PureVC

VCs Believe in the Power of RSS

I must admit that I didn't realize the power of RSS until I started blogging and downloaded Feedburner. Turns out that RSS should stand for "Really Something Special." According to a blurb on the Red Herring, a group of VCs have ponied up 100 mm to create a fund that focuses solely on RSS technologies. If you still are not a believer in RSS and the power of this technology to leave HTML in the dust, please read Fred Wilson's recent post on Blogging 1.0. If you look at some of the traffic sites can get by being creative and adapting this technology to different uses, you'll see that things seem to be moving toward a dynamic collection of constantly changing information via blogs and syndication systems that is more valuable than a static information site. Given that things could get awfully complicated with such dynamic changes happening with multiple users or syndicators, you can see that this clearly opens the door for new technologies to sift through this information and also to make such an engine interactive. I would not be suprised if the next Google or Ebay comes out of RSS technology. I'm not sure exactly where this is all going to go, but it is going to be an awesome ride.

Conflicts between VCs and LPs

Ed Sim of Dawntreader has an excellent post mentioning a subtle source of conflict between LPs and their VCs. Ed doesn't post that often, but when he does, his words of wisdom are worth listening to. Anyways, although his main post addresses the benefits of VCs and entrepreneurs getting on the same page, I want to reiterate more importantly that LPs and VCs need to be on the same page. Often, without knowing it, LPs seeking great returns are naive to possible sources of conflict between the VCs and their LPs.

What I am talking about is when VCs may place the value of what is best for their venture franchise over the value of the overall fund return. This could mean selling a company prematurely to return capital to their LPs because their fund is struggling. This could mean doing things with an eye at what is best for the next fundraising rather than what is best for the overall return of the current fund. This could mean holding out for a homerun type return in order to turn the fund around rather than returning less capital to the LPs. This could mean extending the life of the fund to reap greater management fees. This could mean distributing cash versus stock to record the return on their books rather than stock that could appreciate. This could mean using money from their newer fund for follow-on rounds of promising companies to kick-start the return of the new fund at the cost of less equity for the older fund. This also may mean co-investing with other funds with less control in the company for the sake of future deal flow.

Conflicts can not only arise between VCs and LPs but also LPs and other LPs. In this day and age where even limited shareholders and LPs are voicing their opinions, it is not unheard of for VCs to yield to vociferous and deep pocketed LPs at perhaps at the cost of quieter LPs with less power. It is not unheard of for VCs to discount management fees for loyal LPs with deep pockets and future pledges.

As an investor, you must know that every VC must navigate a landscape filled with these potential conflicts. In this clubby world where lots of money and influence is flowing around to get deal flow and produce returns, it is imperative for LPs to be aware of these possible conflicts and to seek full disclosure. At the end of the day, an LP is an LP, and VCs should be aligned with their LPs in every way. What is best for the VC and its franchise should ultimately be what is best for the LPs.

I look forward to your comments, particularly anyone who would like to share about more subtle conflicts between VCs and LPs that I haven't mentioned.

What is unique about venture capital?

People often ask me this question - what is unique about venture capital? How does it differ from other categories of private equity such as buyouts, hedge funds, and real estate? What about venture capital is so interesting to you?

I have nothing against buyout funds, hedge funds, or real estate. In fact, I have a significant portion of my own net worth in these types of alternative assets. For those of you that have an interest in private equity in general but that don't know much about these asset types, here is a little blurb about each:

Buyout funds  -  extremely large pools of cash that seek to takeover cash flow rich companies, both public and private, with the use of leverage with the hopes to extract value from the companies and produce returns. Buyout funds aim to create a leaner, more efficient machine, and to restore value to shareholders. Buyout funds usually fall into the arena of "deep value investing" with large chunks of cash. Some call buyout managers "financial engineers".

Hedge funds -  unregulated private investment vehicles that aim to produce returns by any means necessary. There are tons of different strategies available, both correlated and non-correlated to the public markets. Some of these include arbitrage, long/short, distressed/structured debt, energy/commodity, event driven, and global. Hedge funds are extremely flexible investment vehicles that can use their broad mandate to their advantage. They can go with the market, they can go against the market, and they can sit out of the market. Liquidity is a nice feature of this type of private equity vehicle.

Real estate funds -  investment vehicles that are usually involved in the development of commercial real estate. Some real estate funds focus on new construction while others focus on rehabilitation. Some real estate funds go after income generation from rents.

In response to the above questions, I submit that venture capital is unlike any of these other assets because of its ability to create ventures that have a tremendous impact on society and the economy. While it could be argued that venture capital has produced the highest historical rate of return, despite these returns, venture capital truly is the innovative engine that runs the economy. I would argue that the other categories of private equity do not have this creative effect.

Venture capital creates jobs, it creates opportunity, and it creates new markets which open the door for further opportunities. In the area of technology, it could very well be argued that the internet and most of the technology that is around today would not exist without venture capital. Sure, the government has always given venture capital dollars in the form of research grants, but the pure form of venture capital, the private form, has spawned the finest companies that truly run the world economy.

