Friday, May 11, 2012

On fixing VC ourselves

What good is it for me to sing helplessness blues
Why should I wait for anyone else?
- Fleet Foxes, Helplessness Blues

That's for Fred Wilson.

In his post last month "Can the Crowd Be More Patient", Fred says
We need new medical approaches to preventing and/or curing disease. We need new scientific approaches to generating, storing, and being more efficient with energy. Maybe we need more space exploration. Maybe we need more undersea exploration.
He says this in the context of not being able to fund these things because that is not what venture capital is. But you know what? At this exact point in time Venture Capital can be whatever Fred says it is. If he wants a 20 year fund instead of 10, he could raise it. He wants an evergreen fund? He can do that. I think he could probably raise a fund to do whatever he wants.

So I'm not sure what he's saying. But if what he's saying is that these things are not fundable, no matter the time frame, that they are simply bad early-stage investments, then I strenuously disagree. Investing in the things that make our collective lives better--the very things we think of as progress--should be the only good investments. Venture capital is a means to an end, that end being the commercialization of innovation that makes our lives better.

Here's a thought:
Entrepreneurship is a self-actualizing and a self-transcending activity that—through responsiveness to the market—integrates the self, the entrepreneur, with society. Unavoidably, therefore, entrepreneurship is an exercise in social responsibility. To suppress or constrain innovation and improvement—and their implementation—ignores a society’s needs and wants, holds it back, and diminishes its future. Entrepreneurship is the unique process that, by fusing innovation and implementation, allows individuals to bring new ideas into being for the benefit of themselves and others. It is sui generis, an irreducible form of freedom.
That's from the Kauffman Foundation's 2008 report on Entrepreneurship in American Higher Education [pdf]. Meanwhile, this week Kauffman had a new report [pdf] that--as Ed Zimmerman had it--blames investors in VC funds for being co-dependent enablers of bad VC behavior (for the tl;dr, see Fred Destin's excellent post on the report.) I've heard a lot of opinions on this report: some agreeing, some denying Kauffman's conclusions (for instance, Brad Svrluga's rebuttal.) But while the degree to which venture investors are doing a bad job is arguable, the fact that, as a whole, we are is not.

Nice as it would be to agree with Kauffman and say "I'm doing a bad job because I'm being managed poorly," that's no excuse. Every VC I know complains about bad practices in the industry, because bad venture capital practices affect us all. And while the bad behavior might make short-term economic sense, as outlined in Kauffman's report, I am not in this for the money and neither is anyone else I know.

Yes, I want to make money; in fact, I need to make money if I'm going to keep investing, I'm also competitive by nature and making money is how we keep score. And then, if it's true that the market ends up choosing companies as winners because they are the ones that contribute most to societal growth, then making money is not a bad metric in the long-term. But the real reason I'm in the business is that I want to contribute, I want to be useful. "Entrepreneurship is an exercise in social responsibility." That's what I want to enable. Every good VC I know feels the same way, but almost all of them feel helpless to change the current broken incentive model.

How would we do that, as venture investors? I'm sure there are smarter people than me thinking about this, but here are a few ideas.
  1. Change LP Behavior.

  2. I agree with Kauffman about misaligned incentives, not that my agreeing is going to change anyone's behavior except my own. But if Fred Wilson and his ilk agree with Kauffman, then it does make a difference, if they want it to. Fred talks his talk in public and he walks his walk in private, so maybe he's already in the process of convincing LPs to accept a different model so he can make the investments he thinks make a difference. I hope he is. And I hope he's not just volunteering USV, but the whole industry. When you're really good at something, explicitly raising the bar for the entire industry is a killer strategy, so convincing LPs to hold VCs to a higher standard would just be good business for him.

  3. Professionalize VC.

  4. One of the odd things about venture is the lack of seriousness about what we do. Venture is the only professional services business which does not think training its employees is a good idea. Witness Brad Feld's comment--ironically, in the textbook that Kauffman asks its Fellows to read--"We don't intend to hire associates and train them; [when we retire] we are just going to shut shop and go home. Done!" This après moi le déluge attitude means that our industry continues to be half-staffed by people who half know the job. I am constantly amazed at the crazy things other angels do, usually sins of omission, and VCs I know express the same sentiment about other VCs. In no other profession do they expect people to just show up and do the job well. In our profession many show up and do the job poorly. We all suffer. If we care about innovation--not just making money--we should be training people how to invest in and manage investments in startups.

