Alternate VC

Rewarding Private Investors at Public Cost

noreply@blogger.com (Praveen Sahay) — Tue, 22 Feb 2011 21:45:00 +0000

Vinod Khosla wrote a feisty defense for Range Fuels in the Wall Street today. He argues that the government provides hidden subsidies to the fossil fuel industry that tilt the playing field in favor of the incumbents. Instead, the government should be supporting innovative solutions that are going to provide more competitive and sustainable solutions. Though the argument may have some merit, it skirts a more important question: When is the right time for the government to step in, and how does it ensure fairness in its selection process?

Many industry observers would argue that the top tier venture capital firms have tried to corner the market for public subsidies. No surprise there. But availability of ‘free money’ appears to have given rise to a new profit model for venture investors. The model works like this. Throw big money at immature but ‘sexy’ technologies – attract hundreds of million dollars in subsidized financing – file for an IPO. It does not seem to matter if the company has staying power or not. Several recent examples come to mind – Tesla, A123, Amyris Biotech, Gevo, etc. There is no doubt that federal grants and loans enabled these companies, which are far from being profitable, to raise capital in the public markets.

In these events, the taxpayers seem to be taking a double hit. First, they subsidize the risk of private companies through federal/state funding. That support creates profitable exit opportunities for the private investors but transfers the risk of those companies back to the public shareholders. No wonder the taxpayers are arguing against government subsidies for cleantech companies.

As a cleantech investor I am saddened by this unfortunate dynamic because it can hurt innovations that are more deserving of support and encouragement. The government clearly has a role in supporting innovation by spurring R&D and maintaining a healthy business ecosystem. But it creates conflicts of interest and places unjustified burden on the taxpayers when it selectively and prematurely subsidizes privately funded businesses.

Entrepreneurship in Mexico

noreply@blogger.com (Praveen Sahay) — Thu, 17 Feb 2011 23:49:00 +0000

It seemed odd to me that the Kauffman Fellows would choose Mexico City for the recently concluded annual summit. When one thinks of Mexico, venture capital rarely comes to mind. Well, I was in for some big surprises.

Robust Economy: Mexico seems to be enjoying robust economic health. Despite its heavy reliance on the northern neighbor (US accounts for 80% of its exports which are 40% of its GDP), the economy is growing about 5% a year. The peso is stable and the country has recovered all the manufacturing jobs it lost during the recession. One can also see a rise in Latin American pride – a sense that the country can emulate the success of Brazil, Chile and Peru, and that entrepreneurship holds the key to success.

Young VC: Naturally, PE/VC is nascent in the country. Regulations that permitted the insurance companies to invest in venture firms were put in place as recently as 2001. There are only 5 or so VC firms that invest in small entrepreneurial companies with high growth potential, and they are typically small with less than $100 million of capital. Many VC-funded companies incorporate in Canada to avoid double taxation. A lot more can be done to promote innovation (here is a nice article), but that has not prevented gritty entrepreneurs from bootstrapping very high performing businesses with global ambitions.

Comparative Advantage: Since most Latin American markets are small, successful ventures tend to develop cross-border footprints. Hence, most successful businesses build multi-language and multi-local capabilities early on, growing through distributed operations across multiple countries. This global mindset could be their secret sauce – their comparative advantage in a flatter world. Their other advantage is more obvious – the proximity to the world’s largest market and highly competitive factors of production. With a three-fold rise in Chinese wages in the last decade, Mexico has substantially narrowed its wage gap with China.

Exceptional Entrepreneurs: Let me share a few outstanding examples. A company that provides software infrastructure to dozens of microfinance institutions across Latin America is now expanding overseas. Another, which has POS installations across 40% retail stores in some countries, is venturing into Asian markets on the backs of its multinational partner. A technology entrepreneur who has built an impressive SAP consultancy after graduating from Carnegie Mellon is seeking capital to grow through acquisitions. These are businesses bootstrapped by very capable and driven entrepreneurs – the best one will find anywhere.

