VC 2.0 part 2

First rule: Don’t write blog entries so late at night as they end up being cryptic. Sorry ‘bout that, Mark.   

Here’s some additional information on this whole VC disruption thing from my perspective.

I’ve been doing the VC thing for about 5 years which makes me a complete novice/nobody. I’ve had one partial realization on an investment I’ve done, while the others that I’ve championed are still evolving. The jury is totally out moi as a “proven” VC.

No question, I’m a newbie, so listen to what I have to say with the newbie filter on. And remember, I could be wrong.

My partners have knocked some out of the park, with my partner John having been in the investment biz for 17+ years, doing great, leading the charge on our fund raising, etc. We’ve recently had our first close of Fund 4, so we are still in the game. We have great limited partners and I’m working with a super team everyday. I say all that because I don’t believe the VC business is going to die, go away, or anything like close.

I think the phrase disruption fits because we have a status quo and anytime the status quo is not faced with change it gets slow, sloppy, and just needs a jolt.

Also, I’m only talking about a very narrow portion of investment capital.  New Drugs, Life Science, Computer Chips, Big Iron, Hardware, etc, all have much different capital requirements then the software/software services space.  It is this last space where I’m focused.

There are a number of things happening which, in my opinion, require a re-think of the way things have been done. This is not a complete list.

The Rolodex.

How many times have you heard about the VC with a great rolodex? They can pick up the phone and get you an intro to anybody. And this, sometimes, will be labeled as the value add for which you give up a piece of your company. This is important for lots and lots of companies, don’t get me wrong. However, consider this.  Let’s say you have a new web service, for example, a blogging tool. You’ve spent your time writing it while keeping the day job.  In the old days, a rolodex might get you an intro to Frank Derfler. Don’t know Frank? He started PC Magazines’ LAN Labs almost 20 years ago. You didn’t have a software product unless you made the trek to Frank’s place to get blessed. An Editors Choice was the gold standard. Commander Derfler and crew were tough. And get ink in the press? Walt Mossberg was not returning your calls.

Fast forward to today.  Meet Larry Borsato. He has a blogging tool, in beta, called Bleezer. It’s a good tool, off to a good start. Mark Evans, my friend and National Post reporter, talked about it here. Mark has, according to what I can tell, about 1000x the readers I do (well deserved) and is well thought of in the tech circles. Cost to Larry for the plug? Zip.  An email, perhaps, to Mark.  I know about it because Mark wrote it up, then Larry, who has commented on my blog before, mentioned it to me. In fact, I’m testing it out and it’s pretty interesting.

And if he needs/wants to start a dialog with Microsoft? He doesn’t need my ex-Microsoft rolodex because the world has changed. Robert Scoble puts his phone number on his home page, answers every email and says, here, “At Microsoft you always have a personal connection (or you can build one)”. He is not alone. Pick a company and chances are you can find somebody out there in public that can get the ball rolling for you.

The blogging community is the new rolodex.

So, the value of the old Rolodex?  A blogger who is reasonably popular or a VC who can call any one of the Fortune 50 CEOs and get you an intro.  Which is more valuable to Larry? 

No Money Down – Start ups.

I have two very smart daughters who, fortunately, get all the brains from their double masters, PhD. candidate mother.  My oldest daughter has a great idea for a web services company. Rachel and her friend are diving in. They have jobs, are going to school, and working on this idea. My value add? Not money. They don’t need money to get this running, given the open source, ‘free’, etc out there. They are getting the first version up on pretty much nothing, own the whole company and come to me for advice but not money.  Even tho funding daughter is a slam dunk, she doesn’t need it. That, to me, is a bit of a VC wake up call.

Keep in mind they are at the exact same spot as Larry was above: idea, get going, a little blogging link love, rinse and repeat.

Rachel and Cort’s excellent adventure is being played out all over the world without the good old days which required a bunch of capital to get going. When you can get a domain name registered for a grande decafe no foam latte, trust me, the world is changing and the VC community has to change or we will miss out on a number of these ideas.

And by miss out, I simply mean missing out on some good opportunities to put capital to work which  provides a good return for our limited partners. That’s my day job and I’d like to be good at it. I want to find lots of Larry’s, Rachel’s, etc, make them rich and keep a piece for my limited partners. Don’t need my money? Uh oh, time to think about this.  That’s my point.

