Invest in the mess

There is none of that hyperactivity in the middle stage, which I call the ugly adolescent stage

There's a front page story in the NY Times about the hyperactivity in Web startup land. They quote from a few posts I've made on this blog and I think Jenna and Evelyn did a nice job with the story.

The thing that's clear from reading the story is the hyperactivity is in the early/seed stage market and the late-stage market. Investors are throwing money at energetic entrpreneurs with plans, hopes, and dreams and at emerging winners like Groupon, Gilt, Twitter, Facebook, etc.

But from where I sit, there is none of that hyperactivity in the middle stage, which I like to call the ugly adolescent stage. The ugly adolescent stage is when you've built the product and are now building the business. It is when the team grows beyond the intial founding group and not everyone is getting along so well. It is when you are no longer that "bright shiny thing" that everyone wants to talk about. It is when your users are complaining that the service is not reliable or they hate that new feature or interface. It is when you have to figure out how to make money and get profitable. It is when the founder starts to wonder whether this CEO thing is for him or her. It is when you need that next round of financing and it isn't so easy to raise this time.

This is the messy stage of startup life. I have watched hundreds of startups go through this phase. Some don't get through it at all. Some throw in the towel and find a home for the company and the team. Many make it through and into adulthood.

Right now, this is where venture capital investing remains attractive. Like all forms of investing, the hard investments to make are the ones that are the most rewarding. Everyone knows that Facebook is a winner. Investing in Facebook is not hard and it is expensive, although it may well be rewarding.

Not everyone knows how to invest in the mess. But experienced VCs should know how to invest in the mess because they have all had to help their companies get through this stage. They understand the issues, they understand what it takes to cure them, and they should have the courage to know that investments made at this stage will be handsomely rewarded when the companies emerge into a successful adulthood.

We have plenty of portfolio companies in the ugly adolescent stage. And most of them are not finding it easy to raise money. We are doing many of these rounds as inside rounds, meaning the existing investors are funding the company without a new lead investor. I see this as a big opportunity for our firm and I am excited about it and entusiastic about making these investments. I know that not all of them will be great investments. But I know that many of them will be. And we are getting to make these investments at attractive valuations that don't have the least bit of irrational exuberance written on them.

I know that many of my friends in the VC business are doing these inside rounds in their portfolio companies as well. And I think they will be similarly rewarded. What I don't see is a lot of firms interested in leading these messy middle stage rounds as a new lead investor. I'd like to see more deal flow from other VCs at this stage because I think this is where you want to be in the VC business right now. I think you want to invest in the mess.

(For more from Fred, visit his blog)

(Image source: Rubberball.com)