If you think about the impact these technologies have had on the world and the individual, you will find that venture capital has played a large role in bringing technologies that empower the individual, that level the playing field in varying capacities, have promoted the free flow of information, and that have helped democratize people.

Now don't get me wrong, not everybody gets into venture capital for the greater good. There are obviously lots of people that are in it for the money both on the investing and the entrepreneurial side. The returns are there and have been there for a long time. But if you take a look at the greatest VCs of all time and the deals that have provided the greatest returns, those typically involve investors or companies that had the greater good in mind, that involved individuals who embarked on a journey to change the world through innovation and develop a product that made life easier or solved a significant problem.

For those of you with an interest in venture capital, I strongly urge you to read one of my favorite books - "Done Deals" by Udayan Gupta which talks about some of the historical deals of venture capital in this country and perhaps more importantly talks about the lineages of  many firms back to some of the founding fathers of the industry.

As always, I would love to hear your thoughts on the question at hand.

Partnerships & Compensation

I deal in many partnerships - venture partnerships, real estate partnerships, investment partnerships. I have seen and heard of different compensation structures within partnerships. It is interesting that there are so many blogs about start ups and compensation structures but I haven't seen that much about how compensation is set up within partnerships. Some partnerships are structured in a corporate fashion with different levels of compensation and ownership. Some partnerships are truly equal in that all partners have an equal share. Those in the latter category usually are only possible when all the partners are there from the beginning or if the partnership is relatively small.

Tonight I had an interesting conversation about compensation within real estate partnerships. A friend of mine was wondering what type of compensation is appropriate within a partnership of equals. Should everything be split equally? Should a partner be compensated extra or get a kicker on the back end for bringing a deal? Should partners be compensated for bringing deals by not putting up equity?

Interestingly, my friend who works in the real estate industry feels that it is common practice for equal partners to be compensated differently on each deal depending on who brought the deal, did more diligence, or enabled the exit. I had a different opinion, perhaps due to my greater experience in the venture industry where an equal partnership usually means that each partner gets the same piece of the pie no matter what. If one partner has more winners than the other, the partnership and its partners split the profits and carry without regard to this.

I submit that in true partnership, the partners are equal. They try to stay on the same side of the deal at all times. They do not divide the pie differently because each deal is different. At the end of the day all the partners have their strengths and weaknesses but the whole is greater than the parts. It seems to me that once partners start dividing the pie differently, the slope becomes slippery and eventually begs the question - why exactly are they in the partnership in the first place?

I would love to hear thoughts about this issue. I feel that one of the most important things within a partnership is to keep everyone happy, motivated, and on the same page.

Should you take venture capital?

In my short blogging career, this is the first time I am posting twice in one day. I can't help but respond to Mobius' Seth Levine and his thoughts about not taking venture capital.

Let me first say that there obviously are good and bad times for venture capital. The first question should always be - what is the long term goal of the business and what is the exit strategy? Far too often entrepreneurs do not solidify this basic concept and embark on their ventures without knowing this. Do you want to grow large and aim to hit the public markets? Do you want to stay private and pocket the profits? Do you want to be doing this for five or ten years or for the rest of your life or do you want to bail with substantial value in equity after it is sustainable? This is an imperative before deciding to launch.

The description of venture investors as active, vociferous, and pressuring can be true. This is precisely the reason you want to ask all of these questions and more. Rather than go into details in this broad topic, I will focus on the example of the entrepreneur who has never taken VC money vs the serial entrepreneur who has successfully taken VC money.

Venture capital can be great for the entrepreneur who has never taken venture capital. It forces the entrepreneur to be aggressive and grow, to see if the business really has legs and traction. It forces the entrepreneur to report to someone who usually has more experience and knowledge. I know several entrepreneurs who have never taken venture capital and should. They have taken the leap to start businesses and have gotten some money from close friends and family, but what they really need is to be accountable to an investor who is concerned with the bottom line - an investor who will commit capital and a set amount of time to seeing if the bet will pay off. An investor who will not hesitate to replace the founder or entrepreneur if he is not cutting it. And perhaps most importantly an investor who will legally bind the entrepreneur into devoting everything to the business.

Seth's example is a great one of an entrepreneur who should not have taken venture capital, right? Well, I submit that Seth's friend is better off for taking venture capital. He took investors who realized the time value of money and placed a bet on him and his company to produce. Ultimately his company crashed but that is far better off than being the walking dead. I believe entrepreneurs whose companies fail after taking venture capital are better entrepreneurs from the experience. Without knowing the details, I suspect that Seth's friend has a stronger company now than it would have been had it not taken venture capital.

Whenever I talk about this topic I inevitably bring up the "serial entrepreneur" who uses venture capital to his advantage. I am talking about the entrepreneur who starts a business who plans an exit in 3 to 5 years. This is the guy (or gal) who thinks like a venture capitalist and whose plan is to have the company go public or be acquired in his time frame or have built substantial value in his equity by the time he hands it over to another CEO or whomever his venture investors deem appropriate. In essence, this is the guy whose own VC currency is his sweat equity.  This is the entrepreneur who understands the time value of money as well as the value of his own time. He does not want to spend his whole life building equity in his company. He wants to build something and then ride the steep part of the curve and then get off to start another venture.