Endeavour: One good place to locate promising entrepreneurs in Mexico and other emerging economies is through Endeavour. Active for more than a decade in Latin America and developing a global footprint, this non-profit organization identifies emerging business leaders and provides them with advice, resources and mentorship. They are a perfect complement to the Kauffman Fellows program – developing next-generation entrepreneurs just as KFP develops next-generation VCs.

I’m happy that KFP and Endeavor are collaborating in meaningful ways. The outcome can be very positive for entrepreneurs globally, especially in emerging economies like Mexico.

Recent VC Funds may have brighter future

noreply@blogger.com (Praveen Sahay) — Thu, 30 Sep 2010 02:08:00 +0000

According to a 2009 Global Insight study, venture-backed companies accounted for 12.1 million jobs and $2.9 trillion in revenue in the U.S. in 2008. In the last 30 years, the US venture capital industry has established itself as bedrock of innovation-led growth of the US economy, and a model of success that other countries around the world have sought to emulate.

In recent years, however, phlegmatic returns have given rise to the criticism that the US venture model is bloated, or at worst, broken. I came across a recent paper published by veteran industry researchers – Professors Steven Kaplan of University of Chicago and Josh Lerner of Harvard University – that counters that notion. They contend that the industry may be strongly positioned for the years ahead. Some interesting findings are –

a) Historically, the industry returns have been strong when LP commitments have declined. This suggests that 2009-2010 vintage year funds should perform well.

b) Major corporations are reducing their central R&D facilities and are instead relying on acquiring technology through purchase of small entrepreneurial companies. This is a positive long-term trend for the venture capital backed companies.

I hope that asset allocators at big pension funds and endowments will take note of this study and resume at least a modest level of capital commitments to the venture capital. We all know that the incessant debates and stimulus measures coming out of Washington DC will not alter one important fact about our economy. Innovation and small businesses are the most important drivers of national jobs and prosperity, and we need a well functioning venture capital industry to keep that 'little engine' running on track.

I also came across an interesting survey of large pension and endowment managers conducted by colleagues in the Kauffman Fellowship program. It has been featured in the September issue of Venture Capital Journal. The survey concludes that the investors are willing to support funds established by experienced managers and are favoring smaller VC funds with late stage/ growth equity strategy. They have a penchant for US based funds, but many would like to reap the benefit of stronger growth in the emerging markets.

These are sage words. Hopefully our confidence in US innovation and venture capital will return soon.

Can Cleantech companies achieve escape velocities?

noreply@blogger.com (Praveen Sahay) — Sun, 22 Aug 2010 21:19:00 +0000

Many investors in the Cleantech space have been soured by lackluster industry returns in the past few years. Startup companies in solar, wind, batteries and electric cars, even when successful, are not known to generate 10x returns that sustain the VC industry. To compound the problem, too many companies and investment themes appear to have low survival rates – witness the micro-bubbles in fuel cells, corn ethanol, and algae.

I do believe in the promise of the Cleantech industry, but clearly the current practices are not working very well. To understand why, let us define a logical framework that adequately captures the industry's unique challenges and opportunities. One such framework is offered by the elementary principles of space flight.

The launching of a startup company can be compared to the process of launching a rocket. The startup attains success when it achieves enough velocity to escape the earth's gravity. Now, the principles of Physics state that a spacecraft’s ability to achieve escape velocity and reach its destination depends on four important factors:
1. The force of gravity
2. The quantity of fuel and rate of burn
3. The weight and design of the spacecraft
4. Careful alignment and timing between launch and destination sites

There are additional design issues (multi-stage rockets, control systems etc.) and people issues (preparedness, team work, continuous course correction, etc.) that we can ignore for this discussion. Even this simplified model can be instructive in understanding factors that impede or promote success of a startup company. When you apply this framework to compare IT and Cleantech startup, the latter appear disadvantaged on all of dimensions – begging the question, “Can Cleantech companies achieve escape velocities?”

