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]]>Of unhatched chickens and VC returnsMahendra RSat, 13 Aug 2016 22:02:16 +0000https://medium.com/@thebusinessofvc/first-mover-advantage-should-vcs-care-5fd70126ff3c#.1y5nor2w255aa9f87e4b08ed55ae9dcee:55aaa2e1e4b0a0d1a2fe31ee:57af93d8d482e9e1c4c852ebAt a recent talk, Ajay Royan, Co-founder of Mithril Capital elegantly debunked the first mover advantage in startup investing. “Paypal, Facebook, Google, Airbnb, Uber — none of these companies were first movers. Rather, these companies did one thing really well — they shut the door behind them. The rest is history.”  Read the rest of this blog on Medium

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]]>The myth of the first mover advantageMahendra RFri, 11 Dec 2015 18:23:30 +0000https://www.thebusinessofvc.com/blog/stasis55aa9f87e4b08ed55ae9dcee:55aaa2e1e4b0a0d1a2fe31ee:56697da8a12f44d5ecc91313tl;dr — VC is stasis. Changing. Slowly. Will we see a punctuated equilibrium? 

A recent New Yorker article quoted Marc Andreessen, who asked Ben Horowitz — “What if we’re the most evolved dinosaur, and Naval [founder of AngelList] is a bird?” Can an upstart like AngelList disrupt the business of venture capital ? Software is eating the world, as A16Z’s tagline goes. And so, will it eat venture capital?

Huoy Ming Yeh, Founder of CSC Upshot Ventures and I were recently invited by “Founders & VCs” to discuss the future of venture capital. We discussed dinosaurs, VCs, angels and entrepreneurs.  Let’s start with the VC business model, and the friction and incongruities that exist in this model. This gives us a basis to make predictions. Of course, it's easy to make predictions. Some may even come true - I just dont know which ones. 

The VC business model hinges on the ability to raise a fund. If you can raise a fund, the second part — investing & generating returns — is harder. All startups look great at the first date and any fool can write a check. Some startups become blazing successes and others become epic failures — we just dont know which ones will rise. 

Raising a venture fund:

The venture fundraising process is probably the only time a VC experiences some humility. It’s a karmic circle where the LPs [Limited Partners, or institutions that invest in venture funds] indulge in the same maddening behavior that VCs themselves thrive in. Go dark, stall, give vague answers, string along etc etc..

Opacity, indecisiveness & bias: All investment activity is mired with these three elements. Be it VCs raising venture funds. Or startup entrepreneurs raising capital. Identifying investors is no easy task. Let’s take three simple questions: 

1. Who is actively investing?
2. What is their decision making criteria / process /timelines?
3. What terms should you expect?

When any entrepreneur starts the journey of raising capital, often these are the first few questions that pop up. Which angel / VC should I talk to? Can I get a warm intro? To avoid being called founder's bitches, we must move away from the dark ages of “warm intros” — after all,  VC is the only business where the customer (entrepreneur) needs a ‘warm intro’ (enter — middlemen) to a service provider (VC).  The opacity on investors ability and willingness to invest can be frustrating. It creates a level of uncertainty and friction on all sides. Buyers feel like they may be overpaying — sellers want to optimize. Granted these are ‘private’ markets and a level of ambiguity will prevail. But what price do we pay when we choose to live in the dark? Longer timelines, nauseating processes and a level of angst + suspicion that plays out on all sides. Such inefficiencies need to be done away with. Prediction #1 would be: 

“A simple, searchable database - a Yelp for VCs - is much needed”  

We can search for flights (Google / Orbitz), real estate (Trulia / Zillow) and pretty much anything else. So why not VCs? After all, 20,000 investments are made each year with over $50 billion exchanging hands. A well curated, contextually relevant database could reduce a lot of friction and save time. 

Accelerators have "insider lists" of VCs - founders know which VCs are worthy of conversation and those who are gasbags. Accelerators have solved this opacity  — to some extent — by building lists of active investors. Except that VCs are not aware nor have any say in the content. Demo-days act as a forced function to “accelerate” decision making. The fear of missing out forces VCs to make “spot” decisions. The inefficiency of raising capital is minimized so entrepreneurs can do what they do best — build products and companies. All opaque processes will eventually drift to transparency.  

AngelList started off as a simple, publicly available list of angels —the first step towards eliminating opacity. No more clubs or secret handshakes! 

It shined a light on those who have capital, can move fast and empathize with an entrepreneur.  It's a marketplace that brought the buyers and sellers together in an efficient manner.  It’s not much different for VCs raising funds. The world of limited partners is far more opaque. You can subscribe to expensive databases and try a lot of cold-calling. But I have not seen a simple tool that would help a $20 million fund to identify potential anchor LPs. Or provide a screened shortlist of family offices actively investing in venture. A lot of such information flows word-of-mouth. And if you are not connected with the right sources, too bad. 

The average time spent by a VC raising a sub $20m fund is 11 - 16 months. Further, the number of smaller "Under $50m" funds is growing rapidly. Raising capital is a long painful journey for most of these funds.  The ability to raise a fund is often correlated to being a good investor, which is counter-intuitive. Fund raising requires salesmanship - its strategy combined with tenacity combined with LP connections. A lot of larger funds have full time dedicated staff for "investor relationships" - they manage the money side of the LP-GP marketplace. But smaller funds will not be able to afford such a full-time team members. The demand for LP data will continue to grow. As micro-VCs proliferate, they need an LPList, just as entrepreneurs need AngelList.

So my Prediction #2 is:

An online LPlist will emerge to support micro-VCs. 

AngelList is already pioneering the online set-up and tear down of a fund — a streamlined process that costs less than $10,000. This is a 10X improvement in fund legal costs, timelines and closing processes. Software is eating the lawyers! And the next logical step is to gather / make LP data available. I foresee a nice subscription model here, where micro VCs and scouts have access to pools of capital. This phenomena has already started but need not be hidden or secretive, really! ( WSJ report on Scouts - Secretive, Sprawling Network of ‘Scouts’ Spreads Money Through Silicon Valley)

Skill versus luck: Decision making:

LP decision making criteria for fund investments is primarily based on track-record. Track record is the proverbial rear-view mirror. It’s the past and cannot be replicated easily. Nor it’s a guarantee of future success. Sectors are cyclical, regulatory forces impact markets and black swans spoil the day. Partners quit venture firms and individual performance attribution is often overstated. So LP’s add another layer to past performance — consistency of returns over multiple funds. Call me when you are past Fund V becomes the baseline threshold. Fund managers who have just started, often find themselves locked out. The bigger debate — is it skill or luck that generates consistent VC returns — remains unanswered. If we look at IRR data over 2001-2010, the top quartile returns go from 37.6% (2001) to a low of 9.5% (2006) and then back up to 19.8% (2010). The delta between the top quartile and bottom quartile is large. The challenge for LPs is to find a top quartile manager. And once a LP finds such a manager, it's always hard to predict if their skills can be persistent. Can they repeat their performance? 

Author and Investor Michael Mauboussin writes in his book “The Success Equation- Untangling Skill and Luck in Business, Sports, and Investing” that greater skill often leads to greater reliance on luck. This is baffling. The more skillful we become, the more we rely on luck! Go figure! In “The Theory of Gambling and Statistical Logic” Richard Epstein writes, “It is gratifying to rationalize that we would rather lose intelligently than win ignorantly.”

But are we losing intelligently in venture? According to Aileen Lee of Cowboy Ventures, 1 in 1,538 companies become a billion dollar company. That’s a pretty lousy ratio. Are we one big glorified slot machine? We owe a better answer to our LPs that to pretend that we are losing intelligently. 

Improving our odds: 

LPs have not pushed VCs for innovation on improving our odds.  In their book, Made to Stick, Chip and Dan Heath describe how British Petroleum (BP) decided to reduce their ‘dry-holes’ — the costs of unsuccessful drilling. It costs as much as $40 million to drill a large oil well. BP found that their estimates of hitting 1 in 10 were way off — they were actually hitting 1 in 100! This is actually worse than venture capital investments but read on. To avoid wasted expenditures, BP launched an ambitious ‘No dry holes’ strategy. There was much push back internally. Explorers like to explore — it is education, they say! And they were irate. But the senior management stuck to their guns and voila, in ten years, BP’s hit rate moved from 1 in 100 to 2 out of every 3 wells! Put another way, from 1% to 66% ! When I brought up this example to a Sand Hill Road VC, he scoffed, “Tch tch..so many reasons why these companies fail. Where should I start?”  Let’s file this away under intellectual laziness for now. BP reflected on their situation, probably felt some financial pain and decided to improve the odds. When we dont reflect on our pain / losses, we dont make progress. In the meantime, our LPs pay the price. So I look forward to the day when prediction #3 will become a reality:

VC’s improve the performance odds, just like BP did!

I rarely find VCs reflecting upon the losses. It’s a common practise in the medical community to hold a Morbidity and Mortality (M & M) conference. Practitioners learn from complications and errors, to modify their own behavior and judgment based on previous experiences. The focus is improved patient care. In VC, we bury our dead quietly, fire the investment partner and move on. If we can “pattern match” in some parts of the business, it’s disingenuous to say we cannot learn from our failures. Brad Feld shared that at Foundry Group, they assess each portfolio company every year and ask if they still love it. If not, why not? Such exercises can be a great start. Just like the M & M conference, we could ask (a) under what conditions we made the investment decision (b) what assumptions went wrong and (c) how can we reduce the probability of making the same mistakes again. 

Pain + Reflection = Progress

A small asset class — can venture grow:

In any year, VC funds raise ~ $30 billion from LPs. But in comparison, private equity pulls in $200 billion every year. That’s more than 6X VC allocation. And hedge funds are averaging $1.5 trillion each year.