  5. Think bigger.

  6. Wired publishes "When Will this Low Innovation Internet Era End?" at the same time as the Guardian has an article called "Has the Internet Run Out of Ideas Already?" Rick Webb calls a bubble in the very part of the startup world that has the least to do with societally useful progress (progress defined as improving GDP per capita and thus living standards.) Fred's complaint: it's true.
    As an industry, we are funding too many ideas which do not make a difference. We can take pride in helping build companies that create jobs. But creating jobs is not as good a goal as we make it out to be if those companies and those jobs disappear three years later. Jobs come and go, but technological progress is forever. Funding progress makes a difference. This is not a "they promised us jetpacks" rant. Jetpacks are stupid. I don't want a jetpack. I don't want you to have a jetpack. I think all of us having jetpacks would not make the world a better place in the least**. That's not progress. Google was progress. Twitter is progress. These are tools that enable us to think better, to communicate better, to find the things we need to know more efficiently.
    Paul Graham had a post on "Frighteningly Ambitious Startup Ideas." I think that his ideas as a whole were not ambitious enough. A new search engine, replacing email? OK, those are big ideas, and they're ideas a small team can make progress on over the course of a YC session. But the big ideas are more akin to his latter ones: a wholesale reconfiguration of existing industries that suck, efficiency-wise or societally: Hollywood, medical care. I like companies that are trying to destroy and replace our most hated industries***. But there's big and there's bigger. How do you create a company that doesn't solve a specific problem but rather makes us better at solving problems in general?
    Google and Twitter both make us better at solving problems. They don't just make us more efficient, they make us more efficient at finding efficiencies. They are tools to make our brains better. But they are primitive tools. We should be building companies that make us--as a species--more creative, better problem solvers. Our bottleneck in making more progress is ourselves as people: we can not on our own think any harder or better. Where are the startups that change that? I don't want a company that cures a disease, I want a company that helps researchers figure out how to cure diseases. The best, and best returning, industries that venture capital has funded have done just this: the computer industry, the biotech industry. These were meta-tools.
    What's the next meta-tool? If I knew I'd be building it. I don't know. So instead I spend my days looking for the type of people who think they do know. That is the job of the venture investor. We need to do more of this, and less of what we are doing now.
Kauffman's report implicitly suggested that there should be only 20 funds, each of $400 million or less. If this advice were taken, the venture industry would be a fifth the size it is today. Almost all VCs would be out of jobs. Entrepreneurs would be back in the bad old days when ARD funded DEC with $85,000 and received 70% of the company in return. No one wants that, except maybe the LPs, but that's what is in the cards if that's what it takes to make the investment class work. To avoid that, we--the venture investors--need to do better and we need to do it preemptively.

We are not helpless, we should not wait for anyone else.

* Many small companies do make a difference in people's lives, and certainly do so in the aggregate. But in some sense it's just as much work to build a small company as a big one. My philosophy is to aim for the moon and land on the roof: a big idea can produce a moderate size outcome or a big outcome; a small idea can produce a small outcome and that's it. Many entrepreneurs I've worked with have showed up with a modest idea. I've pushed them all to be wildly immodest--there's always a big idea surrounding a small idea, go for the big idea.
** Just go buy yourself a Ducati.
*** My current bets are in banking, mobile telecomm, and, of course, advertising.


Alessandro Piol said...

That's a great post Jerry, and I don't know what the answer is, but it's also true that if the VC industry continues with its current structure than it will be constrained by 1) time, 2) money and I would add 3) ability to achieve liquidity. We need to invest in companies that can generate good returns within 8-10 years tops. Fred's comment is great that we need to find the cure for cancer, the alternative sources of energy or explore space or the oceans, but in reality clinical trials are super-expensive and take a long time and you might have nothing at the end of the process; it is difficult to invest in alternative energies when the price of gas energy has fallen so low (below coal!) that it makes absolutely no economical sense to invest in alternatives; and exploration projects are going to take a long time before they can generate returns. When you add to that the fact that liquidity for venture companies has been scarce for the past ten years, and there was little capital generated for re-investment, we end up in a situation that stretches the boundaries of the current venture fund model.

What to do? I think it's unlikely that LPs will decide to invest in 20 year funds, so VCs will continue to invest in opportunities that can mature and generate returns within a few years, and these will be, generally, incremental advances.

I think what we have lost, and few people talk about this, are Bell Labs, Xerox PARC, to some extent Watson Labs and other corporate research centers. When I went to work for AT&T in 1985, the company was spending $3B in R&D, of which $300M a year in pure research. This is the type of research that invented the transistor, the laser and discovered the Big Bang, just to make it clear. And from those inventions revolutions were created. Today these research labs could be working on all these long-term projects and make great discoveries, but unfortunately they are not there anymore ... and VC is not structured to fund this type of research.

mh71619 said...