(1) Force of gravity (market, regulation and competition): The IT companies are, by and large, addressing white spaces. In contrast, Cleantech companies are building applications for a hundred year old industries that are sluggish, regulated, and commoditized. That’s tremendous amount of gravity to overcome.

(2) Quantity of fuel (financing and burn rate): In order to overcome all that gravity, the Cleantech companies will burn more fuel over longer durations. The irony is, adding more fuel weighs down the spacecraft even more which, in turn, requires even more fuel. This is a common predicament faced by the startup companies – the more investors they add, the more conflicted and complex their management becomes.

(3) Weight and design of the spacecraft (the innovative product): In the IT space, the spacecraft, or the ‘solution’, is a software product which is relatively light, nimble, and adaptable. On the other hand, the Cleantech solutions are big and heavy, requiring physical manufacturing plants and big projects. Moreover, these vehicles are expected to be perfect at launch so they are bankable, and can produce guaranteed performance in commodity markets.

(4) Careful alignment and timing (product launch): Most IT companies launch their solutions in deep skies where destination is evolving with time and experience. Hence, their voyage is more like space adventure. In contrast, the Cleantech companies are expected to provide superior solutions to very well understood problems relating to clean energy, clean water and clean environment. At times, they appear to be providing shuttle services to well identified destinations rather than an adventure, albeit more cheaply and speedily. This means that all conditions have to be perfect at the launch – any slippage anywhere will lead to mission failure.

What we find is that the IT startup companies are nimble and light (no factories), consume less fuel, contend with less gravity, launch quickly and take their crew on an adventurous ride. On the other hand, the Cleantech startups are more like heavy crafts that fight immense gravity by burning a great deal of fuel, but are expected to launch perfectly to well known destinations – cheaply and efficiently.

It is not a surprise, therefore, that the Cleantech startups rarely achieve escape velocities. There are just too many factors working against them.

I hope the readers find this rocket metaphor useful to understand what impedes the Cleantech startups. Next, we will see how we can apply this metaphor to the industry dynamics to see if there we can develop a more successful launch program.

Why I’d Hire a Kauffman Fellow

noreply@blogger.com (Praveen Sahay) — Mon, 16 Aug 2010 17:28:00 +0000

I received my best professional break with the Kauffman Fellowship. It was early 2003 when I was a budding but anxious venture capitalist. Then, as now, the industry was in contraction and VCs were concerned about industry overhang, bloated portfolios, and stagnating economy. Had I not been invited by VIMAC Ventures to join its team as a Kauffman Fellow, it is unlikely my career as a venture capitalist would have survived the tumultuous years that followed.

As it is, finding an entry level position in the VC industry is tough. In an earlier blog, ( You the Venture Capitalist ? I cautioned those targeting a VC career that it should be treated as a long term project that offers scant success. As the industry shrinks from about a 1,000 firms to about 600 today, entry level positions are declining. Firms hire irregularly and almost never through campus interviews or career offices. When firms do hire someone as Analysts or Associates, they often expect ask them to leave after two-year tenures. As a result, the proportion of Associates that get on the partnership tracks is relatively small.

Consider the Kauffman Fellowship (www.kauffmanfellows.org) program.

Fellowship:The fellowship is perhaps the best qualification you can obtain to gain entry and ensure long-term success in the venture industry.
Each year, the Center for Venture Education (CVE) picks over 20 Kauffman Fellows who will spend two years with an IT, Biotech and Cleantech firm as an Associate (occasionally senior roles as well). In addition to the performing their regular role at the firm, the fellow will follow a detailed training regimen that consists of several modules every couple of months. These modules bring the entire class face-to-face with some of the most successful investors, entrepreneurs and industry professionals, and also teach them the ropes of the industry through case studies, role plays, team assignments, and class lectures. The fellows build a strong relationships that help them learn best industry practices, develop innovative ideas and source deals that will make them successful investors in the long run.