When asked, most LPs told me that VC is 

1. Illiquid — LP money is locked up for 10 years.
2. High risk — we can lose all our money.

AngelList has solved the sourcing side of the VC business - one half of the problem . You could be sitting in London or Dubai and invest in a YC startup — this could not have happened 5 years ago! Granted AngelList has to continue to list good opportunities, but this is the dawn of the marketplace. The other half of the problem  — liquidity or selling shares  could well be on the horizon, regulatory challenges not withstanding.  

History of the NASDAQ is a precursor indeed. At first, it was merely a quotation system. NASDAQ merely presented the bid-ask prices of various shares. It did not provide a way to perform electronic trades. It brought transparency to an opaque market. This helped lower the spread (the difference between the bid price and the ask price of the stock) - as buyers and sellers were empowered and became savvy, NASDAQ became unpopular among brokerages which made much of their money on the spread.

Any open trading system that hurts the middlemen margins is always unpopular - with the middlemen. This often drives the middlemen away - in search of opacity in other areas. How do open platforms like AngelList impact the "VC" middlemen remains to be seen - for now, most of the talk is about partnerships. VCs often conduct outreach & source opportunities that are featured on AngeLlist. 

Prediction #4: AngelList becomes a marketplace for selling shares.

If we can solve the liquidity risk and improve the odds / performance, can we expect the VC inflows to increase to $50 bn? $100 bn? After all, mutual funds like T Rowe Price and Fidelity have already jumped in the later stage market. 

Who drives innovation in VC? And of what kind?

Innovation is much needed in the VC model. But when innovation occurs from within, it’s often self-serving. As Josh Koppelman quipped at a PandoMonthly event, “If you look at the venture business, for an industry that funds innovation — it really doesn’t have that much - there are many firms where I’d say their single greatest innovation over the last 20 years was raising carried interest from 20 percent to 30 percent.” And the origins of 20% carried interest go back to biblical times. 

Sourcing and diligence of opportunities used to be based on a blend of analytical + subjectivity. In the movie, Moneyball, three baseball talent scouts describe a potential baseball player, which offers a classical insight in how management diligence is conducted. The scouts, while picking baseball players speak of intangibles such as eye candy test, attitude, swing, ugly girlfriends and lack of confidence. Then there is one scout who describes his pick as a “the kinda guy who walks in the room and his dick has already been there for two minutes..”  Subjectivity in conducting diligence can often be crippling. Yet it is often the case in baseball as well as in venture capital. The attributes of strong management teams, or the proverbial jockey, are difficult to assess and often, practitioners have a short window of time to say "yes" to a hot deal. But technology and data can help minimize our biases. Some interesting "big data meets social media" techniques of sourcing opportunities have started to emerge: 

• YL Ventures has hired a firm to track over a million entrepreneurs in Israel. Their gambit is to catch these opportunities even before they are formed. They look for social signals and generate over 100 alerts a month. See WSJ story here.
• SignalFire, a $53 million "quant" seed fund took six years to build a platform, Beacon, which tracks talent and capital. They look at more than half a trillion data points  from two million data sources, from patents to academics publications to open source contributions to financial filings. More in the WSJ story here.

While such innovations in sourcing, services, brand & marketing has occurred, the results are always uncertain. I believe much exponential innovation in VC has come from outsiders like Naval, PG and CSC.  All of them follow the mantra for seed stage investments which is: 

"The information required to make decisive investments  in disruptive technology simply does not exist…It needs to be created through fast, inexpensive and flexible forays into the market” – Clayton Christensen, The Innovator’s Dilemma

Paul Graham ("PG") is not a VC  but has done fast, inexpensive and flexible forays into the startup land. We can debate if YC is a fund or an accelerator, but does it matter? They invest in cool companies and generate returns - in 2015, they will invest in 1000th portfolio company. 10 years later,  700 YC companies are active. That's better odds than VC. And they just raised a $700m fund.

Naval, the bird, was an entrepreneur - he launched AngeLlist to reduce opacity for other entrepreneurs. China’s CSC Group has pledged $400 million to launch CSC Upshot Fund - the largest seed fund for startups on this platform. USA has some of the largest, most sophisticated LPs managing trillions of dollars. Yet no one saw the light that AngelList can be the platform for VCs.

The accelerator boom ignited the path, angel.co created the platform and CSC committed $400m. As the story goes, it could have been more than $400m, but Naval wanted to start slow. But can AngelList become like Blackrock ? That's my moonshot prediction #5, as it has the potential.  At Blackrock,  1000+ investment teams deploy capital in public markets. Fundraising teams are separated from investment teams. And risk is managed in a centralized manner. In a period of 25 years, it has become the world's largest asset manager, managing $4.5 Trillion in assets.  

With the ability to improve transparency / data, trades / liquidity, the VC model is being disrupted. I dont know what it will look like in 20 years. But when Model T arrives, people seldom care for a better horse-buggy.

Fund due diligence is much like startup diligence. It's about the team and strategy. And the odds are the same - LPs source a thousand fund opportunities, invest in a dozen, and get returns from a few. For LPs, due diligence begins and ends with the fund's investment team.  The one question LP seeks to answer - Can this team generate strong returns?  

Top-quartile managers with demonstrated & repeatable track records over fund cycles are sought after. Yet other LPs focus on emerging managers, who may bring fresh thinking. All fund-raising is at the mercy of markets. With Mr. Market on its side, even a mediocre group may have an oversubscribed fund. 

A typical investment process for any LP follows the following steps:

• §  Sourcing and screening of fund managers: The art of finding the right fund managers
• §  Fund due diligence: The ability to assess the various risk-return measures
• §  Negotiations and closing: Investment terms, negotiations &  'middle-of-the-road' positions
• §  Post-investment fund monitoring: Do both sides have the ability to build a transparent relationship? 

Sourcing and First Screens

While some seek to invest proven top-quartile established funds, others seek emerging managers. Some start the search with sectors and whittle down the universe of fund managers based on additional criteria. For LPs, the primary filter—performance—remains high on the list.

Lisa Edgar, managing director of Top Tier Capital Partners, a fund-of-funds prefers to start her screening process with performance. "In an environment defined by change, it is important to assess the fund manager's ability to produce superior returns across various technological and economic cycles," she says.  A GP's ability to produce superior returns across various cycles is evident only after the venture firm has raised and invested a few funds. Georganne Perkins, managing director at Fisher Lynch Capital, a fund-of-funds seeks proven GPs as well. "A roman numeral V or higher is a good start," she points out. The "V" indicates the firm has invested capital over four previous fund cycles. Such a firm would have established a track record and a brand in the investment arena. Perkins, who formerly managed the PE investment portfolio at Stanford University, reviews over 200 fund documents, or private placement memorandums (PPMs), each year to invest in a handful of funds.

Most institutional investors typically see anywhere from 200 to 600 fund documents on a yearly basis. With such a high volume, the best way to stand above the ambient noise level is to begin a relationship via an introduction. Without a warm introduction, fund documents that come in the door cold often head for the trash can. But who makes the introduction is equally important. A trusted relationship, ideally another peer-level limited partner, an existing GP, or a respected attorney can make this path much easier. An inappropriate starting point could blow up this process very quickly. 

"For state pension fund managers, getting calls from politicians is typical, including calls from the governor's office. Those who use pressure tactics, despite stellar performance, are starting with a deficit," says Robert "Bob" Clone, who served as director of private equity State of Michigan and Indiana retirement plans, managing over $50 billion in assets. Institutional investors often like to take it slow and warm up to a new fund manager over time, cautiously observing the fund's evolution and performance. 

G. Thomas Doyal, managing director of global private equity investments for a family office, says, "We watch managers over several years and multiple investment cycles before we are ready to engage." Doyal, who sees about 50 fund documents each year, reviews them only after a strong relationship has been established with the investment team. "It is very unusual for us to look at anything cold," he says.

For newer managers, the ability to engage via an introduction and proactively build these potential institutional relationships is important. Providing meaningful updates on investments and performance can make the path easier. "Like any entrepreneur looking for the next best opportunity, we are always seeking the most promising managers—the Kleiner Perkins of the future,"advises Kenneth Van Heel, who manages $10 billion in assets as the head of the corporate pension fund for Dow Chemical Company.

Alex Bangash, an advisor to institutional LPs has found the best managers by watching for those who become magnets for smart entrepreneurs. “How desirable is a VC to entrepreneurs? Do they want your service?” he asks. Alex is the founder of Trusted Insight, an institutional investor platform for Alternatives, with over 60,000 LP members in 98 countries. A social network of LPs, Alex Bangash launched Trusted Insight to share LP expertise and due diligence across various sectors and geography.

Fund diligence - How LPs evaluate the venture firms

Institutional investors evaluate venture firms on the two primary criteria: the fund managers' expertise and their investment strategy. Secondary criteria include investment terms and market conditions.

• §  Fund managers' expertise. The foremost and primary criteria, limited partners seek to understand entrepreneurial /  domain expertise. Performance is one of the foremost criteria.
• §  Investment strategy. What is a fund's investment strategy, and how does it stand apart from the rest of venture funds? What unique factors / differentiators or "unfair advantage" does this combination of people and strategy bring to the VC arena?

In "What Drives Venture Capital Fund Raising?" authors Paul A. Gompers and Josh Lerner conclude that  "Fund performance is an important determinant of the ability to raise new capital. Reputation, in the firm age and size, also positively impacts the ability to raise a new fund."

This theme, "performance is primary," recurs in various strands of academic literature. In a survey of investment criteria, over 200 U.S.-based LPs confirm the importance of performance. In order of priority, the LPs started with internal rate of return with a minimum floor of 12 percent and ideally closer to 30 percent to be considered for investment. The returns are also typically tied to a benchmark index for comparing performance. A performance of 400 basis points above the benchmark index, Russell 3000 or S&P 500 is often a threshold established by institutional investors. Other criteria included a consistent track record, diversification of the limited partners, team experience, and fund strategy.