I agree; it will be tough to convince LPs to commit to a 20 yr plus fund. I think Fred has a powerful presence, but think he commands respect in the entrepreneur community, not sure how the LPs feel though. Back to the topic: I think it's sad we don't have more interest in the medical/education field, where much innovation could be used. I think the ability is out there, commitment is needed though. I do think when it happens Fred will be there to push it along, but I am not sure who will be the one to "stick their neck out." Maybe Andreessen, it's a big to do about the commitment to pledge gains; maybe he will user us to a new era? What are the chances of getting a not for profit fund together that focuses on these area we need innovation in?

Brad Feld said...

Re: après moi le déluge - I want to be clear about my comment in Mahendra's book.

It's not that we hire a bunch of associates and don't train them. Instead, our strategy is to NOT have associates. And we don't - the four partners at Foundry Group do all of the work ourselves. That's part of our fundamental strategy and we believe that it benefits (a) the entrepreneurs we work with since we believe they want to interact with us directly and (b) our LPs as we believe it results in better performance.

This is our strategy - I'm not asserting or suggesting that "the venture capital industry" should adopt it. But I do suggest every firm have a clear strategy rather than just blindly follow the approach that firms before them did.

Jerry Neumann said...


I respect you and what you've done to improve Venture with TechStars. And frankly, you're far from the worst example of the behavior I'm citing, you're just the only one I know of who's gone on record with it.

But I think you just confirmed what I said: you do not feel it's your responsibility to train the next generation of Venture Capitalists. If that's the case, then while you are benefiting today's entrepreneurs by spending all your energy on them, you are not benefiting tomorrow's. I'm not saying you have to. But if you don't then you'd have to agree that "apres moi" is a propos.


I doubt it. In USVs case, LPs would kill to get into the fund. Venture returns by fund are persistent over time and if, as Kauffman says, there are fewer than 30 funds that make venture returns, LPs would kill to be allowed into them. USV is one of the top performers. I could be completely wrong, but I'm guessing that for every LP that wouldn't accept a 20 year fund, I'd bet three would step into their place.


You've been doing this longer than most, so I respect your opinion. I think you;re probably right that LPs would not generally invest in a different structure. My point was that for someone like Fred, they might change the rules. I think he has that kind of clout. And if that worked, they might change the rules generally. Even a 20 year fund would be constrained by the rule of time and would certainly be motivated to exit sooner rather than later. But if there are, as Fred intimates, great investment opportunities that have a longer time horizon, something with an expected IRR of 30%+ over a ten year time horizon rather than a five year horizon, then a fund should be able to be structure to make it.

I agree on the value of corporate R&D and government-funded research. It's just that other than continuing to vote for people who support these things, I have no way to make a difference. You say VC is not structured to fund this type of research: then the only lever we have to change that is to change how VC is structured.

Anonymous said...

hi Jerry

there's a lot of interesting stuff in here. at USV we don't have much, if any, experience in life sciences or energy sciences. so i am not sure we are particularly well suited to fund the cure for cancer or sustainable energy. but i sure wish there were more VCs who were set up to make those investments.

as for talent in our firm, we believe that our job is to serve the entrepreneurs who choose to work with us. so we don't want to be foisting inexperienced partners on them. we want to fill our firm with experienced people who entrepreneurs want to work with and will respect as peers.

Andy Weissman said...

Hey Jerry - typical Neumannian post - there's like 5 good ideas in here. I want to comment on one, the supposition that "Venture is the only professional services business which does not think training its employees is a good idea" for which you use the example of a venture firm's junior-level professionals (or lack thereof). The problem you identify as needing to be solved - "we should be training people how to invest in and manage investments in startups" can be solved in many other ways too. Perhaps, indeed, investing in and entrepreneurs and supporting an ecosystem of startups and related businesses is a way to be "training" people to later become investors, but just not directly. For example, look at the new investors that Greylock has brought on board in the last year. At some level, these are people who came from within the environment Greylock is attempting to foster as a venture fund. That kind of stuff advances what we all do too.

Anonymous said...

Observing lots of VCs, one generally unspoken criticism is the current fetishism around star founders. If you have a name you can get funded to build the next "great" company to monetize the inside of bathroom stalls but if you are new to the game there are precious few firms that will help you (and remain patient) about solving a great big, messy problem. It reminds me of a post by Mitch Kapoor (I think), where he wrote about submitting his resume back into Lotus and could not get an interview. Perhaps it is rational, but I see too much group-think around personal brands.

Anonymous said...

Brilliant post, my two cents on the training of VCs:

I see (bigger/stuffier) firms training new VCs -- but it's often the wrong people. Too many VCs `in training' are either partners brought in from a pure finance background, or associates brought in from MBA programs.

Neither of these groups of people can possibly appreciate what it takes to build a company from the ground up.

We should hope to see more former CEOs as VCs -- wether or not their previous companies were successful.

Indeed, I'll bet there are lots of CEOs of failed startups out there who could direct entrepreneurs more effectively than some guy who has hit it big.

