It's often said that good things come in small packages. That is, by at least some measure, the case with the size of venture funds and their respective returns. A larger portion of funds in the $50 million to $250 million range had outsized performances relative to funds with more than $250 million in capital, according to an often-cited study by Silicon Valley Bank.
Yet back in 2004, when Josh Kopelman started First Round Capital, which turns 10 this year, bigger was still perceived to be better.
Think back a decade ago. At that time, Google was just teeing up to go public at a valuation of $25 billion; Mark Zuckerberg was still at Harvard starting the Facebook, where he paid $85 for three months to run his operation. I was writing about social media and providing a definition every time I wrote the term, since it was hardly part of the American lexicon, George W was running for his second term, our photos and thoughts were still relegated to a few friends via email and instant messaging, and a Tweet was the sound of a bird.
Importantly, venture capitalists were the gatekeepers of tomorrow's innovation. From the outside looking in - only they seemed to have enough money and knowledge to spot and jumpstart new companies. At the same time, investors (both public and private) were still feeling the painful aftermath of the bubble bursting, and the thought of placing any money to work into startups or technology still seemed far too perilous to even consider.
Yet what was lost on so many was that the amount of capital needed to invest in startups was significantly less than the capital previously needed. Kopelman, an entrepreneur-turned-VC, was one of the few who saw this opportunity.
He believed he could be a VC with very little capital. As he fundraised for his own fund, venture firms (particularly the traditional ones) would often refer to Kopelman's activities as "cute," he said.
Yet clearly, he was right. In 2004, the median amount invested in a seed-stage deal was $1 million vs $500,000 today, according to DJX VentureSource.
Fast forward, while Kopelman may have made his initial fortune founding Half.com and then selling it to eBay for $350 million during the dot-com boom, he's certainly making a bigger name for himself as one of the leading seed-stage investors in the Valley and the world.
That cute-ness has paid off. First Round closed its fourth fund, and the second one at some $135 million. Since institutionalizing his investment efforts, First Round has backed Mint (acquired by Intuit for $170 million), HotelTonight (raised about $80 million), Fab (raised some $300-plus million) and One Kings Lane, to name a few.
And now the industry looks at Kopelman to spearhead change. In fact, he's not only ushered in the notion of small is beautiful, he's becoming an evangelist for VC platforms and communities as a way to leverage network effects that can come from relationships amongst his portfolio companies. Certainly, the idea of encouraging partnerships and karma is not new. Back in the dot-com bubble days, CMGI, which rose and fell with the best of the Internet mega-hits and flameouts, was one of the first, if not the first, incubator to make portfolio companies work like a family.
While First Round is not an incubator, its positioning has similarities.
CMGI, which invested in Kopelman's Half.com, promoted a "way to merge small-company entrepreneurialism with big-company resources..." and it encouraged "intra-company deals," wrote Saul Hansell, a former reporter at the NY Times.
Kleiner Perkins also had a similar idea about the value-add of relationships. Kleiner called it a "keiretsu."
"We formed this network 20 years ago and named itkeiretsu, based on a Japanese business expression that describes the principle of interlocking operating relationships between companies," according to its Web site. "The keiretsu gives emerging start-up companies a unique ability to learn from more established operations, entrepreneurs an opportunity to pool their experiences, and companies an environment to explore synergies,'" wrote Mike Yamamoto of CNet, back in 2001.
The big difference is that 10 to 15 years ago, social and professional networks and the idea of a relationship graph that made connections visible and actionable was hardly a well-thought-out concept amongst Silicon Valley venture capitalists and entrepreneurs, much less mainstream America.
Today, enough engineering and innovation has been done around how to connect people based on their interests and common experience.
Hence, First Round isn't encouraging partnerships as much as it's enabling them through its platform. And it's not so much that there are partnerships being created as much as information being shared. CTO to CTO or Marketing person to Marketing person. This is a big difference between "encouraging" network effects a decade ago vs today. The value can be transferred at each level, not just top-down.
Read on to find out more about Kopelman's views on VC.
When you started First Round Capital, beyond realizing it took less capital to fund startups, what else did you think about how the VC industry was changing?
A: Part of the realization was that the venture industry was getting capital inefficient. I started in 1991, and from '91 to 2004, the average fund size tripled. At my first company, we raised $5 million to get a product and to ship. We were funding companies with $500,000 in 2004. Venture funds were looking 3x capital inefficient at that time. For an industry that forms, there wasn't disruption in that industry at all. So what if you could create a venture fund designed in 2005 and not in 1975? In that span, it was an industry that looked far more similar than dissimilar. If you looked across other industries - real estate, travel agencies. Nothing looked like it was. But if you looked at the venture industry, it looked far more silmiar.