In their book Beyond the J Curve, authors Thomas Meyer and Pierre-Yves Mathonet propose qualitative scoring criteria, which ranks the fund management team and fund strategy as the two top weighted factors, as shown below.

• Management team skills          30%                 
• Investment and operational experience, sector expertise, regional connections, size of team, and complementary skills
• Management team stability      10%
• Clear roles, responsibilities, decision making, historical relationships and stability, economic alignment of incentives, financial stability of fund, and succession planning
• Management team motivation    10%
• GP commitment percentage, incentive structure, reputation, team independence, outside activities and conflicts of interest
• Fund strategy            15%
• Sourcing, stage/sector, fund size, exit strategy, and overall strategy fit
• Fund structure           10%
• Costs/fees, governance and compliance
• External validation    10%
• Track record of previous funds, performance of comparable funds, quality of co-investors and recurrence of investors
• Overall fit                    15%
• Considers the overall picture. For example, the fit between the team, fund size, and the strategy.

Source: Thomas Meyer and Pierre-Yves Mathonet, Beyond the J Curve—Managing a Portfolio of Venture Capital and Private Equity Funds (Chichester, UK: John Wiley & Sons, 2005), 221.

While all the listed criteria are important, Lisa Edgar of Top Tier Capital Partners asks a fundamental question - "Are we going to make money in this fund?"

Which pretty much sums it all up. It may be easier for a proven team to raise Fund V but what if you are just getting started? In my next post, we'll look at emerging managers - those who are on the path to raise Fund I. 

Now the obvious question is why do smart, institutional investors bother adding a layer in this mix? After all, they could bypass this step and invest in VC Funds directly. The fund-of-funds model (FoF) emerged in the late 1980s to meet the asset allocation and diversification demands of larger financial institutions. OK, let's try  that in plain english - large multi-billion dollar institutional investors have to sprinkle money in different buckets. Each bucket is an asset class. There are many buckets like stocks, bonds, real estate etc. out there - even Bitcoins. VC is one such bucket. Its a small-ish bucket when you compare it with other buckets.

 Chris "SuperLP" Duovos  once told me that "If public markets are like an ocean—multi-trillions of dollars at work—and private equity is a bath tub ... say $300 billion a year ... venture capital is like a small sink."  Indeed - the VC bucket attracts about $60bn a year (2014). A decade ago Dick Kramlich, founder of NEA, said, "As an industry we are only raising $20–30 billion, while private equity as an industry is raising $300 billion. And there's two trillion dollars worth of hedge funds. All of these resources are within the same purview ... and there's a whole different definition of how rates of return are obtained and who you compete with." So not only VC is small bucket, it competes with a lot of other buckets for attention.  The pie-chart shows what a typical asset allocation looks like - as you can see VC is a "sub-asset" of Private Equity (PE) which is clubbed under "Private Investments" 

And that "Private Investments" bucket, which is 20% of the portfolio has several mini-buckets.  These are sliced into categories like Buyout Funds, Distressed Debt Funds, Middle Market Funds and so on. On top of that is the geographic axis - US, Europe, Japan and Asia. An institutional investor has to assess risk/returns from these ever-changing asset buckets and then make some intelligent bets. Some buckets have lower returns but are considered less riskier - for example, money market funds or bonds are as good as cash. In my badly drawn graphical format, risk (Y axis) and returns (X axis) looks like this:

As a result of this risk / reward dynamic, not all buckets are equal. VC is the riskiest of them all - indeed, we often brag that 9 out of 10 companies in any fund's portfolio will fail. Thats 90% of your LP capital that's lost on cat-video sharing apps. VC is risky but also suffers from lack of consistency of returns. The standard deviation ( which is a fancy term for a measure of risk) varies as much as 150% in VC asset classes and thats a big headache for investors. And on top of that, every VC claims to be a top performer. FLAG Capital, a fund-of-funds bemoaned in one of their newsletters that VCs sound like "Lake Wobegon, where all the women are strong, all the men are good looking, and all the children are above average." Another FoF manager told me when every VC fund walks in and tells us "they are all top quartile. I wonder where the rest of three quartiles managers are - I just cannot seem to find them." So when you have (a) high risk and inconsistent returns coupled with (b) less than 10% of your assets allocated to VC and (c) everyone is a rock star VC, you end up with a challenging situation. Hence, institutional investors have "outsourced" the selection process of VC Funds to Fund-of-Funds.  

To institutional investors, FoFs offer the following advantages:

Efficiency: FoF's are an efficient mechanism to access various asset classes/venture funds. Institutional investors have optimum resources to research or manage certain asset classes. For example, a $50 billion pension fund may have less than 10 percent of its assets in private equity. This could be further sliced into mezzanine, buyouts, and VC. Apply another set of layers of risk diversification—sectors, geography, size, and vintage year—and what you have is a fairly complex matrix of relatively small investments. The ability to manage such investments effectively becomes a challenge for the pension fund managers. In such situations, FoFs allow for larger institutions to efficiently participate in the venture capital asset class without substantially increasing their overhead. 
 

Access: FoFs offer access to elite funds and have deeper knowledge of emerging funds with higher potential for performance. As FoFs are often keeping a close eye on the market dynamics, emerging managers and high performers, FoFs are domain experts in such asset classes. While institutional investors may be experienced in private equity, they often lack the abilities or resources to conduct research and proactively build relationships. FoFs also offer specialized expertise to track and monitor industry trends, identify leading funds, build relationships with key managers, and staying current with investment terms.

Diversification: The universe of the private equity and venture capital fund managers evolves with the ebb and flow of economic trends and opportunities: venture, distressed, real estate, sector-focused funds and turnaround funds. FoFs are attractive investment strategies because they enable investors to diversify and spread out risk over a range of different assets (e.g., a typical FoF will invest in 10 to 20 underlying funds, which in turn are investing in hundreds of portfolio companies). 

Cost structure: FoFs are cost-effective solutions for institutional investors because the due diligence, negotiations, and post-investment portfolio management is outsourced to the FoF managers. A typical FoF fee structure is 5 % carried interest combined with approximately 0.75 % annual management fee. Institutional investors effectively pay two layers of fees in such a structure: one at the FoF level and another at the PE/VC fund level.

FoFs raise approximately $30 billion in any year. The first FoF, a firm that would eventually become Adams Street Partners, raised a mere $60 million. Today, Adams Street Partners manages $25+ billion and raises about $2 billion each year to be deployed in 15 to 30 new partnership commitments. Its target allocation typically includes 30 percent in venture capital, with the largest slice allocated to buyout funds 40 percent and the rest being set aside for mezzanine and distressed debt funds. 

 Variation of a theme
    

Each FoF is designed to accomplish certain goals for its investors and for any venture fund seeking capital from these FoFs. Its important to identify how their own fund strategy aligns with the FoF’s strategy. Here are three FoFs all investing in venture capital funds, yet their investment strategy differs substantially.

Top Tier Capital Partners

• Strategy = Focussed on proven VC fund managers with established track record
• Average investment = $25 million / fund
• Assets under management = $2.6 billion
• Geography = US only

Cendana Capital

• Strategy = Focussed on micro-VCs
• Average investment = $1million to $5 million / fund
• Assets under management = $130+ million across three funds
• Geography = US - Primarily Silicon Valley and New York

Renaissance VC Fund

• Strategy = Focussed on bicoastal funds investing in Michigan
• Average investment = $5 million / fund
• Assets under management = $100 million 
• Geography = US & Midwest

So as you build your LP target list, ask the following: Are we a good fit for this LP? Consider:

• Timing: Are they investing in VC funds? Not now, later?
• Portfolio: Are they planning on re-upping with existing funds? Or bring on new funds in their portfolio?
• Experience of fund managers: Does this LP invest in noob / emerging versus proven managers?
• Sector and Stage: Does this LP typically invest in {sector / stage / geography of your fund} ?
• Amount of investment: Large multi-billion LPs do not cut smaller $1m checks - it's a lot more work and they don't get paid for it.
• Process: Investment committees, votes, memos, diligence...why do LPs take so long? 
• Timelines: This can range from a few weeks to a few years. One LP told me that they watch a fund manager complete an entire cycle (raising a fund, building a portfolio, exits and performance) - that's like a 3-5 year dance. 
• Expectations: What constitutes a good relationship for them? How do they succeed? Ask them. Please. 

In comparing all LP types, the Fund-of-Funds stand apart from classical institutional LPs (such as endowments / pension funds). This is because the FoF Managers  (a) Can guide VCs on various best practices / processes (b) Connect VCs with relevant counterparts and (c) Are driven to succeed as much as VCs are.  After all, if they don't generate returns, they go out of business. I have found that some FoF Managers are thought leaders - they keep a close watch on the technology frontiers, they see a lot of funds / strategies / fancy IRR data and challenge every assumptions.

They hold VCs to a higher standard.  These are the "Super LPs of choice" you want on your side ! 

While pension funds are the largest contributor, these are also conservative with respect to VC allocations. Endowments and foundations are comparatively more aggressive and allocate larger portions to VC asset classes. Finance companies function as specialized intermediaries and follow the guidelines established by their sponsors. A fund-of-funds (FoF) is established as an intermediary to allow larger institutional investors to research, access, and manage VC investments. Within all these players, some have a stronger penchant for PE and VC and will often deviate from the aggregate.