The New VC Competition – HR

The person I think about when it comes to Microsoft? Lisa Brummel. Lisa is in charge of HR at Microsoft. She, and her counterparts at AOL, Google, Yahoo, and lots of others are eating at the back end of the VC ecosystem.  Back in Bubble v1, we had corporate brain drain. Everybody with an idea headed for the garage, ate Kraft Mac and cheese, got funded and did the wild ride.  Today, Web 2.0 is not unfolding exactly like before. If you take a look at some of the recent buy outs of small, really small software companies and services, you will see a that most of the big guys figured out that it makes far more sense to buy early and think of the whole thing as a sign on bonus versus a true acquisition in the absolute sense of the word. Or, even more disturbing from my VC perspective, are those same companies showing up and offering the web service start up some cash (or stock) for the idea, a contract to help integrate it and then, see ya later. 

Back to our man Larry.  Assume for a second, Larry broke the code on what makes for the perfect blogging tool. It is in Java and Sun decides, heck, we should buy that product, give Larry a million bucks cash on the spot, a year’s consulting contract to integrate it into whatever and presto, we are done.  Larry will be dancing in the streets, Sun gets a ‘buy out on the cheap, and the VC community never had a shot at the return because Larry didn’t need the traditional VC thing (cash) and, today, we don’t have a good model to work with Larry. 

Some time ago, Robert Scoble made some jokes in his blog about trying to get a checkbook. While Microsoft may not up Robert’s credit limit, they are, in fact, out there with a number of checkbook as are the other players.  They are being smart and have clearly figured out that paying 5 million bucks beats 500 million every day.  Google is famous for the 20% rule whereby 20% of your time should be devoted to fun/research.  Eventually, we will see people leave Google to start new companies. I believe for now, tho, we have an issue with this portion of the start up ecosystem and VCs who want to play in this space will have to address it.

Paperwork – Costs vs.Time

It’s simply not possible to do a $100,000 (or a $300,000) investment with $30,000 in legal fees. Yes, I know that’s a brilliant conclusion from the VC newbie. There are a number of things that get in the way of small “seed” deals.   The first problem is structure. I’m not sure putting together a triple dip, full ratchet, dragging and tagging term sheet along with 90 days of due diligence is the message I want to give to start ups in today’s Web 2.0 world.  I’m exaggerating but not by much. 

Most anti-VC rants tend to focus on a number of things, ownership, meddling, pressure to flip, etc.  So, like any industry, product, or service, a perception is created that tends to lay on top of the whole VC industry.  This, of course, tends to have people with ideas heading for the hills or more accurately, heading for the credit cards vs. coming to see me.  And if, via my blog, boyish charm, and some luck, you do come see me, the 90 day due diligence, pref share cha cha, is not going to look particularly appealing vs. paying Master Card.

In order to invest in the Web 2.0 world, this model can’t work.  Proper due diligence, term sheets, ownership stake, board seats, etc, all do apply to varying degrees, for sure.  The new trick is finding the balance and changing the rules a bit so that is becomes more then money.  It’s not Las Vegas so laying bets down is not the right attitude, for sure, but getting a new way for smaller investments to be efficiently made is certainly required.

Beyond the Demo

Obviously, once you get beyond the demo, it does take skill and money to build something that will scale.  You need some level of marketing besides total and complete word of mouth. You’ll need a skill set of technical talent, marketing talent, and other important aspects of a successful venture. Typically, this is where the gobs of money comes into play. And it is here that I believe we might have an opportunity to change the game a bit.

I started writing this last night and since that time, others have been super busy.

Mark Evans wrote a post which pointed me to others. It’s a good read, as are most of Mark’s writings. Disclaimer, he’s a friend, like em, want to work with em, etc. etc.

Dave Winer wrote a post on his thoughts.  Dave’s general view of users are driving is not all that far fetched. Esther Dyson’s PC Forum  is into year 28. The theme of PC Forum 2006 is Erosion of Power: Users in Charge.  I think it is telling and I believe there is an opportunity in all of this to change the game a bit for the benefit of everybody.

Robert Scoble weighed in with comments. The only thing I would add is to change the words slightly. Robert asks what are ventures the entrepreneurs actually need.  I would phrase this slightly differently to say, what capital do the ventures need with defining capital as everything but money. That is the capital, in my view, which doesn’t really have an efficient way of being deployed. 