And... definitely more helpful than some guy who's been reading textbooks on management for two years.

Jerry Neumann said...


The Kauffman report on LPs talked about narrative fallacies that LPs suffer from. I think we in the startup and VC world suffer from our own. One is that only people who have been through the pain of starting a company can possibly be good VCs.

I co-founded a startup after being a VC and then went back to investing. I think I was a better person after going through the startup experience, and I think I'm a better investor now than I was way back then. But the narrative that only ex-founders make good VCs is demonstrably false.

Fred Wilson was not a founder; he went from business school into VC. The firm he learned his trade at, Euclid, was started by bankers. Arthur Rock was a banker. The founders of Accel went from banking into VC. Alan Patricof was never a founder. NEA was started by bankers and a VC. Battery was not started by entrepreneurs, neither was DFJ, nor was Greylock. Fred Adler was a lawyer before becoming a VC. John Doerr was a salesman at Intel.

Of the top 20 VCs on Forbes' Midas list, only half were ever entrepreneurs. So, while it would be great if the best VCs had startup experience to give them empathy for founders, it's not true that it's necessary for VCs to be succesful.

Phil Wickham said...

Jerry - I enjoyed your post, and the thoughtful industry response to the Kauffman Foundation report. To be clear, The Kauffman Fellows Program was spun out from the Foundation over a decade ago as a perpetual global licensee of the trademark and content, and is now housed at the Center for Venture Education in Palo Alto (where I serve as President and CEO). They have no say in our activities, nor do we in theirs. Our approach - brilliantly laid out 20 years ago by Mr. K's associates who ran the Foundation at the time - in developing the next generation of leaders in innovation investing spans the globe and touches on policy formation, university education, angels and corporate investing in addition to institutional venture capital. The goal is a comprehensive capital food chain in service of the entrepreneur, and we are getting there. In the newest generation of venture funds, many of the LP/GP problems highlighted in the report are being addressed. For those who read the report, I'd strongly suggest Dan Primack's response here: It's the best I've seen.

Sean said...

Yet another terrific post Jerry. On training and educating future venture investors, I'd agree with Andy's comment:
"The problem you identify as needing to be solved - "we should be training people how to invest in and manage investments in startups" can be solved in many other ways too. Perhaps, indeed, investing in and entrepreneurs and supporting an ecosystem of startups and related businesses is a way to be "training" people to later become investors, but just not directly."
And indeed - indirectly - this is a key element of our structural thesis at Anthemis: by focusing on building and nuturing a loosely-coupled ecosystem of financial services innovators, we hope to play a significant role in creating a deep and broad pool of talented people who we expect during the course of their careers to play many different roles within this ecosystem: founders, investors, advisors, board members, team members, etc.

We have a few more junior people on our team but quite frankly our model - which includes advisory businesses where they can be deployed alongside directors and partners with great results - allows us to bring them up the investing curve in a much safer environment than the typical VC and gives them multiple paths to pursue before eventually (if they even want to) coming back to base so to speak as a senior part of our capital allocation team.

nikiscevak said...

RE: Training aspect I think that the usual path of MBA -> Associate role is just a flawed one and the better path of training is through other means.

For instance, Brad and Techstars. David Cohen and David Tisch are now pretty well established and it could be said got their partner level VC education through running Techstars. They're both running angel funds and who knows if they might turn into venture funds in the coming decades.

Mike Maples, Steve Anderson, Jeff Clavier etc. started off with really small angel funds that turned into super angel funds that turned into micro vc that will turn into just-like-every-other vc fund.

So like all good things in life being able to be described by a baseball analogy, new venture professionals who have a clue should be pitching in Scranton/Wilkes-Barre like environments rather than trying to learn the game by sitting the dugout at Yankee Stadium. And that's why associate jobs don't make a lot of sense.

mh71619 said...

I think we somewhat got away from what I think is the key issue with investing in key industries such as health. Thus, I'm trying to shift the conversation away from how to train VCs to how to change VC.

How do we change. Make it an evergreen fund? Raise new a fund every 10 yrs. to "buyout" current LPs if interested in getting out. Staged liquidity of sorts. This relies a lot on ability to raise future funds -- but this is like a company -- must show traction to raise future funds. Also, I would not suggest that the fund go out and try to cure cancer with every investment, but there are many other places that healthcare lags, such as technology systems and devices. This is the same for education. Where there are many more effective ways we could deliver and present education materials that would make learning more effective. These investments may take longer to develop but I would think a more funds could be centered about this idea of investing for the greater good, versus following trends and investments focused on largest market. I know all this is easier said than done.

However, it is a viscous circle. Many of the people that become angels and VCs are self-made millionaires who have enjoyed large exits from their previous companies, which have been in the tech industry because those warrant the VC dollars which drive growth which drive large exits. Evil begets evil.