As a VC, you should be able to answer:

1. Which LP is best suited for my fund ? Larger well established venture funds attract pension funds as LPs while upcoming emerging managers are often successful in attracting family offices and foundations.
2. Do I understand the LPs constraints? Every LP operates with a certain set of constraints. Some need a steady stream of cash flows (annuities in pension funds) and other are risk-averse (insurance companies). Some are bold and can bet the farm and some make decisions quickly (family offices - if you talk to a family member). To put it in LP jargon, the four criteria LPs care about are:
   • Capital Preservation - How do LPs minimize their risk and ensure their principal amounts stay safe?
   • Capital Appreciation - How do LPs expect their capital to grow? At what rate per annum?
   • Current Income - What cash flows do LPs expect from their entire portfolio? Does the need / pressure for cash flow trump long term capital gains?
   • Total Return - How is the total portfolio value increased and surplus generated?
3. Can I meet their expectations? Well. everyone expects high IRR but some expect VCs to address socio-economic or environmental goals. 

In this post, I will lay out each LPs underlying "business model" and cash flows, as well as their appetite for venture capital. Note that venture capital is often a subset of "Private Equity", which in turn falls under "Alternative Investments".  Let's start with the pension funds:

Pension Funds 

By far, the largest source of capital for the VC universe are pension funds. A public entity or a private corporation establishes a pension fund to manage employees' investments. Employees set aside a certain amount of their paycheck in a separate account, with the goal of savings for and enjoying their years of retirement. Employers, with an objective of attracting the talented employees and incentivizing savings, match the employee contribution into the pension plan. Thus, the two sources of cash inflows into pension funds are a sum of contributions made by individuals and employers. With a larger pool of employees, the steady trickle of contributions grows to a significant amount over time. The goal of any pension fund is to provide financial security to the employees and their beneficiaries. The pension fund is typically a separate entity and is governed by a board of trustees. The typical asset allocation strategy for this pool of capital depends on the cash needs of the pension plan. Pension fund cash outflows are a factor of the benefits paid to retirees. Consider California Pension Retirement System (CalPERS), the largest public pension fund in the United States, which had over $299 billion in assets in management.  CalPERS has allocated ~10% or $28 billion to Private Equity asset class.

It's worthwhile to take a deeper dive in this treasure trove and read their annual reports - all publicly posted online. In many cases, the government mandates investment activities and prescribes language requiring that pension funds "maximize returns without undue risk of loss." Pension funds are also subject to political pressures, and political interference can severely affect a pension fund's viability. All these factors impact the pension fund’s ability to make investments in venture capital funds.

Endowments and Foundations
 

University Endowments: 

University endowments invest heavily in Private Equity and Venture Capital. Like every financial institution, they have to manage inflows, outflows and returns on their capital.  A university's cash inflows are a sum of student fees, grants, and contributions. On average, student fees and grants constitute 48 percent of a university's revenues; as these sources are uncertain, universities seek to insulate their position by creating endowments.  Less than ten percent of revenues at Yale University have resulted from tuition but over forty percent of the university's operating income comes from its endowment.  An endowment generates investment income and provides a cushion against any potential uncertainties. With it, a university can focus on its primary goals of providing education and conducting research (or building a football stadium, depending on priorities)—activities that further social causes and knowledge. The grants and contributions are fickle and insufficient—neither of these are tantamount to predictable revenue streams. More than 90 percent of endowments typically spend around five percent of their assets each year. They use these cash outflows for university operations or capital expenditures. The rest is often set aside for investments. Due to limited demands on their cash outlays, endowments are better suited for investments in alternative strategies. At Yale University Investments Office, as much as 33% of the assets are set aside for Private Equity. Recall that with CalPERS, it was less than 10%.

In comparison with pension funds, endowments have invested as much as four times the percentage of their assets in alternative assets. In a perfect world, endowment funds can potentially last forever, while pension funds can run out of money due to demands of current liabilities. 

Foundations: 

Like endowments, foundations are a significant force in the world of private equity. Foundations exist to support charitable and nonprofit causes. Governed by federal laws and regulated by the United States Internal Revenue Service (IRS), foundations are managed by their trustees. Foundations support programs that are likely not supported by federal or state grants, such as childcare, arts and education, health care, climate and environment, and religious and social causes. The emphasis placed on health care by the Bill and Melinda Gates Foundation is one such example. Foundations offer grants to various nonprofit organizations to conduct these programs. Over 75,000 foundations in the United States manage over $500 billion in assets. Private foundations are established and endowed by corporations (e.g., Ford Foundation, W. K. Kellogg Foundation) or families or individuals (e.g., Bill & Melinda Gates Foundation) and fund programs that are important to the donors. To meet IRS eligibility, private foundations must grant as much as 5 percent of their assets each year. The balance, 95 percent, is invested using asset allocation strategies. Foundations have to report their financial information publicly, as IRS guidelines mandate this disclosure.   Besides private foundations, other types of foundations include community foundations, which attract a large number of individual donors from a geographic region, and corporate foundations. Corporate foundations exist to further the cause established by the donor corporation and are funded from the corporation's profits. Over 2,000 corporate foundations in the United States hold over $10 billion in assets.  As seen from NACUBO research, larger endowments are more aggressive with private equity investments with as much as 57% of capital invested in Alternative Strategies for endowments over $1billion. The number falls to 10% with smaller endowments below $25 million.

Other forms of foundations include operating foundations, which conduct research or provide services, as opposed to grant-making activities. Compared to an endowment, the short-term cash needs of a foundation are not as significant. Hence the allocations toward long-term assets, such as alternative assets (which includes VC), tend to be higher in comparison to those of a pension fund.

Finance Companies
 

Within the LP universe, finance and insurance companies provide as much as 25 percent of the capital for venture capital and private equity. Finance companies are treated as a catch-all category to ensure clarity of presentation in this book. These include banks, nonbank financial companies, fund-of-funds, and other entities like TIAA-CREF funds, investment trusts in which assets are pooled for investment purposes. Each finance company defines its own internal criteria such as target returns, volatility, holding period / time horizon which helps develop their asset allocation plan. Consider GE Capital, Equity—the financial arm of General Electric that positions itself as an entity that "maximizes the return on GE's investment capital by combining deep equity investing experience with GE's industry expertise, operating experience and global reach." GE Capital, Equity has invested in over 500 LP funds and currently has over $5 billion of assets under management.  

Insurance Companies

Like pension funds, insurance companies manage a large amount of cash inflows and outflows. Any insurance company is in the business of managing risk. An insured party pays a premium at a fixed time interval—say, monthly, quarterly, or annually. Insurance companies invest the premiums, but the underlying driver is to meet a potential obligation that may occur in the future. If an accident occurs, the insured receives compensation. The business model of any insurance company can be reduced to inflows via premium payments and investment income. Underwriting expenses and incurred losses are primary outflows. The scope of the insurer's business and required guarantees drives the target rate of return. These factors determine an asset allocation strategy for any insurance company.  As the demand for liquidity is high, the insurance companies do not wish to lock up their capital in VC funds for 10 years. The appetite for VC / PE is often low.

Insurance companies have a unique advantage as a business model: The customer pays up front and eventually, at some point in the future, may receive benefits. In some cases, all a customer may ever get is the proverbial peace of mind. The primary mechanism to generate investment income for insurance companies is management of "float"—the amount of money that "floats" with the insurance company as premiums arrive and sits around, waiting to be paid out in the event of any claims.  Insurance companies need to maintain certain levels of capital; if they fail, regulators can swoop in. Solvency requirements are an important factor; hence the need to maintain a certain level of cash is important. Thus, insurance companies have to model their cash needs based on an actuarial assessment of risk and liabilities. In any insurance company, the accounting and actuarial teams develop the overall plan that determines cash inflows and outflows. Inflows are predictable, but outflows are not entirely predictable. Actuaries invest an enormous amount of time in modeling demographic patterns of fire, floods, accidents, and other acts of God to derive a co-relationship between premiums and claims—or risks and rewards. Hence, insurance companies attempt to manage their cash positions and liquidity effectively, as unanticipated events could occur and affect their solvency. Thus, asset allocation for insurance companies is heavily weighted in low-risk investments such as bonds. Venture capital investments are lower on the totem pole and fall in the "Other" category for most insurance companies.

Family Offices and High-Net-Worth Individuals

As much as 10 percent of PE and VC assets come from family offices and HNWIs. A family office is a private company owned and run by a single wealthy family. The family office manages the investments and trusts of the family. A single-family office (SFO) or a multi family office (MFO), as their names suggest, are professionally managed investment services companies that serve wealthy families. One of the primary functions of a traditional family office is to consolidate financial management with a view to preserving wealth, generating returns, and minimizing the tax impact for any family's fortune. Small teams of confidants, including professional investment managers, are responsible for managing the family's assets and the family office.

Among the other major tasks handled by the family office are the management of taxes, property management, accounting, payroll processing, and other concierge-type services such as travel arrangements. Family offices are classified as Class A, B, or C depending on their administrative structure. Class A family offices are operated by an independent company with direct supervision from a family trustee or an appointed administrator. Class B family offices are operated by an accounting firm, bank, or a law firm, and Class C family offices are directly operated by the family with a small support staff. MFOs consolidate activities for several wealthy families with the objective of minimizing operational costs. The Family Wealth Alliance estimates there are approximately 3,000 U.S.-based SFOs and 150 MFOs. SFOs manage assets ranging from $42 million to $1.5 billion. Total assets under advisement by MFOs are upward of $350 billion, with an average client relationship size of $50 million. Median asset size at any MFO is close to $1 billion.  According to a study conducted at the Wharton School, the most important objective for the SFO is trans-generational wealth management.  Having an SFO also allows the family members to pursue their own careers, while enjoying the benefits of cost-effective money management. As the wealth comes from family business, 58 percent choose to focus on their strengths and remain involved in operating the businesses, and 77 percent are majority stakeholders in their holding companies.  This has implications from an investment decision-making perspective. Cap Gemini World Wealth Report reports typical asset allocation for HNWIs and family offices. In comparison to endowment and foundation allocations, this category is conservatively slanted, with around 8 percent in alternatives. However, some family offices have a strong propensity to invest heavily in venture capital asset class.  

