whom to entrust as a married member of your business.

After all, if the banking process sanitizes your company and makes it more efficient to raise capital without all the “hard work,” so to does it sanitize the investors. Yet once they’re in your deal there is no turning back.

I’ll take messy and hard work any day.

****************

Let’s call this the “Hunter Walk” footnote. He pointed out that while I changed the title from “Why Early-Stage VCs Should Be Careful About Intros from Bankers” to the current title I hadn’t explained the change.

I thought a lot about the original title (by the way, I often change titles after re-reading, editing and reflecting on the post) and I felt it was too hostile towards investment bankers, for whom I have no animus and I have many friends who are in the biz.

The real point of my article seemed to be broader. It was … VCs need proprietary deal flow. Getting excited about a company at a conference and investing is a sucker’s bet. Entrepreneurs raising at prices not normally supported by progress face risks downstream when they have to raise more capital. And that fund raising is part of the job of being an entrepreneur – not something that gets in the way of your doing your job.

So I changed the title to reflect the tone I wanted to get across.

I travel the country a lot. And I am often approached by entrepreneurs in cities which don’t have a vibrant VC community. They often ask whether they have to move to SF, NY or LA to get financed.

I have the same response always, “Where do you want to live? Where do you want to build your community, your relationships, your family?” I’m trying to get a feel for their commitment to local community versus being in a place where financing is easiest.

If their commitment to staying local is weak I normally say, “Well, it certainly would be easier on you to be in a larger community. It would be easier in terms of getting access to angels, VCs, the media, whatever. So if you’re really indifferent you might consider it.” On the other hand, if they have a strong preference to staying local I usually tell them that I believe you can build a business anywhere these days.

You can build a meaningful company just about wherever these days. Just ask the people of Portland, Seattle, Boulder, Iowa, Princeton, Dallas or countless other cities that don’t have enough venture capital.

Ask SuperCell. Or Rovio. Or UrbanAirship. NewToy, Dwolla, Pollenware or Wonga.

If you don’t live in a major VC zone, I have some tips for how to make it easier to raise Venture Capital.

Before I explain, let me give you some backgrounds why it’s harder to raise money if you live outside “the zone.”

Let’s start with “oversight.” Most VCs view it as their responsibility to mentor, debate, cajole and generally assist with investments they make. They also view it as a responsibility of the money they manage on behalf of others to provide oversight of these companies. And it is significantly easier to help when you are local.

Take me for example. This afternoon (Saturday) I have a coffee meeting with a portfolio company founder. Tomorrow I’m meeting with a senior exec who is considering joining a company in which we’ve invested. He would be a very senior hire for us and filling an urgent gap. I know local talent. I know who is perceived as good and who has a fancy resume but others think didn’t perform. That’s what local allows. I know the whole ecosystem: VCs, CEOs, tech teams, founders, angels – and I know people who have worked together for 15+ years.

Local knowledge runs deep. Thus, a desire to invest more locally where I think I have a competitive advantage. Otherwise I’m just money.

But I do invest outside of LA. Examples include DataSift (San Fran & London), MyTime (SF) and awe.sm (SF).

Every year I’m in the SF Bay Area 12-14 times. I’m in NY 6-8 times. And then there are smatterings (Dallas 2x, DC 3x, Philly 3x, Austin, Boulder, Seattle not to mention San Diego 8x, Santa Barbara 8x – where I invested in RingRevenue).

This isn’t a complaint. It’s a goal to help you understand the life of a VC. And I no longer control my calendar. When DataSift sets up a board meeting (next one in London, last was in NYC) we have investors from NYC (IA Ventures), SF (Scale Ventures) and the founding team + chairman in London. So when dates & locations are set – they’re set.

So ….

Am I looking to add 8 trips / year to [name your location not already on my annual itinerary]. Not easily. Of course if it’s a company on fire I would travel to any 2-hop city from LA.

So how do you overcome that given that all VCs must have a similar pattern to me other than super-human VCs like Brad Feld or Dave McClure who have insane travel schedules but an unbelievable ability to put in the air miles and be whenever/ whenever?

Here’s what I would do if I were you. I’ll pick a mythical company in Kansas City.

• For starters I’d try to raise my initial capital locally
• Next I’d research every VC in the country and find people who grew up in or near KC. Why? Because you know they must already come back 1-2 times / year anyways. Plus, they know the local market better and therefore don’t have the uninformed biases of those that don’t. If these people work for reputable firms and have the right industry knowledge they ought to be on your pitch list
• Importantly … I would pitch investors in SF, NY, Boston, LA, etc. and say the following

“I live and work in Kansas City. I have the tremendous advantage of access to a hard-working, loyal and technical talent pool. So I want to stay here and build my business.

That said I want the best VCs in the industry and for that I know I need to be in a major VC hub.

So here’s the deal. I will commit to traveling to NYC seven times per year for board meetings. I’ll make your life easier because I know you travel all the time anyways and KC ins’t exactly on your normal path.

Heck. I need to be in NYC a lot anyways. All I would ask is that you hold 1-2 board meetings / year in KC.

You’re going to want to do that anyways to always kick the tires of the local team. Plus, we have some rocking bbq to make it worth your time.”

I know some people will cringe at this idea, “if the VC really wanted me they would come to ME.”

Maybe. But until you’ve achieved the kind of success you know you’re capable of, it’s a harder ask. And with my strategy, you take their biggest objection off the table. By the way, no VC will ever tell you, “I don’t want to come to KC 8 times / year” because it would sound bad.

But as I always tell entrepreneurs, “Better That You Deal with The Elephant in the Room.“

Note: if you’re a parent please check out their website.