A wacky example: Seth Godin runs a seminar from time to time along with all the other things he does. If he was just one seminar a month, easy, cough up cash to send somebody to New York.  You can also hire him for a speaking gig, possibly.  But if I, as a VC, believe Seth’s knowledge would be a huge edge for start ups, what’s the plan? Today? Retainers, perhaps. Pieces of the company, perhaps. All kinds of different ways to ‘bottle’ Seth but none have really been figured out in a way that applies to the Web 2.0 world we are in today.

Robert’s co-author, Shel Israel is another interesting fellow. When you read his bio, you will find that a ton of amazing products and companies have chosen him as ground zero to get the product/service off the ground. Again, same interesting question.  The conventional way to use this type of talent is ‘for hire’, in other words hire the consultant, he does the voodoo, give em the check, done.  Maybe a VC firm calls upon him from time to time or maybe he (or Seth or others) are on retainer. Maybe.

Matthew Ingram, in his post, makes the point Venture Capital didn’t create the bubble and I agree with Matthew on doing a variation on public company thing, not sure if that would work any better/worse then what we have in Canada, aka Labor Sponsored VC funds. 

But here’s the question that I’ve been thinking about: If you don’t need my money, the blogging world is your rolodex, and you could possibly be snapped up before you require capital which allows me to do my VC thing, what do I offer? I believe there is a different model out there that might work for the Web 2.0 type companies.

That’s my point of disruption.  My working theory is that a “Capital firm” with Esther Dyson, Mark Evans, Shel Israel, Doc Searls, Robert Scoble, Dave Winer, or some combination, might have value that, along side my money, could bring ideas into the mainstream in a much different fashion with great returns for all.

I believe if you come into my office for a 30 minute no harm, no foul meeting and, as part of that 30 minute meeting some combination of the people above giving you some feedback is a priceless piece of capital.  If I can harness that capital in a form that makes sense for the fine folks above as well as me and the start up, well, we’ve got something I think. And the capital of smart technical folks who have build world class systems, etc, etc.

So, these are some of my thoughts.  I am reminded of the words of guitarist Robert Fripp (thx Robert):

“We should not expect good work to be acknowledged; and where it is, we should not expect it to be welcomed. Rather, the strength of a creative impulse is measured by the strength of opposition it meets.”

I’ll also end with what is, I believe, going to be a universal statement on all of this. It comes from Fred Wilson:

“I would suggest one rule and only one. Be the entrepreneur's partner. Help him or her. Be there for them. Support them. Counsel them. Share the risk with them. Have fun with them. Laugh and cry with them. And make boatloads of money with them. It's a time tested formula and it will work forever.”

Amen.

Comments

[Jeremy Wright]

I wrote some of my response to this in my post yesterday, but I believe the key values that I and most of my entrepreneur friends (who, admittedly, aren't the Robert Scoble's and Mark Evans' of the world, but we still have a lot of fun in spite of that) are looking for from VC's are:

1. Support: In spite of our egos, we're all very aware of what we do and don't know. And most of us have somehow learned that "play to your strengths" is a great mantra. We just don't know who to turn to for our areas of weakness.
2. Knowledge: One of the areas that isn't a "strength" for this new generation of entrepreneur is knowledge. Sure, we have lots of head knowledge, but the experiential, stand-alongside mentor type knowledge is missing, and most of us want this from investors / VC's.
3. Training: I touched on this in the post, but training new entrepreneurs is, to me, absolutely essential. In addition, running training as "camps" would allow entrepreneurs to develop relationships with each other early on, which is sure to help the VC / early stage investment firm in the long term.
4. Connections: Yes, blogging is a rolodex. But, getting beyond that rolodex is still very hard. Getting ad deals with newscorps, content partnerships with MSN and Yahoo, etc, is still a lot of hard work. Hard work that the relationships VC's have can mitigate.
5. Money: Not much, and not too much all at once, but in the right hands, it's amazing what 50-100K can do these days. In truth, many of my entrepreneur friends are asking for 3-5M$ these days because they have to. Sure, the investment looks good to VC's and many of my friends are getting that funding. But they know that they could have done just as much with 1/10 of what they received. Strategic funding.

This is a great discussion. I'm doing a lot of travelling in the next few months (Rochester, Toronto, Vancouver, San Fran) and I'm hoping to continue having this discussion with entrepreneurs, business managers and whoever else I bump into.