The Hillman family office of Pittsburg, PA, played a significant role in the launch of Kleiner Perkins Caufield Byers (KPCB) Fund I in the early seventies by investing as much as half of the entire fund. KPCB Fund I invested $8 million in seventeen companies (including Applied Materials, Genentech, Tandem Computers and one called "Snow-Job") and returned $345 million to its investors. The estimated 43X Cash-on-Cash return made the Hillmans very happy, thank you very much. 

In Europe, 63 percent of SFOs perform asset allocation in-house versus 47 percent of SFOs in the Americas. Thus, investment decisions and process timelines may differ if professionals manage the office. Due to the size of assets, and the conservative undertones, the decision-making cycle for investment in PE and VC is comparatively longer. Family offices and HNWIs are a significant source of capital for venture funds. According to World Wealth Report, worldwide, wealthy families and individuals control about $42.2 trillion. More than 100,000 individuals in the United States are estimated to have assets in excess of $10 million.  

North America remains the single largest home to HNWIs, with its 4.3 million HNWIs (2014) up from 4.0 million in 2013, accounting for 31 percent of the global HNWI population. In terms of the total global HNWI population, it remains highly concentrated, with the United States, Japan, and Germany accounting for 60.3% percent of the world's HNWI population. The fastest growths of HNWIs are in Asia or "Ch-India." 

Corporate Operating Funds
Corporate investments in venture funds make up a bare whisper of 2 percent of all capital flowing into venture funds. A number of corporations such as SAP, Dow Chemical Company and IBM invest as LPs in externally managed venture funds. Others establish internally managed "corporate VC funds," (CVC) such as Intel Capital or Google Ventures which invest directly in companies. CVCs invest ~6% of annual VC investments in companies.

 Sapphire Ventures (fka SAP Ventures) spun out of the corporate venture arm of SAP AG, the German software giant with $16 billion in revenues. The venture arm manages over $1 billion.  The fund has invested in companies as well as ten early stage venture capital funds. Its fund-of-funds portfolio consists of funds like SV Angel, a seed fund, August Capital, a Sand Hill Road-based fund, known for big data investments and Data Collective, a seed fund. Internationally, Point Nine, a Berlin-based seed fund with a focus on SaaS, marketplaces and mobile investments and Magma, a Tel Aviv-based Israeli seed and early stage fund have received commitments from SAP Ventures. Elizabeth ‘Beezer’ Clarkson, Managing Director of SAP Ventures says, “SAP’s global software ecosystem and 50,000 customers bring a strong advantage to any fund or startup relationship. We know enterprise software can impact a startups go-to-market strategy effectively.”

Wrapping it all up

The universe of LPs is vast, with each LP seeking different risk / return goals. A seed stage fund may be better suited in targeting HNWIs whereas a national / global fund with an established track record can attract pension funds and endowments. As in any sales process, understanding LPs will help you to manage your "somewhat hellish"  fund raising process. Fund-of-Funds is a separate "mini-LP-universe"- I will write about it in my next post. 

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]]>A deeper dive in the LP universeVC CareersMahendra RThu, 23 Jul 2015 19:04:25 +0000https://www.thebusinessofvc.com/blog/getting-in-vc-with-some-luck55aa9f87e4b08ed55ae9dcee:55aaa2e1e4b0a0d1a2fe31ee:55b067d3e4b07b56fb98b4f6Terry McGuire, a venture capitalist of 25 years and chairman emeritus of National Venture Capital Association, is the co-founder of Polaris Ventures, a firm that manages $3 billion and has invested in over 100 companies. After college, he spent a year in Ireland and learned to speak Gaelic. Co-incidentally, at his first job interview at a Chicago-based venture firm, the interviewer spoke fluent Gaelic. As the interviewer walked in, he softly muttered, "An bfhuil se fluic, amach?" which is Gaelic for "Is it wet outside?" Terry promptly responded in Gaelic. The two hit it off, and Terry landed the job.

But was it just a stroke of luck? It certainly helped that Terry was the president of the Harvard Business School Venture Capital Club. "It's a combination of training, the network, and opportunity that presented itself," says Terry, who went on to start Polaris Ventures after a seven-year stint at a Chicago-based venture firm. 

For a few chosen practitioners, the entry into VC was not an uphill crawl or a series of grueling interviews. It was as if the opportunities came seeking them. Bryce Roberts was planning to go to law school and in the interim decided to start a ski company in Jackson Hole, Wyoming. "One of my neighbors, a venture capitalist, invited me to sit in on pitch meetings and offer feedback," he says. Bryce went on to be the co-founder of O'Reilly Alphatec Ventures (OATV), which has led investments in a number of prominent technology startups.

Jack Ahrens, co-founder of TGap Ventures, has been in the venture business for over 35 years. Employed at a bank in Illinois, one afternoon he stumbled upon an internal memo that suggested his department was being shut down. "I was irritated and told my boss I would be leaving." His boss promptly jumped in: "We have a venture capital arm—what if we made you the president and gave you a raise?" "I took it—I barely knew what the heck venture capital was, but here I am some three decades later," says Jack. In these three decades, Jack has led over 35 successful exits, including twenty IPOs. 

With Terry, Bryce and Jack, luck may have played a role in getting inside the promised VC land. Luck can get you in the door. But Luck leaves as soon you get in that room  – from that point on, the show is yours. There is no way of knowing whether you are a natural, as Sanford Bernstein puts it. Bernstein, founder of the investment-banking firm Robertson Stephens and Company, had invested in venture funds for two decades. "Some do it, some can't and like with athletes, there is no way of telling till they take the field," he once remarked.  

In the meantime, let's practise our Gaelic ..repeat after me...An bfhuil se fluic, amach?

Examples of questions you can ask at an interview:

1)   Fund’s investment strategy:

• Of course, you have done your homework, checked out the websites and online data sources. You know the firm’s history, and primarily the background of the founders.
• Research one or two specific investments, and assess the competitive universe of similar investments made by other venture firms. Dive into the investment rationale and find out why this opportunity was chosen over others.  
• Ask how the fund’s investment strategy has evolved over time. What challenges has the fund faced, if any, in sourcing opportunities? In raising capital? 
• Find out the life-cycle of the current fund i.e. recently raised, partly invested with 3 more years to go in the investment cycle. All venture funds have a 3 / 5 year investment period from the time the fund is raised. Thus, depending on the timing of your entry, you could be involved in making investments, managing the portfolio or preparing for the next fund raise.

2)    A typical day at the firm: While this is somewhat of a cliched question, it's a good way to get some insights. Who would I report to and what self-development opportunities exist for an entry-level person? Look for opportunities where you will participate in all facets of the business. 

3)    Chemistry and Culture: This is best found via offline reference checks and informal conversations, especially with portfolio entrepreneurs. Is this a collaborative environment or a field of cowboys who thrive solo? How does the team collaborate with each other, especially when the portfolio companies are in trouble? When has the firm let go of any people and why?

• Look for troubling situations and how were these handled by the internal team – be prepared to get smooth talked. You will rarely hear honest statements like “We screwed up on that investment” or the GP “screams his head off and throws things all around, muttering obscenities”.
• Look for insecurity amongst the existing partners. In one interview on Sand Hill Road, the first thing a candidate was asked was "I don't know what the f___ is going on and why you are here?" Needless to say, the firm and its key people were struggling with infighting, politics and such.  New hires often suffer when they jump into such cesspools. 
• Can you see yourself having fun with this team? A beer on Friday night?

4)    Performance / Rewards: How will my performance be measured? What milestones would established? Will I be able to measure my own progress?  At what point will I be eligible to be on a “partner-track?” Often the position description will state if it’s a partner track position.

Of all of these, in my opinion the culture and chemistry matters most. You want high integrity, a sense of camaraderie and a very high discipline for performance.  Very few firms truly have a healthy mix of all three. 

LPs  include institutional investors (e.g., pension funds, foundations, endowments, banks and insurance companies) and family offices and high-net-worth individuals (HNWIs). The bulk of capital for venture funds comes from pension funds.  While considering an investment in a venture capital fund, each LP assesses the fund based upon:

• Institution's asset allocation strategy: Any investment institution will establish an asset allocation strategy - this is a fancy term of how they invest their capital. Such a strategy includes a set of investment principles and portfolio construction guidelines designed to generate an overall target rate of return for the LPs. Venture capital is treated as a sub-asset class of private equity that falls under "Alternative Assets."
• Investment criteria: The factors that help LPs choose target investments within each of the asset classes. In venture capital, this may translate to fund stage (seed /early, late stage or multi-stage), fund sector (technology, health care) and geography (US, Europe, Japan, Global).
• Investment process: Time lines and steps each LP needs to follow to make an investment decision within each asset class

All LPs aim to minimize risk and aim for a target financial return. For any venture fund, targeting the right mix of LPs is a bit like matchmaking; understanding the array of potential investors and their decision-making process is the first step to raising the fund in an efficient manner.

For example, a first-time fund launched by first-time managers is more likely to raise capital from individuals and family offices and will seldom get the attention of institutional investors. In future posts, we'll look at why this occurs, and understand the allocation strategies of the various LPs. This may help develop a framework for targeting suitable LPs. While pension funds are the largest contributor to VC funds, these are also conservative with respect to VC allocations. Endowments and foundations are comparatively more aggressive and allocate larger portions to VC asset classes. Finance companies function as specialized intermediaries and follow the guidelines established by their sponsors. A fund-of-funds (FoF) is established as an intermediary to allow larger institutional investors to research, access, and manage VC investments. Within all these players, some have a stronger penchant for PE and VC and will often deviate from the aggregate.