Kara called me on a Tuesday. She was leaving IAC to start a company.

“Tasha, clear some space on my calendar tomorrow. OK?”

“I want you in my offices tomorrow, Kara. Does that work for you?”

Kara came. She didn’t tell me she was bringing anybody. I didn’t ask her for a deck. Or what she was working on. Or whom she was working with.

Tasha screamed. Literally.

WTF?

WTF is she going on about? Tasha! Pull it together.

It was Soleil Moon Frye. Aka Punky Brewster.

So?

I repeat. WTF? We’ve had many celebrities walk through our doors including a-list film stars. Heck, I even had Robert Downey, Jr. bang on the windows of a board meeting recently and stick his tongue out at all of us.

And Tasha never screamed before?

We’re in LA. They’re only people. It’s not much different than having Dave Morin, Dick Costolo or Sheryl Sandberg sitting next to you at lunch.

Turns out Punky was a childhood hero for Tasha. Ok. That’s cute.

They pitched on a Wednesday. I had them at my partners’ meeting the next Monday. We had them a term sheet the same week. We signed it the following week.

That happens, right?

Well, sort of. Remember, it’s about Lines, Not Dots.

I first met Kara 5 years ago. I considered her one of LA’s great talents. You can imagine the narrative … Native Angelino. Competitive sportswoman. Princeton. Stanford MBA. Ex Venture Capitalist with Battery Ventures. Leaves to work in Corp Dev at IAC. Tells me she wants to do operational stuff so she joins a small team of people running City Search. She learns how to ship product, how to deal with merchants, how to hire product managers. She had previously acquired UrbanSpoon. Now she was tasked with running it.

She was a young mom back then. 2 kids. Sheryl Sandberg leans in? Kara perfected that. Somehow she was always on a flight up to Seattle or San Francisco. Always meeting her product ship dates. Getting involved with political events and fund raisers. And still able to make it out to LA networking events. She was always able to get into the weeds on product or biz dev discussions.

She was everything I was looking for in an entrepreneur to back.

Still.

What was she doing with Soleil Moon Frye?

Didn’t I make myself clear about celebrities & startups?

Ok. ladies, show me what you got.

It was magic at first meeting for me.

Kara on one side of the table showing me market sizes, competitive dynamics, product roadmaps, pricing plans for physical products with COGS and gross margins.

Soleil on the other side getting out sticker packages. Showing me designs. Talking about how to inspire moms to get their children engaged with iPads and physical activity sets customized for their kids and based in part on their digital lives. She speaks about ethical sourcing of eco-friendly products. She’s passionate about near-shore manufacturing in places like Haiti where we can do good and do well. About the need to be careful about being the low-cost provider of physical products but risking not providing products that mom’s can feel safe using with their children.

She is a brand ambassador at Target. She runs a mom segment on the Today Show. 1.5 million Twitter followers. Nearly all probably moms. Plus me. She won me over at first meeting.

Soleil returns emails at 1.30am. She flies from LA to NY every two weeks. She helps write press releases. She debates manufacturing strategies. She talks about creative design of websites and physical products – in our case – stickers.

Turns out she’s done this startup thing before. Who knew?

Kara & Soleil are hard-working powerhouses. Great moms, both. But passionate about building businesses.

Soleil is paranoid about leaking design & product information because she’s been burned. Kara is showing me GANTT charts, wireframes, user stories and ship dates.

They are yin & yang. In the most perfect sense of the definition. And they’re both full time committed to their startup – Moonfrye. Kara as CEO. Soleil at Chief Creative Officer.

When I told them I really wanted to work with them and lead their funding round they each had their, “but can you please save some space for …” moment.

Unsurprisingly for Kara is was the VC connections. So we have the pleasure of working with Dana Settle at Greycroft, whom I have a blanket offer with that any entrepreneur that wants to create room for Dana in a deal that I’m involved with has a free pass. She’s awesome to work with. As are her partners.

And for Soleil it was her entrepreneur friends: Dan Rosensweig, Tim Ferriss, Kevin Rose, Shervin Pishevar, Randi Zuckerberg, Gina Bianchini, Erik Lammerding and Rick Marini.

At one point she actually reached into her pocket and allocated some of her personal shares in the company to be sure that the people who advised her up to this point had enough advisory stock – she felt they had contributed to her success to date. I wonder if she even ever told them. That is Soleil. And part of the secret of her success.

So, Mark, enough entrepreneur love. What the eff are they actually building?

Turns out it’s something that instantly resonated with me. They have designed a digital, mobile product that engages parents and kids. It’s something you’d imagine working best on a tablet where the parents take digital assets (think: photos & stickers) and engage with their children in story telling, arts-and-crafts, scrap-booking and the like. They are designing physical products that will be shipped to kids and become both activities to do with friends & parents as well as collectibles.

When you think about physical stickers and activity books every parent can understand. I drove 45 minutes across LA to The Grove to a specialty sticker shop when my boys were young – so obsessed with stickers were they. At every holiday: Thanksgiving, Passover, etc. my wife bought activity sets to put together little collages of turkeys and Pilgrims and talk about Thanksgiving.

And I’m a huge believer in the merging of our digital and physical lives but mostly in preserving our physical ones. I’m passionate about personalization. Kids love stories that involve people they know: Aunts, uncles, cousins. They love looking at pictures PapaKay. And Bubbie.

But mostly I’m a believer in Kara & Soleil. I’m excited to take this journey together. And watch the magic of what they produce working together.

Now ladies, get back to work. Don’t think I’m going to be Mister Nice Guy if you miss that next product release date. Grrrr.