Musings of a VC in NYC

When Things Don't Work Out

I have said many times that early stage VC is a lot like baseball, if you get a hit one out of every three times, you are headed to the hall of fame. And if I look back over my career, and also over the track records of the firms and funds I have helped manage, that is pretty much the hit rate I have seen. By "hit" I mean an investment that returns 5x or better. But of course, many of these hits return 10x or even 100x every once in a while.

So what happens with the other two-thirds? Well that is the part of the startup world that we don't talk too much about. Sometimes an entrepreneur will take an early exit. They will have raised a small amount of outside money, will still control the company, and will get an offer they can't refuse, and take it. That's a win for the entrepreneur but not for the VC. But it is a happy outcome for everyone anyway. That's maybe 10% of the total outcomes. So at least 50% of the outcomes are not a win for the VC or the entrepreneur.

So what happens when things don't work out? There are generally two scenarios.

The first is the "slog it out" scenario. This one is in many ways the most painful. It means that there is a business that can be built, but it won't be one that makes the VCs much money and because it takes so much time and money to "slog it out", it doesn't make the entrepreneur much money either. And in many cases, the entrepreneur chooses to leave and the company has to recruit outside management to operate the business.

In the "slog it out" sceanrio, the VCs are often left holding the bag. They have a lot invested in the business and have a responsibility to figure out how to get it out. In some cases, the entrepreneur sticks around and slogs it out along with the VCs. I have great admiration for the entrepreneurs I have worked with who have slogged it out. There is very little upside for them in this scenario. Mostly they do it out of a sense of responsibility. These "slog it out" businesses can go on for a long time. I am involved with some that are well into their second decade and I am afraid that they may be headed into a third decade. I have heard these kinds of companies called "zombie companies and "the living dead". That's a bit unfair because there is no way a company can operate for two or three decades without being able to sustain itself. VCs do not keep pouring money into these businesses, maybe they do that for the first five years, but not after that. These "slog it out" companies turn into real companies eventually but just not companies that have the growth trajectories or strategic profiles that make them great acquisitions.

The second scenario is "hit the wall". In this scenario, the company runs out of cash and there is no more coming from the investors. The company cannot sustain itself and one of two things happens. There is a fire sale or an acqui-hire, or there is a shut down. The fire sale is the preferred outcome and VCs and entrepreneurs have gotten pretty good at finding homes for the teams in recent years. There is such a vacuum of talent out there that a fire sale can often be arranged just for the talent that a company has assembled. But often the fire sale cannot be arranged and the company has to be shut down. Again, the responsibility for an orderly shut down often falls onto the VCs to manage. In a shut down, the employees must be notified and paid through the date of the shut down. All required tax payments must be made. Liabilities such as leases and bank borrowings must be managed. In particularly messy situations, a bankruptcy filing is required.

There are two interesting things here that I always think about. The first is that even the very best investors in the VC business only get a hit about 1/3 of the time. That means that they have their share of "slog it outs" and "hit the walls" too. I am certainly in that camp. The second is that we end up spending an incredible amount of time and energy (hopefully not money) on the 2/3 of our investments that don't work out. When everything goes well, you really don't need that much from a VC. Of course, I have added value in all of my winners. But its the ones that don't work that I have left my blood, sweat, and tears on. And that's the paradox of being a VC that cares. Which is the only kind of VC you want to work with.

Video Of The Week: Rohan's Interview With Albert Wenger

One of the secrets of the venture capital business is the magic behind a successful partnership. It is one of those things where the total is way more than the sum of the parts. At USV, I've been lucky to work with Brad for ten years, Albert for eight years (starting with his stint as President of Delicious), John for three years (but really for many more than that), and Andy for almost two years.

Each of us brings something different to the partnership and like a winning basketball team (we are also five), each person knows their role and delivers when it counts. Each partner has a hot hand for a while, then cools down, then gets hot again.

The hottest hand at USV in the past few years belongs to Albert who has been killing it. Many of you know him from his blog called Continuations. I finally got around to watching AVC community member Rohan's interview with Albert and it captures much of what makes Albert so great to work with. So I am making Rohan's interview the video of the week:

DIY Data Science

In a comment on yesterday's hobbyist post, Pete Griffiths offered "Do It Yourself Data Science" and I really liked that suggestion for a bunch of reasons.

I think data science and machine learning (I know they are not the same thing) are going to be a very big part of tech innovation in the coming years. And I also know that putting powerful tools in the hands of "everyman" produces more innovation than can happen when the tools are limited to mathematicians and scientists.

The blogging revolution in publishing is a great example of this. Once everyone could have a printing press, we got to see many important developments that did not and would not have happened as long as publishing was a high cost operation limited to professionals.