For any venture fund, it is prudent to know that your competition does not come necessarily from other venture funds, but from other asset classes that offer a better risk-adjusted return to the LPs.

It's too complex and trying to use any classical or logical frameworks are inadequate. It boils down to the ability to pick "good" investments. The ability to pick the good investments typically comes after making a lot of bad investments. Like good judgment, which comes from experience, and experience comes from bad judgment. Some attributes that define good practitioners include:

§ Student of Market Trends: The foremost and primary criteria, a practitioner’s ability to understand how markets are evolving, and where investment opportunities lie is the essence of this business. Arthur Schopenhauer once wrote ‘Everyone takes the limits of his own vision for the limits of the world.’ Good practitioners are able to recognize their limits. Equally important is the ability to time the market. “The pen computing fiasco occurred in the 1990’s — it was like the iPad era, yet twenty years to early. You had a battery life of twenty minutes and a steam crank on the side” says Marc Andreessen.

§ A good judge of teams: A practitioner is a good judge of human character and entrepreneurial abilities. “We see a lot of executives who have a vision. Our job is to decide if it really is a vision or a hallucination” says Frank Caufield, Partner Emeritus, Kleiner Perkins Caufield and Byers.

§ Speed of decision making: “Having a great brand is a good start. Speed of decision-making is equally important” says Jeff Clavier of SoftTech VC. If you like the startup, you have to move quickly to seal the deal. Else someone will gladly do so. This is a highly competitive business, especially in Silicon Valley.

§ Optimism & Stability: “You have to believe that the world can change…be optimistic and at the same time, be realistic and guarded, not romantic” says Terry McGuire, co-founder, Polaris Ventures and Emeritus Chairman of National Venture Capital Association. “You've got to be a good listener. I find if the venture capitalist does all the talking, he doesn't learn very much about the people he’s thinking about investing in. Very important to listen … and judge who looks and feels like they have the makings of making a real company. Eventually it becomes instinct if you do it often enough,” says Paul “Pete” Bancroft, former CEO of Bessemer Securities, former Chairman of National Venture Capital Association. Its a combination of innate skills (optimism, judgment, comfort in ambiguity) combined with real world experience.

“Good instinct, well honed by experience makes a good venture capitalist. The most difficult part is dealing with uncertainty" -  C. Richard Kramlich, Chairman and Co-founder, New Enterprise Associates. 

§ Situational Awareness: “A lot of good venture capitalists have ‘situational awareness’ — they can walk into just about any kind of meeting and, in about five minutes, figure out who’s doing what to whom and exactly what the issues are, sort of cut through it and figure out what’s going on. You can look at a given situation and project its trajectory reasonably well” says James R. Swartz, Founder of Accel Partners. And good judgment comes with experience. “It really pays off to come into venture capital after you’ve had a fair amount of experience doing something else. I think it’s a business that you’re probably better off entering in your thirties and forties than you are entering it in your twenties, because you need to build a frame of reference by which to judge people and to judge opportunities and to be able to judge markets and what’s going on in the economy, says Reid Dennis, Founder, Institutional Venture Partners.

Christopher Rizik, a former VC who now manages Renaissance Venture Fund, a fund-of-funds says a good VC has three qualities - starting with situational awareness:

• First, have a good sense of the world around you and how it is changing. After all, we put money behind ideas that change the world — the demographic, technological — unfilled needs. You have to be open and curious to look out into the future.
• The second quality is patience — nothing will be as fast as you want. A smart practitioner never panics or gives up when companies hit a bump. Those who are patient will not only profit but will ultimately succeed at the expense of those who panic. Patience should be married with intelligence — if you can no longer achieve the end game, it takes discipline to walk away and say, we are just not going to get there. Swallow hard and realize you just lost a few million.
• Finally, the third quality is to be fair with one and all. What goes around, comes around — in the end, the best VCs are people who were fair, were smart and treated everyone well. People seldom want to work with those who are out only for themselves.

Do I need startup experience to be a VC? 

“I don’t think there is a good predictor that just because someone has an operating or entrepreneurial background that they are going to be a good venture capitalist. Conversely, if you don't, it doesn't mean you are not going to be a good venture capitalist,” Marc Andreessen, co-founder of the leading venture firm Andreessen-Horowitz said once, while speaking at a Stanford Entrepreneurship forum. The partners at Andreessen-Horowitz have deep entrepreneurial and operational experience. Having real-world entrepreneurial experience qualifies an investor to understand the challenges of any startup. It’s a necessary condition, but not a sufficient condition towards being a successful venture capitalist. “Fred Wilson of Union Square Ventures does not have an operational bone in his body — yet he is so effective in helping companies” says Bijan Sabet, a venture capitalist with Spark Capital.

The primary goal for any venture capitalist is to create value — for their entrepreneurs and their investors. “We are in the business of helping a company achieve critical path milestones. Being able to determine what is critical path is a matter of survival — our job is to be insanely rigorous about what the critical path is.”  A definitive characteristic about a venture capitalist is being analytical about these milestones, says James Bryer, Accel Partners, Former Chairman, National Venture Capital Association.

Successful venture capitalists have an entrepreneurial mindset, — the ability to understand the basics of value creation. Yet, the background of some of the leading venture capitalists demonstrates no clear pattern. You could have strong operational expertise. Or not.

Consider these two diametrically opposite views on entrepreneurial experience as a determinant of being a VC:

“I think you become a venture capitalist by being a great entrepreneur. As a successful entrepreneur, you can better figure out how to serve entrepreneurs in their mission. So those folks in the business school who figured they, like roll out of the womb born as a venture capitalist, I don’t think they’re going to be great venture capitalists. I think they should go get a job at a high technology company or a start-up. And then see if they want to step back from where the real action is into the world I work in, which is much more indirect and supporting entrepreneurs.” — John Doerr of Kleiner Perkins Caufield and Byers (KPCB)

And the contrarian, David Cowan:

“As I was finishing up my MBA, I was told, “You don’t have anything to bring to the table. The last thing a CEO wants is some snot-nosed MBA telling him how to run his business. So go get some real experience.” I had to reject the prescription and carve my own path. Operational experience is a short-term advantage. It helps a venture professional to assess and manage investment opportunities but only in their sectors of expertise.” — David Cowan of Bessemer Venture Partners 

David Cowan rejects the notion that even entrepreneurial experience is a prerequisite. “Entrepreneurs have expertise in certain domains. But in venture, domains shift all the time. And when exposed to any opportunity, those with operating expertise tend to try and fix things — that can, at times, be counterproductive,” he says. Rightfully so, several practitioners who had very strong entrepreneurial background concurred that the hardest part for them was to transition from being a player to being a coach — to let go and let someone else run their own company. They get impatient, question the pace of execution, or the direction. Entrepreneurial success for VCs, if not modulated, can translate to being a royal pain in the rear for portfolio company CEOs. Gibson Myers, emeritus partner, Mayfield Fund, supports that view, “Some people are just operating people. It’s a whole different world to go to work, make things happen. And those people don’t transition to venture capital very well, because they want to operate. In venture capital, you’re one or two steps removed from that, and you’re advising. You have a relationship. You have a bunch of companies. You can’t spend the time, so some just don’t like it for that reason, or don’t make it as a venture capitalist.”

Subject Matter Expertise: What about a PhD in Physics? 

While there is no good predictor of what makes a good venture capitalist, some patterns are obvious. Those without substantial start-up or operating experience can be successful in the profession. Yet here are some more contradictory observations — generalist versus specialist — both from very successful venture capitalists: “Back in the seventies when I started, you could be a generalist and be successful in this business. As the business has evolved over the past 50 years, it has become a lot more focused around certain sectors and now, you need to be an expert in a few areas that matter,” says Frank Caufield of Kleiner Perkins Caufield and Byers (KPCB).

While domain expertise may be a good, it certainly is not of significant importance in the long run. Your performance eventually matters. “In my 20-year career as a venture capitalist, I have invested in all kinds of domains and companies. For long-term success in this business, you have to think more generally and push yourself out of your comfort zone. You should be willing to reinvent yourself,” says David Cowan.

It's not just a few skills that matter but the ability to “adapt / grow” with the company and reinvent oneself. Promod Haque of Norwest Venture Partners echoes this sentiment:

“Being a venture capitalist requires a varying degree of skills. At a seed stage, the skills required are different from say, investments at a mid or later stage. At the seed stage, we have a founder. The venture practitioner needs to have the ability to understand risk, validate ideas, and connect these to the market. Exploration and validation are key steps at this stage. A start-up is a no-name entity — the credibility and track record of the venture practitioner can be a tremendous asset in recruiting management talent and customers. Talent that can grow the company is usually in high demand and otherwise would not be available. In the early stage, the practitioner’s ability to help the start-up to find customers is very important. The Fortune 100 companies — those marquee customers that all start-ups seek — unfortunately avoid start-ups. They are trying to minimize the number of vendors and stick with the proven ones … even if you get your foot in the door, these companies need time and ability to assess the new product. It’s a significant commitment … these are extremely busy executives and asking them to check a new product out requires strong suite of skills. As the company evolves further, the ability to syndicate the investment becomes critical. Other investors will look at how you are putting the investment rationale and leading the round”

When Seth Levine is not managing his investments at the Foundry Group, he blogs on how to teach your child to ride a bicycle. He writes:

The core of being a good VC is the ability to move from one thing to the next, often completely disconnected thing, quickly and without slowing down. Rare is the time when I sit down and spend a few hours doing something (anything) without interruption; so much so that I generally interrupt myself these days if I’m spending too much time on any one thing, but mostly because in any given day things just seem to come up constantly. With something like 8 companies that I actively work with these interruptions are all over the map — I may be helping one company sell its business, another raise capital, another plan for a strategic offsite and another with an executive search. Keeping all of this straight in my head is a bit of a task, as is shifting gears from talking about the tax considerations of a particular merger structure with one company to looking at moving into a new vertical market for another.