I know a bunch of guys like this, one that comes to mind who I have invested with before is Andy Klein, founder of Wit Capital, which ultimately was bought by Schwab, and founder of Soleil Securities. If you follow the career of a guy like Andy, you will find someone that welcomes venture capital and allows VCs to ride his talent and conversely someone who utilizes VCs and rides their talent.

So while I agree with Seth that entrepreneurs should "look before they leap" into taking venture capital, I believe all entrepreneurs benefit from venture capital. I guess then the key question that each entrepreneur needs to answer is this - "What type of entrepreneur do you want to be?"

Real Estate & VC

The last few days I have had a few interesting pings back and forth between a dear friend who is putting together a real estate company. I suggested before he form the company to figure out what his exit strategy would be. Would he like to stay private and pocket the cash flows from rents and sales of newly constructed buildings? Would he like to reach liquidity via the public markets? He wasn't exactly sure what the best exit strategy would be for a real estate venture.

Unfortunately, I don't know what the best exit is for real estate investment either. Seems to me that the public markets have been placing a healthy valuation on REITs these days. These are investment entities that invest in income producing properties. Some REITs do development activities, some do improvement, others only try and acquire cash flow in specific industries such as hotel, medical office, residential, etc.

While I am not sure what the best exit strategy is, what I do know is that the public markets place a healthy valuation on businesses that have free cash flow. In the arena of real estate not only can the owners reinvest the cash flows back into the business, they can also realize value in the equity of their ownership in the business model. For some reason, I don't think people understand that fully when it comes to real estate. I guess that is why most real estate entities remain private for their managers to keep profits.

I would love to hear comments on this topic because I am thirsty to learn more.

Fire in the Belly

This morning a few things happened to me that remind me why I love venture capital. First, as part of my daily blog reading, I read Steve Jobs' commencement speech from Stanford. Second, I got a call from my good high school friend who is working at TDR Corp, a hot boutique consulting/VAR firm in the city. And lastly, I read Fred Wilson's blog and his comments on how VCs and entrepreneurs are "Always On" more than other fields.

First things first - Job's commencement speech is pretty moving. Simple, albeit, but in it is the deep message for entrepreneurs - that you must follow your passion and let it guide your career. I'm often approached by friends and colleagues about career and financial advice. And I usually advise people to take control of their careers and finances and to think outside of the box. Jobs' message is so clear and so utterly true, death is all around us and you really must look in the mirror each day and evaluate if you are happy or if you should change course. I wish I did this more myself and his speech reminded me how this is so important.

Secondly - my friend at TDR is a passionate and thriving individual. In high school, one of our teachers described him as having "Fire in his Belly." He has always been a raw individual and the best at everything he has done, a real winner. In fact, one of the things we share in common is that fire, perhaps both instilled by strict immigrant hard-working type fathers. We spoke for about 30 minutes today and just like every conversation, you can hear the fire and passion in his voice. I believe he will one day be a leading CEO and successful entrepreneur in his own right. I wish I could find more guys like him to be my friends, colleagues, and entrepreneurs.

Lastly, Fred's blog about how VCs are always on more than other professionals really hits the underlying theme of this post. That being hungry, having fire in your belly, and being always connected is really what drives entrepreneurs to live with such passion.

China Men

I know the title of my blog is "Pure VC" and it is to be about nothing else, but I guess in my third blog I am going to stray a bit. Seth Levine of Mobius recently posted some of his father's observations on his recent vacation to China. These were stimulated by Tony Perkins' piece on the moral views of China. I can't help but agree that the one-child policy has social and cultural implications that are at odds with Western values that will deepen the divide between the two cultures in future generations.

While the gender disequilibrium from such a policy is obvious, think about the consequences of not growing up with a brother or sister, and therefore, in future generations, not having aunts, uncles, cousins, or any extended family. This policy thereby has the potential to slowly disintegrate the extended family unit and consequently separate and divide a people into smaller nuclear units. This coupled with the pressure to have male children to be competitive will create a world far different from the Western way of life.

What does this have to do with venture capital? Well, like Tony Perkins hints at, the VC community is throwing lots of dough toward China without knowing exactly how things will shake out over there socially and politically. While the population boom is terribly attractive, the differences between our systems must be closely observed and monitored or I fear that the age old admonishment of China may hold true as a "great place to invest in theory but where you will never see your money return."

The VC Guild

There is an interesting post regarding "Venture Fratricide" on the AVC blog. Rather than rehash the issue of whether this is free market vs collusion, there is a subtle point by Fred Wilson that everyone seems to be missing - collegiality in venture capital is not what it used to be. Rather than call this being "clubby" or collusional, I liken this collegiality to the guild that is established in many professions. When someone new comes to town they meet other practitioners in their field. Yes, in some sense, they are meeting the competition, but in a more global view, they are meeting their colleagues who if push comes to shove have aligned interests in supporting the common industry. I am not saying that VCs should not compete or should not fund companies in competition with one another. What I am echoing is that if VCs did return to this unwritten code of conduct in which they shared more often than competed, the industry would be better off in the long run.