So what is the Tumblr or Blogger or Wordpress of data science? When will my son and his friends be able to take the NBA dataset and start running algorithms against it to produce better fantasy picks? When will my daugther and her friends be able to take the TV viewing dataset to decide what TV shows to go back and watch that they missed last year?

I believe data science is going to go mainstream in the coming years. What will be the platform(s) that make that happen?

Hobbyists

One of my favorite posts in the past month came from Chris Dixon. It is short and sweet, just the way I like a blog post. In the post Chris lays out three constituencies to the startup economy; business people, engineers, and hobbyists. And he makes the point that hobbyists are a great lens through which to see the future.

I love Paul Bucheit's edict to "live in the future". I totally agree that is the best way to find the things that will turn out to be the next big thing. Being a hobbyist is a great way to live in the future. And so I try to play around with all of this stuff in order to wrap my mind around it. You should too.

Chris lays out some things that hobbyists are playing around with a lot these days:

Today, the tech hobbies with momentum include: math-based currencies like Bitcoin, new software development tools like NoSQL databases, the internet of things, 3D printing, touch-free human/computer interfaces, and “artisanal” hardware like the kind you find on Kickstarter.

I am very pleased to say that we have investments in most of those hobbies and are working to make more.

But I also think that they may be the hobbies of the moment or even possibly the hobbies of the past few years. What are the hobbies that we should take on next? That is what I woke up thinking about this morning.

Why We Spend So Much Time On Policy Stuff

Last month I wrote a post mentioning that we have an activist in residence at USV. And I write a lot here at AVC about the policy stuff we have been working on. It might seem to some that we are more like policy think tank or adovacy organization than a venture capital firm. I think that is somewhat true. We make a lot of early stage investments and we work hard with those companies to help them succeed. But if you hung out at USV, you would see that we spend a lot of time on policy stuff. And that begs the question "why do you do that?".

The short answer is that Brad, who I founded USV with a decade ago, has felt from day one that policy and governance will be as important as technology in shaping what the market looks like in the coming years. And that, of course, will shape how impactful our portfolio companies are, and that will ultimately shape our returns. And we are in the returns business.

The longer answer has to do with the power of networks, which are central to our investment thesis, to be an economic force in society. These networks will reshape markets, lower costs, bring efficiencies, and disrupt the ways that things are done. And those who are incumbents in today's model will fight these networks tooth and nail, because they threaten their incumbency. And that will lead to policy fights. We want to get out ahead of all that as much as we can.

I have not seen much written about this coming change. So I was pleased to see a post by Om Malik yesterday that laid all of this out clearly and succinctly. Om says:

the challenges of the connected future are less technical and more legislative, political and philsophical. The shift from a generation that started out un-connected to one that is growing up connected will result in conflicts, disruption and eventually the redrawing of our societal expectations.

This redrawing of societal expectations is likely to be the political battle of our time. Om goes on to talk about this in the context of the labor issues that Uber is having in San Francisco. That is a good example of what happens when networks and the data they produce reshape a market that has been operating in a traditional framework.

We are at the start of this battle between incumbents, be they black car drivers or cable companies or government itself, and the network driven upstarts. And we have many of those upstarts in our portfolio. So our policy work is ultimately an investment in the success of our portfolio companies. And that is why we spend so much time on policy stuff.

Doing Business On A Handshake

I often wish we could do business on a handshake.

I've been thinking about it more and more these days. We negotiate a sophisticated set of documents when we invest in a company and for the most part, those documents never come into play. Many times when things go badly, we rip up the documents and decide what to do based on an honest discussion among the interested parties. When things go well, all we need are the stock certificates.

I am not suggesting USV is going to start doing deals on a handshake. We have investors and we have a responsibility to them to act responsibly.

But if I were an angel, I might do things differently. There is something powerful that comes from establishing trust early in a relationship.

I always like to imagine the way that Andy Bechtolsheim handed Larry and Sergey that check for $100,000. I have no idea how it went down, but I always imagine they that pitched him, he said "sounds great" and whipped out his check book and wrote a check for $100,000. I sure hope that is how it happened. If instead he said "I will get my lawyers to draft a purchase agreement" I will be really bummed out.

The biggest problem with doing business on a handshake is you may not be dealing with the same folks in a few years. And when the person you are dealing with changes, things change. In those situations, you have to have a written agreement to fall back on. And it will be too late to get that document in place when the circumstances change.

So the right thing to do is get it in writing before you part with your cash. That is how I have always done it and how I suspect I will always do it.

But the most important thing in business is the understanding, the look in the eye, the handshake, and the personal trust that comes from those things. No piece of paper can beat that.