What are some of the assumptions about venture investing or changes that have occurred over the last 10 years that are most surprising?
A: First, you're seeing the unbundling of things. All the value was delivered by partnerships. Now you're seeing services models, agency models and platforms. You're beginning to see new methods for value delivery to companies. Historically, the VC would interact 80% with a CEO and 20% of the time with the CTO, VP of Sales, or a few other top people at a company. One of the things we're seeing through community/platform-based models is that you could deliver value at all levels throughout the organizations. Designers and heads of customer services can now help one another.
Elaborate more on the platform/community model.
A: We see every day, new funds trying to move into this direction. Dave McClure of 500 Startups, True Ventures, Index Ventures, Spark. It's inevitable. In 2004, when we launched a micro-VC, no one heard of micro-VCs or Super Angels. When we talked to VCs then, they'd say, "That's so cute." But it's been a pretty disruptive force. Just as a micro-VC was novel in 2004, we're at the vanguard of community/platform initiatives. We're seeing that value delivery can change through these platforms.
Agency models have a different proposition with regards to value delivery.
There are a number of firms doing this [the agency model], such as Andreessen and Greylock. There are a lot of portfolio companies having trouble recruiting. So the agency modeled-VC firms have their own internal recruiting firm or PR firm to help their companies. But this agency model is hard to scale. But if you're building a community and network-driven model, the value of the community goes up vs down. You now have a new CEO, new head of sales, and the value is being delivered by every company in the network. We've also created over 60 events a year, helping our companies connect to one another. We also have workshops. We see that there is real power of having a community of connected enterpreneurs who are willing to help each other. I will posit that a year from now, if you're looking back at the top VC firms, a network/platform one will appear.
You have made traditional VCs look very hands off with entrepreneurs. When you started introducing your value-added services - business network platform, events, business development, PR/marketing - did you offer these to differentiate your firm?
A: It started more organically. Our job is to help our companies. We didn't sit down and say, "Well, this is what First Round Capital needs to do to win." We asked, "What can we do to help our companies win?"
Do you see other firms offering these services and if they start doing so, how does this take away your edge?
A: Having a smart partner is necessary, but not sufficient. Having a good platform is necessary, but not sufficient. We see a ton of consumer companies who say, "We'll just make it viral" [with regards to marketing]. It's hard to achieve virality. If there was a virality button, if there was virality dust, then no one would spend a dollar on advertising. Viral is not easy. It's hard and it has to be built into your product. The best viral apps are built around viral mechanisms. The same thing applies to community. Building a community isn't easy. You can't sprinkle community dust on it.
Would your VC model have worked well when you were an entrepreneur?
A: I raised money for Half.com from CMGI. My sense is that there weren't yet the tools for distant collaboration. There wasn't the comfort. People didn't understand. For instance, there's a big difference between Facebook and online discussion grouops from back then.
If you look at venture capital today, there are far more micro-VCs and accelerators. Are these the companies doing real venture investing? And given that they're funding more companies today than 10 years ago, is it harder or easier to be a Series A investor today?
A: Easier. Series A investors benefit from seeing companies with far more traction than ever before. There's a number of 3x seed funding, but there hasn't been a 3x in Series A funding. So it's a great time to be a Series A investor. Imagine if you were in the admissions office every year and you got 10,000 applications and you could only choose 800. But all these applicants were applying in their junior year. Now imagine that you got 30,000 applications, but the applicants were applying in their senior year. You have 3x increase, but you also get a lot more information, which makes it easier. The Series A crunch is real. [So] I think it's a great time to be a Series A investor. You're getting a lot of people to take on that seed risk.
Will we see more Series A funds if it's a better time?
A: I think you'll see more Series A funds. The data shows the power of capital efficient companies, as early as 2004. But the bulk of the micro-VC funds were raised in 2010 and 2011. That's a six to seven year gap to when the data was available. So it needs to get into equilibrium.
From the start, you were always focused on seed stage. You're still doing so today. There's a study that says that funds raised under $250 million have outperformed. Why not raise more than $135 million?
A: Our fund is based on a specific model. It's the amount we think will ultimately yield good returns.
Update me on how many investments you make per year and the average investment per startup. And what percent of them have you done follow-on investments with?
A: We've done more than 200 (since inception). We don't talk about the details however.
Given that you have a relatively small fund, why not invest in 75 to 80 comapnies? Why not be more diversified, aka 500 Startups and Google Ventures?
A: That might work well for them. There's a level of engagement at the community level and partner level where we think we can deliver the most value. From our perspective, we think it's optimal for our capacity. Some funds are trying to build the index model - a broad array of stocks. We think selection, curation are important for a portfolio and community.
Happy 10th Anniversay First Round!
(Image source: Firstround.com)