Mentorship: Each fellow is also assigned a mentor, typically a senior partner at her firm. The CVE takes the program rather seriously and enforces a strict code of mentorship. Mark Robinson, my mentor, had to set periodic professionals targets and share my progress with the CVE staff every quarter. The CVE expects the mentor to assume the responsibility for ensuring mentee’s success in the industry – a unique privilege for any new inductee in any profession. The bottomline is that the Kauffman Fellows end up as blue-eyed trainees who are expected to provide future leadership to their firms.

Competitive: Not surprisingly, the Kauffman selection process is extremely competitive. The candidates go through a three-stage selection process and one final visit with the venture firm before they get hired. Even though the class size has grown from 5-10 to 20-25 now, the number of fresh hires remains as low as 5 who are selected from an applicant pool of several hundred. The rest of the class consists of existing industry professionals who have been sponsored by their firms (and selected by CVE) to undergo the fellowship. In all cases, the venture firms pay a substantial ‘tuition fee’ to the CVE, hence the selected candidates go through a fairly severe scrutiny by the firms as well. The competition is also increasing with increasing internationalization of the program. Now, the fellowship links over 400 industry professionals in six continents.

Unique: It is worth emphasizing that this is the only formalized VC training available anywhere in the world. No other firm or institution teaches the art and science of venture capital, and new professionals are just expected to absorb skills as they go along. This lack of training is particularly disconcerting in the venture industry where people come in from a variety of different backgrounds but are expected to contribute a diverse set of skills that span technology, team building, entrepreneurship, financial acumen, salesmanship, company building, negotiation, marketing, business judgment, economic trend analysis, and so on. Though not every skill can be taught, Kauffman Fellows usually develop an edge in this challenging profession. This can be seen both from the high success rate of the Kauffman alumni in the industry, as also the number of new venture firms successfully established by the alumni. Personally, I’ve benefited immensely from the advice and support that several senior alumni offered during the process of founding WAVE.

Positioning for Success: Though there is no success formula, a few trends are visible. Increasingly, specialists are being favored over generalists. WAVE is a cleantech firm so we will obviously look for specific industry skills. But even generalist firms now tend to have industry-specific teams. Many firms prefer resumes that have international work credentials, entrepreneurial gigs, relationships with industry leading firms, and a mix of business and technology skills. But VC industry is the ultimate ‘black swan’ industry, and sometimes fellows come in with very tangential experiences. Majority of my experience, for example, consisted of working for the uniformed services, the government and the United Nations. Being people and tech savvy is important, but any generalization beyond that is risky.

So, what can I advise future applicants? I’d urge anybody considering a venture career to give this program a serious consideration. It’s a legitimate door to the industry, and a privileged one at that. Though only a few will succeed, the process itself provides an intense learning experience that helps people understand the industry dynamics and allows them to judge their professional fit. It can also open doors later on. CVE puts together a resume book of all finalists and reaches member firms who may have hiring needs. As a result, several finalists have found positions at well respected firms well after the conclusion of their Kauffman interviews.

You Want to be a Technology Investor?

noreply@blogger.com (Praveen Sahay) — Fri, 16 Jul 2010 01:43:00 +0000

One of the questions friends often ask is how one can become a technology investor. The general advise usually includes the following which, though rational, do not offer assurance of success with any degree of certainty:

1. Get close to the venture firms, either by working at venture-backed startups or by providing advisory and consulting services to venture firms. Since most firms tend to hire people from pre-existing relationships, this is a reasonable idea. Seth Levine wrote more on his popular blog How To Become a Venture Capitalist.