Seth says that a good practitioner needs to have some ADD — attention deficit disorder. In his “Attributes of a Good VC” blog, he jokes that ADD may be a necessary and a much-desirable condition to be a good venture capitalist. 

To summarize, a good VC has the ability to pick good investments and help build great companies. Yet unlike the 1970s, entrepreneurs today have plenty of choices — they can pick VCs who have the right mix of experience and empathy, those who understand their business, demonstrate a supportive mindset and can help build the companies.

This has forced VCs to up their game — each firm is trying to be "the firm of choice" and magnet for entrepreneurs.  VC firms now have operating partners, investment partners, board partners and more.

The axis is tilting in the right direction — towards the entrepreneurs. Or as Steve Jobs would say, towards the crazy ones.

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]]>What makes successful VCsVC CareersMahendra RMon, 20 Jul 2015 07:13:29 +0000https://www.thebusinessofvc.com/blog/2015/7/18/getting-in55aa9f87e4b08ed55ae9dcee:55aaa2e1e4b0a0d1a2fe31ee:55aaaa14e4b03fdc81fee9d2When Bill Gurley graduated, he wanted to be a venture capitalist. He went to New York for the first time in his life -- to beg for meetings with venture capitalists and was told “Don’t even think about it kid. Go work for 20 years, and then come back.”

There is no straight career path into venture capital.  

Gurley stuck around in New York and went on to become one of the biggest sell-side analysts on Wall Street, quickly narrowing his focus to “this thing called the Internet, which no one knew anything about at the time.” Microsoft founder Bill Gates recommended Gurley for his first venture job with Hummer Winblad. Gurley jumped at the opportunity, and said yes before even hearing the entire offer. Today, Gurley is a General Partner at Benchmark capital, one of the Silicon Valley's leading venture firms.

In any venture firm, the cast of characters includes the General Partners (GPs, managing directors or managing GPs), vice presidents, principals, associates, and analysts. Investment professionals are responsible for making investment decisions, managing the portfolio and generating returns. Associates and analysts often support the lead investors in due-diligence or portfolio monitoring activities and eventually rise up to leading investment decisions. The primary responsibilities of the investment team differ along the lines of seniority. On any typical day, the GPs would juggle a number of activities: negotiating terms for investment opportunities, participating in boards of current portfolio companies, responding to any LP/investor requests, and putting out a few fires along the way. On the other end of the spectrum, an entry-level analyst is expected to source investment opportunities and screen these for further deliberations.  Roles such as Venture Partner and Entrepreneur-in-Residence positions are created to host proven entrepreneurs. Such professionals may source investments that fit within the fund's investment strategy, or offer sector expertise to assist other partners in making decisions. Newer titles have evolved as fund operations have become more focused. For example, in larger funds, roles such as ‘Director of Business Development’ or ‘Head of Deal Sourcing’ have emerged. For each of these positions, the entry points and tactics vary. 

After spending two years in the investment banking industry, Daniel Axelsen moved to NEA  on Sand Hill Road where he is focused on enterprise software investments. “Having worked on some major acquisitions, such as 3PAR’s acquisition by HP, I acquired a strong set of skills in industry analysis and financial modeling” he says. Daniel has honed his expertise further to seek investment opportunities in evolving markets. He has dived into the early stage universe and speaks fluently on trends such as cloud computing, security and bitcoin trends. “I was stunned to see how hard working most partners are at our firm” he says. To newcomers seeking to dip their toe in venture capital, he says, “You have to prepare for a set of radically different tasks each day. Don’t let anyone tell you this is easy. And you learn quickly to not take the first opportunity that walks in the door, but rather analyze the universe for the best.”  Getting into a Sand Hill Road firm takes a bit of luck, experience and skills – Daniel was able to score a position with a top tier venture firm.  (Daniel is now a Principal at Vy Capital, a Sand Hill road VC firm)

Yet for others, the challenges of getting in can be significantly higher. Take the example of a pre-MBA analyst position posted at Bessemer Venture Partners, one of the longest-standing VC firms in the country (the firm started in 1911). More than 650 resumes, 42 first-round interviews, and 7 second-round interviews later, one offer was made. That's about 0.15 percent odds for an entry-level position! Such odds are daunting for any aspirant. Yet other positions on LinkedIn attract a large number of applicants, as many as 300 for each position. Brant Moxley, managing director at Pinnacle Group International, an executive recruiting firm that focuses on private equity and venture capital career opportunities, says, "The demand is staggering—there are ten times the number of applicants for every job opening in the venture capital arena. Strong operating experience, demonstrated technical and financial skills or experience in the investment banking business may also be a badge of honor at the entry level. What I find fascinating is while everyone wants to get in the business of venture capital, not many understand what it takes to stay in the business." 

Cold calling your way in 

John Doerr of  Kleiner Perkins Caufield & Byers (KPCB), once remarked “I cold-called Silicon Valley's venture groups, hoping to apprentice myself to one."  His cold-calling efforts did not get him a job at KPCB, but eventually, after five years at Intel, John would land at this firm. Brooks Byers, who had asked John to get some experience, famously invited John Doerr for a 5:30 A.M. jog to see how motivated he was. John was at the track the next morning and landed the role. 
Like Doerr, Robert Nelsen chased Brooks too, but found his calling elsewhere. "I remember cold-calling Brook Byers, founder of Kleiner Perkins Caufield & Byers (KPCB) about a hundred times ... I was always interested in venture capital," says Robert ("Bob") Nelsen. Nelsen went on to be the co-founder of ARCH Venture Partners, which has now grown to manage $1.5 billion in assets. In his 20-year investment career, Bob has led nine companies to valuations of $1 billion or more. "Venture capital was my first career choice. I got a guide—this Pratt's Guide to Venture Capital Sources—to find out about this business," he says. In his first year of business school, Bob read about the launch of ARCH and approached the founder, Steve Lazarus. "I told Steve I would work for him for free." Nelsen started with ARCH as soon as he finished college. 

"Back in the 1980s, I heard once that all venture capitalists operated from 3000 Sand Hill Road," says David Cowan. The ultimate Mecca of any wannabe venture capitalist, Sand Hill Road is a small strip that houses venerable names in the venture business: Kleiner Perkins, New Enterprise Associates (NEA), Sequoia, Draper Fisher Jurvetson (DFJ), Battery Ventures, and Canaan Partners. David, who had a brief two-year stint at Oracle, was eager to explore possibilities in the venture universe. One fine afternoon, he drove to Sand Hill Road and walked unannounced into one of the venture firm's offices. The lady at the front desk was firm: "No, we don't have any openings." But David persisted. "I am sure you know a few firms who would be looking." The lady pulled out a copy of the Western Association of Venture Capitalists directory and circled a few names. "I wrote letters to five firms. Two of the five offered me a position," recalls David, who has been with Bessemer Venture Partners, for over twenty years.  

Cold-calling a VC firm rarely works—especially in the modern day. "I don't think that approach will work today—the business is much more complex and competitive," warns David.  What may work is likely a web presence. Famously, Union Square Ventures recruited a two-year rotational analyst position by not seeking resumes but asking for "web presence." Union Square defined web presence as "anything accessible via a URL. It could be a blog, a social networking profile, a portfolio, a company, a social bookmarking archive ... it is whatever you think best represents who you are online."   At the entry-level position, differentiators can be few and competition fierce. A web presence can be a head start in building your path into a venture career. 

Candidates often underestimate the power of internship opportunities. Many practitioners would be open to a thoughtful email or a call along the lines of “Hi, I am graduating next year and wanted to explore a summer internship. I have studied your investment thesis and have identified a few opportunities that may be of interest. Let me know if I can come by and discuss these.” That kind of an opening gambit is bound to get a response. These few links may provide some fodder for hunting suitable opportunities in the promised land of venture capital - 

• www.glocap.com
• www.pinnaclegroup.com/jobs.aspx
• www.efinancialcareers.com

So what does a VC do exactly?

A typical VC’s responsibilities or a position description often reads as follows:
Key tasks and responsibilities: Participate in and contribute to all aspects of the investment process with responsibility for all quantitative and qualitative analysis of portfolio companies and funds

• Analysis: Qualitatively and quantitatively evaluate potential transactions including performing detailed sector and company research and analysis. Conduct due diligence and assist with deal execution and transaction management. Carry out portfolio company analysis including valuations and financial modeling. Prepare materials for Investment Committee and other internal meetings. Interact with external consultants and advisers as required regarding analysis. Assist with closing administration
• Structuring and Execution: Participate in the development of appropriate deal structures in close liaison with legal team. Work with the legal team to prepare and coordinate the execution of agreements, offer letters, purchase agreements and other legal and transaction documentation.
• Post-Investment Monitoring: Familiarity with Board member roles and corporate governance. Keep up-to-date on portfolio performance and address any specific requests for action or approval. Prepare returns forecasts, commentary and other investment information for limited partners meetings.
• Deal Sourcing, Marketing and Fundraising: Conduct desk research for marketing, deal sourcing and fund raising. Build strong relationships with GPs /Investors /Consultants /Advisers. Undertake warm/hot calling and cold calling (all usually as part of a team focused on a specific geographic area, industrial sector or transaction type)
• Skills: Solid knowledge of relevant (Healthcare, Energy, Technology) sector.  Transactional experience and analytical abilities. Advanced financial, business modeling and writing skills
• Competencies: Results driven, ambitious and highly motivated. Strategic and commercial acumen. An entrepreneurial approach, initiative & adaptability. Team player with a strong work ethic. Well informed on market trends and key players. Excellent networking skills

Do a quick self assessment and ask yourself if you can impact at least 3 responsibilities mentioned above. And know that this is a relationship business - VC firms are small shops with typically a handful of people working very closely. Chemistry matters. Especially for senior positions, it's important to engage early with the firm and be prepared for a longer path. 