Why The Unlocking Phones Debate Is Important

The White House and the FCC have recently come out in favor of allowing consumers to unlock their phones. That is a really good thing. Let's hope that the rest of the regulators in this country join them in this stance.

I would go even further. I would assert that rooting, jailbreaking, and other actions that users take to gain total control of their device should be entirely legal in this country.

Here is why. We need to defend the concept of general purpose computing. General purpose computing is the idea that the owner of the computer can get access to the base computing functions on the device. Rewind to the time of the homebrew computer club. Hackers and coders were building their own computing devices and putting software on them and making what became personal computers. Personal computers have evolved a lot since then, most recently ending up in our pockets and purses, but they remain personal to the core.

In recent years we have seen more and more attempts to separate us from the core computing functions on our personal computing devices. The iPhone is stock full of them and that is the fundamental reason I will never use one. The same is true of the iPad. So iOS users jailbreak their phones. The evasion iPhone jailbreak is on 23 million phones now.

Android phones and tablets are better, but the carriers who sell these Android devices play Apple's game pretty well themselves. Getting a Nexus with a clean build of Android what I do. Others cleanse their phones with Cyanogen or other mods.  All of this activity shows that many of us want to control our devices, configure them the way we want, and put the software on them that we want to put on them.

It feels to me and other industry observers I talk to that we are moving away from this notion of general purpose computing to some other place where we use devices that are controlled by others and that we can't truly make our own. This is a dangerous trend in the technology world and one we need to resist.

I feel a growing divide between the users, who are rooting, unlocking, and jailbreaking in record numbers, and the device makers and marketers who are tightening up the screws on their devices ever tighter. I stand with the users in this fight and unlock, root, and jailbreak as much as I can. You should too. And our governement should make this activity legal so that we do not face any adverse consequences from this behavior.

Related articles

The Beginners FAQ to Android Rooting

Senator introducing bill to legalize phone unlocking

Why I continue to jailbreak

Unlocking A New iPhone Is Now Illegal, But Jailbreaking Is Still Safe - What It All Means For You

How to Jailbreak Your iPhone, iPad, or iPod Touch with Evasi0n

US phone unlocking ban under scrutiny by FCC

Video Of The Week: InSITE Fireside Chat: At The Intersection Of Pervasive Computing and Machine Learning

Last monday night, I did the annual fireside chat with InSITE, literally with an iPad fire at my side. I talked for about 20 minutes about two areaas I am thinking alot about, pervasive computing and machine learning, and what might be possible at the intersection of the two. After that there was Q&A, and then we went out for drinks at a nearby pub. It's always one of my favorite public speaking events of the year.

#askjack

It's going to be a fun friday because I get to interview Jack Dorsey late this afternoon at the NYU Entrepreneurs Festival. The festival is sold out but the interview will be livestreamed here. We plan to go on at 5:30pm eastern.

I love interviewing entrepreneurs I've had the opportunity to work with. Last year, I interviewed Dennis Crowley at the first NYU Entrepreneurs Festival and I think it was great. I hope to do as well with Jack today.

And you all can help me. Please tweet out the questions you'd like me to ask Jack. Please include two hashtags in your tweet, #askjack and the festival hashtag #nyuef.

Thanks for your help and I hope we see you on the hashtag and on the livestream at 5:30pm eastern today.

Venture Capital Returns

This post is for everyone who thinks venture capital is an easy business. I'd like to dispel that notion.

Here are short term and long term returns for the venture capital business over the past ten years compared to the public equity markets in the US.

These numbers don't include the internet bubble of the late 90s, so they are just for the past ten years.

What jumps out at me is there are no venture capital returns in this set of numbers that break double digits. When I got into the business in the mid 80s, I was schooled that you needed to produce at least 20% annual returns net to the limited partners to stay in business.

The ten year comparisons to the public markets are also challenging. The NASDAQ Composite beats later and expansion stage funds and all the public indexes beat early and multi-stage funds.

The performance of early stage funds is particularly disappointing. You would expect early stage funds to underperform in the early years. But ten years out, you would expect to see early stage outperform multi and late stage. More risk should produce more return.

This is Cambridge Associates data so it is based on many of the leading venture capital firms and it spans tech, biotech, cleantech and other areas. I believe this is a good representation of the overall performance of the VC business in the US.

Early stage investing is hard. You lose more than you win. And when you win, you need to win big. Later stage investing is a bit easier. You can pick winners in that business more easily. But so can everyone else. Each deal is an auction and the winner pays the highest price.

So the next time you are bidding one VC against another, maybe you can feel just a bit of empathy for us. We are in a tough business, trying to make a buck to live to fight another day. Just like everyone else.