2. Qualifications: There is no ideal resume for an aspiring venture capitalist. If you look at the background of successful venture capitalists you'll find ex-technologists, bankers, consultants, academicians, financiers, writers, college drop-outs, entrepreneurs, and several other professionals (including ex-Generals!.) This makes it hard to prepare oneself for a career in the venture capital industry. Leading a successful startup or exhibiting operational excellence at tech companies perhaps gives you the best shot, especially when you become a repeat CXO or an angel investor. But this circumstance will apply to only a few people.

3. Long Term Project: Actively network with the venture firms and keep a long term view of things. It's a small industry. Though no exact counts are available, it's safe to guess that the total number of Associates at all US venture firms will amount to less than 1,500. The industry association NVCA membership directory lists less than 700 members. A large numbers of firms are not NVCA members but few of them will have the resources to hire full time Associates. Only a fraction of the Associate positions will open for hiring in a year since few people leave by choice.

4. Point of Entry: There are usually two points of entry leading to a potential Partnership within a firm - a junior Partner (or a Venture Partner) or an Associate (or a Principal/Vice President.) The former applies to people who have already proven their ability to generate profits from funding or managing startups. Candidates for Associate face less stringent requirement but contend with a lot more competition. Often, I meet highly qualified people who are too young to be Partners but too old to be Associates. What's the right age to start? Most Associates (those with a potential of Partnership track) will usually start when they're 30-40 years old. If things work out, they can become a Partner in ten years or less. So, starting at the age of 40 is not entirely a bad idea.

5. Skills: Though it's hard to pin down required qualifications for budding venture capitalists, one can observe that domain expertise is more emphasized today than it was a decade ago. For example, an acknowledged expert in the field of nanotechnology or fuel cell can attract the attention of venture firms that are focused on those areas. Yet, non-quantifiable skills continue to be just as important. These can include interpersonal skills such as empathy, networking, coaching, judging and managing people. Time management, effective listening, and persuasive and organizational skills can be critical every day on the job. People that succeed in the long run also display broad awareness of economic and industry trends as well as the analytical ability to rise above the clutter of details and focus on core issues and possibilities.

I'm sorry if the list of requirements seems humanly impossible. Yes, the venture firms will say that they look for these attributes but few, if any, venture capitalists actually fulfill all of the above requirements. You can do a little experiment of your own. Ask any venture capitalist how they became one and most will say, "I was lucky to be at the right place at the right time." Luck, indeed, plays a big role. That should not surprise anybody - the odds of success are so low for any individual that chance plays a significant role. So, never assume that the guy financing your startup is smarter than you are. He is simply performing a different function.

If this subject is of interest to you, I'll encourage you to read the details of the Kauffman Fellowship in my next essay. It's a fine gateway to a career in the venture capital industry.

Playing the Cleantech Roulette

noreply@blogger.com (Praveen Sahay) — Tue, 10 Feb 2009 15:26:00 +0000

If you want an insight into the investment thesis of the current Cleantech venture investors, I recommend the following quote from a leading investor:

"There are many such things going on that are radical, implausible - each individually (is) somewhat implausible, on the aggregate (it is) highly plausible that one plan will work. That's the key to the solution."

Here is a commonsense translation. "I know that my investment looks, and is, funny to you. But hold your breath. From this mass of chaos, an intelligent plan will emerge. I cannot tell which investments will make money, but somebody somewhere will be alright. Take my word."

This comes from a thought leader of the industry. Where he goes, others rush in. Not surprisingly, smart people are questioning if the current investment approaches are working. We have already lived through damaging hype cycles in fuel cell and ethanol, and now working through disasters in solar and algae. When do we stop and say? "Enough carnage. Let's rethink what we are doing and explore if there are sensible alternatives to investing in the Cleantech sector."

What's Wrong with Cleantech VC?

noreply@blogger.com (Praveen Sahay) — Tue, 10 Feb 2009 15:22:00 +0000

An informative and thought provoking presentation from @Ventures.
What's Wrong With Cleantech VC

View more presentations from CleantechVC. (tags: greentech alternative)