As a venture capitalist, you are not creating anything new, but rather fuelling the creation of new innovations and businesses. Often regarded as a commodity, a VC is often compared to a role of a slick glorified financier – most of whom take credit for the entrepreneur’s successes. And hide their losses or blame it upon others. Here is a list of some other challenges of this business -
•    Emotionally and intellectually demanding, a business of thousand “No’s”: The business calls for the ability to handle multiple investment opportunities, complex, and pressing situations; to maintain your drive and discipline; to prioritize tasks; and to be comfortable with ambiguity. “I have stopped trying to manage my calendar,” says Jack Ahrens, a VC of thirty years, “rather I keep a prepared mind for emergencies that may arise on any day.” It calls for a mental tenacity—not becoming exhausted by the times you must say no, turn people down, or throw water on someone's great idea without being abrasive. Entrepreneurs, particularly those who did not make it big due to paucity of capital, look at VCs as vultures, or worse, jerks.

“I’ve heard entrepreneurs say “I don’t want to talk to that firm because they are such jerks.” In almost all cases these are well-known, older firms who come from the era when capital was scarce. Every experienced entrepreneur I know has a list of “toxic” VCs they won’t deal with. There are still plenty of VCs to pitch to get a fair price for your company and only deal with decent, helpful investors. It sounds kind of crazy, but being a reasonably nice person has become a competitive advantage in venture capital" --- Chris Dixon, Partner, Andreessen-Horowitz 

•    Churn: Once you get in, staying in the business of venture capital is easy only as long as you can generate superior returns. Successful practitioners continuously need to adapt themselves over economic cycles. Be prepared to be voted off the island—your numbers will tell you when it is your turn to leave.
•    Performance of partner: The one and only measure of the business: returns are a function of capital invested and time. Time is your enemy - as the clock keeps ticking, the measure of performance – Internal Rate of Return (IRR) is a function of time, keeps dropping. Worse, in bad markets and recessionary times, the ability to exit an investment slows down, not to mention the potential value of the return. But investors really don't care for any excuses. As Roelof Botha of Sequoia Capital said of what keeps him up at night, “Suffice it to say that you’re only as good as your next investment.” 
•    Performance of firm: In a world of one-hit wonders, consistency matters. Top-tier venture capitalists who generate returns over funds get to raise funds quickly, charge higher profits—as much as 30 percent, as opposed to the standard 20 percent. Marc Andreessen once said, "I don't believe there is such a thing as a VC industry. There are about forty firms that really do well as investors and over six hundred firms that will break your heart as an investor. A handful of firms generate all the returns and a lot of firms want to generate those returns."  

“Only a small number of startups are meant to be successful. The same goes for venture firms. I expect most VCs to fail. The entire business is about finding exceptional, awesome companies. If you find one of them every five years, nothing else matters" --- Mike Maples, Floodgate Fund 

•    Market forces: At times, changes in market trends can hurt highly specialized firms. Not too long ago, cleantech investments were at an all time high. As the waves receded, the green practitioners had to tweak their resumes. Some repositioned themselves as generalists. Others went back into the technology sector and sought “clean web” opportunities. Often, when technology / software investments are on the upswing, life science sectors take a beating. Technology sectors have a shorter path to exit while the time horizon of life sciences investments is longer, often mired with technological, regulatory and financial risks.
•    Patience in financial returns. What, no carry? Of the 8,000 practitioners in the business in the United States, very few have seen any financial profits, or as they say, a ‘carry check’. In other words, most practitioners have survived on salaries, coming from management fees. This is yet another cause of heartburn for LPs, who think such perverse incentives are misaligned. 
•    Intellectual honesty (or lack thereof): Any limited partner (LP) will regale you with stories of bad VC behavior. But at its very core, what irritates these investors is how VCs play around with numbers to bloat their performance. It’s an age-old tactic – slice and dice the data to make sure your performance looks good. And then find the next sucker who can invest in the fund. VCs, with their inflated egos, hubris and biases rarely do a mea culpa. No VC in their right mind will say “We lost your money and we learned a few lessons.” Often, VCs blame someone else for poor performance. Several limited partners used terms like ‘disingenuous’. FLAG Capital, a fund-of-funds summarized it as the Lake Wobegon  effect, where in a VC land, all the women are strong, all the men are good looking, and all the children … [add venture capitalists here]…are above average.

The VC business is subject to pressures from multiple ends: the supply of capital, the availability of investment opportunities, liquidity time frames, and regulatory dynamics. Elizabeth “Beezer” Clarkson, Managing Director of SAP Ventures says, “Often, you don’t know if its you or its luck. Having humility is essential.” In any career where those two imposters of fame and fortune prevail, you can be assured of petty politics, backstabbing and opportunistic behavior. As they say, the business of venture capital is not for the faint of heart.

At its core, venture capital is truly an apprenticeship business. It takes years of mentoring to learn how to assess investment opportunities, set pricing and strategy, build and motivate management teams, deal with inevitable and unpredictable threats to the businesses, source additional capital and strategic partners, and, finally, divest (for better or worse) these illiquid investments. “The good ones view it as a calling, not a career” says Diana Frazier of FLAG Capital Management, a fund-of-funds with investments in some of the leading venture funds.

Singer Bob Dylan once said, “I accept chaos. I’m not sure it accepts me.” That sums it up nicely - you can accept venture capital, but will it accept you?

You don't need a license - so what exactly do you need to be a VC? A rich uncle can be a good start. And what constitutes as relevant experience? In the past decade, entrepreneurs like Marc Andreessen, Ben Horowitz, Brad Feld and Peter Thiel have launched their venture funds — after the maturation of their own startups. When the VC industry (if there is such a term) evolved in the late 1970s, most venture professionals came from all over the spectrum — technology, business development, finance and investment banking. Don Valentine, founder of Sequoia Capital started his career in sales and marketing at Fairchild Semiconductor. Tom Perkins, founder of Kleiner Perkins Caufield and Byers (KPCB) started at Hewlett Packard as the administrative head of its research department. Sir Michael Moritz, Chairman of Sequoia was a journalist with Time magazine. David Cowan of Bessemer Venture Partners started soon after his MBA, and has been making successful investments for over two decades.

Do you need entrepreneurial / startup experience to be a successful VC? And what drives smart people to be a VC, instead of starting yet another company?  Why even bother with this VC thing?

Why venture capital

Most are attracted to the arena for intellectual stimulation, financial gain, freedom/autonomy and the thrill of building companies.

Intellectual stimulation

A career in venture capital investing is ‘the most fun you can have with your clothes on’, says Deepak Kamra, of Canaan Partners. A day in the life of a venture capitalist is filled with intellectually challenging even stimulating conversations with entrepreneurs who are changing the world. At various points in their startup journey, entrepreneurs seek investors to validate their concepts, understand industry dynamics and investment patterns. Often, seasoned entrepreneurs will drag an investor out for “a coffee” to test their assumptions. Amidst all these caffeine laden dreams, the investor is exposed to a steep learning curve of technological changes, the shifting sands of market dynamics, sources of opportunity and competitive constraints. For those who thrive on comfort in ambiguity, a rapid pace, head-butting with with Type A entrepreneurs and ‘those crazy ones’, the career path of venture capital offers it all.

Elizabeth “Beezer” Clarkson, managing director of SAP Ventures says, “We forget how unusual this career is. Other sectors seem pale in comparison when we look at the range of energy and creativity that flows to us. It can be addictive.” For those seeking financial gain primarily, this path may not be optimal, at least in the short run.

Venture capital is an ‘anti-fragile’ career with fundamental asymmetry. In his book Antifragile, author Nicholas Naseem Taleb defines asymmetry where you have more upside than downside and tend to gain from volatility, randomness, stressors, errors, time and uncertainty. Venture capitalists thrive on information asymmetry. They have a ringside view of the technological future, and the companies they have funded are often the ones to become the next generation behemoths. Financial gains are expected as a by-product of value creation, but only after asymmetry is identified and realized within a short span of five to seven years.

Building companies as mentor capitalists

Those who have had a successful entrepreneurial journey often see the venture as a pathway of imparting their lessons to the next generation. “At a certain point in your career, it is more satisfying to help entrepreneurs than to be one” says Marc Andreessen, co-founder of Andreessen-Horowitz.Scott Weiss joined Andreessen-Horowitz after selling his company, IronPort Systems to Cisco. “Being a venture capitalist gives me the opportunity to mentor and offer direction to the entrepreneurs. They trust my judgment because I have been down this path before” he points out. Scott built IronPort Systems to $200 million revenues in the tough recessionary post dot-com era and six years later, and sold it to Cisco for $800 million. His prior experiences at Microsoft and Hotmail helped shape his own entrepreneurial path. Several practitioners agreed that this career path allows them to live vicariously via supporting other entrepreneurs.

A change agent

While entrepreneurs are change agents, VCs are change agents ten times over. Schumpeter described forces of creative destruction, where industries are decimated when innovative trends occur. On the other side, the forces of creative construction, entrepreneurs and venture capitalists, are at work. When a paradigm shift occurs in any technological ecosystem, it is more likely that a venture capital investor is stoking the entrepreneurial fire. To be a part of creating of that new new thing can be immensely satisfying. “See, venture capital is reducible to a few words. You have to be interested in managing change, and you have to recognize that change is necessary,” says Donald T. Valentine, Founder, Sequoia Capital.

Successful VC practitioners are not necessarily random change agents or great entrepreneurs — rather they are students of markets, are patient and treat this as a team sport.