At the end of the day, though, I believe you either need to choose between changing everything and changing just a few things. Changing just a few things, in my mind, is far more likely to succeed. I know Dave wants to change everything, though, and I've never been one to stand in Dave's way ;-)

[Andy Freeman]

> I believe if you come into my office for a 30 minute no harm, no foul meeting and, as part of that 30 minute meeting some combination of the people above giving you some feedback is a priceless piece of capital.

(1) Why don't you sell that meeting?

(2) Will you invest in a company that has given some stock in exchange for such a meeting with some other collection of worthies?

[Antoin O Lachtnain]

This is all very well, but venture capital is primarily about the money kind of capital. By going into all this intellectual and human capital stuff you are drawing yourself away from the core of your business, which is putting money to work on behalf of investors.

The venture capital industry risks making the same mistake the major airlines made when they padded out their service into some sort of pseudo-luxury product. In the end the whole thing turned out to be a load of rubbish. For most people, flying isn't a luxury experience. It isn't fun. It's just a way of getting from A to B.

Now, that's not to say that it's completely a bad idea. It might work for you, and you might be able to deliver value for your investors doing it, the same way that Singapore Airlines delivers value to its shareholders through the service formula.

But like it ot not, entrepreneurs go to VCs to get money, not entrepreneurial advice. They don't really buy all the other stuff.

Remember, you aren't hearing the truth on this. Everyone tells venture capitalists that they're looking for more than money when they talk to VCs, that they're looking for knowledge, expertise and all the rest of it. But it's just a fiction to make everyone feel good about themselves. Remember the last time an airline did something bad to you? I'll bet you went to the desk and said something like 'I expected better service from XXX airlines.' But you didn't say it because you really believed it. You know well that all the airlines do more or less the same crappy things to their passengers. But you just rolled out the fiction of quality and differentiation to make the person on the other side of the desk feel good about him- or herself. Entrepreneurs do just the same thing with investors.

The average venture capital fund has to be about money and applying money on behalf of investors in the most effective way possible. Do enough deals. Get rid of the fancy offices. Reduce the cost and time to invest. Get rid of all that 30,000-dollar lawyer junk. Get rid of the 6 percent-plus investment banker fees that hurt your investors at the flotation/sell-off stage. That's what running a great venture capital firm should be all about.

If you want to be in intellectual capital become an engineer or an artist. If you want to be in human capital, get into HR. If you want to get money and make money work, then venture capital is a business to be in.

It's a way of getting from 'A' to 'B'.

[Andy Freeman]

There seem to be two views of what VCs provide - money and service.

Can they be unbundled? Should they?

[Stuart MacDonald]

Well, you and Winer certainly have global jaws a-wagging, now doncha?

:-)

-- Stuart

[Daniel Nerezov]

Great post Rick.

Sure, we're doing a start up over at http://hotbusinessblog.com/

It's great of you to wonder what it is that people like me actually need.

I need risk management.

Of course, I don't mind doing a song and dance how business blogs are the greatest thing since sliced bread, but there are just soooooo many variables that impact on the outcome of this venture.

What I want a venture guys to tell me, "Yo! Danny, you've got risks. Undercapitalisation is one of them. There is a few more. Here's a 2 year program we're putting you on to manage these uncertainties. We'll get through it together."

I have never, ever heard a vc say something like that.

[Michael Suter]

Built a great web service bootstrap style that replaces ACT or Goldmine.... Now what?

Michael
http://pushcrm.com

[Matt]

The thing is, though...your idea sounds great. I'd love to have someone offering my business a service like that. I'd pay cash for it...if I had any cash. But I don't. And I really can't say I want it badly enough to pay equity for it.

Perhaps if there were some _unique_ insights that your all-star crew of experts could offer, then those might be worth some sacrifice to get. But the value-add (not just over what I already know myself, but over what I know plus what I could learn by reading everything they've ever written and posted in public places or offered for sale in bookstores) would have to be pretty significant and extremely obvious.

The only reason I can ever see myself seeking VC funding is if the business needs to grow fast enough that _competent_ sales and marketing types are required, because the wing-it-myself strategy no longer works. If you can find a way to short-circuit _that_ requirement...well, that'd be a value-add I could easily believe in. Trading equity for getting that particular headache off my desk would be an exchange I wouldn't lose a moment's sleep doubting.

[Christopher Allen]

I definately agree with you that often the real value of the venture investor (whether an angel or VC) is the advice and contacts.

If you'd like some perspective on the angel investment side of things, you might want to take a look at my post "On Being an Angel" http://www.lifewithalacrity.com/2006/01/on_being_an_ang.html