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Are angel and seed investors getting entrepreneurs to sell before they should?
Corrected 7/24/12 to clarify Trevor Kienzle's statement.
VCs are dead—long live VCs! A Venture Shift panel weighed in on the future of investment funds as VC funds close up. Moderated by Bullpen’s Rich Melmon, the panel consisted of Rick Marini from BranchOut (the one entrepreneur on the panel), Trevor Kienzle from Correlation Ventures, Dave Whorton from Tugboat, Patrick Chung from NEA, and Ethan Kurzweil from Bessemer Venture Partners. Rich kicked things off with a simple question: How are you responding to the Micro VCs?
Patrick: The way that we’ve responded to this is simply to build big, great companies. It used to be the case a year and a half ago that we had an artbirry rule that we could only invest $500k and above. Today, it takes very little to start a consumer Internet company. We used to not be able to participate in a lot of investments because of our own arbitrary rule. Previously, it wasn’t possible to sell your company for $30 million to Microsoft or Google, and today it is. If you’re an entrepreneur with great ambition and you don’t want to exit early, you have to get matched up with a partner with a global footprint and deep pockets. That’s a firm like NEA.
Ethan: The truth is, to be good investors, you’re always watching shifts. Like any other shift, at Bessemer, we’ve reacted the way we always have. Our style has always been to specialize. Each of us develops our own roadmaps where we think we can bring a lot to a particular company—what situations do we want to see, what types of companies? Each of us only makes two-to-three per year, so we’re going to do all we can to add value to those companies. So we started thinking along our individual roadmaps, what are the specific stages we can do that? Each area is different. In the Internet, we’ve invested earlier on, but in things like dating sites, we’ve waited.
Rich: Dave, Tugboat strikes me as being a modern version of the old fashioned VC. How have you responded to this spray-and-pray mentality?
Dave: Before I worked at Tugboat, I worked at Kleiner Perkins and I started three companies. I believe a valuable board member is irreplaceable and can change the trajectory of a company. The top VCs I’ve talked to have all said that they invested early on and really wanted to be involved in these companies. It’s not old fashioned, it’s enduring. It’s a core value to this Valley. A lot of people want to be angel and seed investors, and that’s terrific. But for those entrepreneurs who want to change the world, they need to think about who they want to bring on and what investors they want involved.
Rich: Trevor, how do you go about this?
Trevor: My co-founder, David Coats, and I noticed an inefficiency in our careers as active lead VCs that many of our best realized returns as VCs were in companies that had had a round or two that was not fully subscribed. Most VC firms were playing the role of lead investor, which involved doing three to six months of due diligence and taking a board seat. But if they didn’t take the whole round, there were often amounts that did not get filled. So we set up Correlation to meet this market need. We provide a decision in two weeks or less. We don’t repeat the classic diligence that has already been performed by another excellent VC, who is new to the syndicate when we are. Instead we ask for five very standard documents to populate our analytics. We don’t take board seats, we tell you what we’re reserving for future rounds and we intend to follow the lead VC – who led our round – pro rata until we hit that cap. As the VC industry enters its fifth decade – Arthur Rock set up his firm in 1969 – we’re seeing the business model evolve where some firms are becoming more specialized. In response to Patrick’s question about what factors our model considers, while we don’t generally share specific factors, we do consider factors related to characteristics of the lead firm and partner, the syndicate, the company, and the round itself. Interestingly, we did look at board composition and we didn’t find a correlation between board size and outcomes or between the number of independent board members and outcomes. The one area where we did find a correlation was between the number of VCs on the board and outcomes...and there was a reduction in the probability of success with too many VC board members.
Rick: I would echo a lot of this but from a different lens. As an entrepreneur, you have to be optimistic that you can create a company that can impact a lot of people, but you have to be realistic. If you have a company you might sell to Google for $20-30 million, that might be a wonderful outcome for you as an entrepreneur. If you have an idea that could be realistically the next Facebook or Google—and you have to be realistic—that’s when you go with the bigger VC. You put yourself in a position to have a much bigger exit—and they have a much higher bar for an exit as well. If you’re thinking you’ll have a $30 or $40 million exit, you don’t want one of these guys on your board because that’s not interesting to them.
Rich: You’ve kind of made it look like these spray-and-pray guys haven’t had much of an impact, but when you look at the ecosystem—a lot of the returns on these companies have gone to the micro VCs.
Ethan: I think they’ve had a tremendous impact on the ecosystem. As Patrick alluded to earlier, it’s a lot cheaper to start a company today. The seed funds and angel funds have encouraged that even further. It’s allowed people with less money to start companies—100 years ago, only rich people started companies. These seed and angel guys makes it more difficult for larger venture capital guys. Pinterest is lucky enough to be in our portfolio—they’ll take over in 2-3 months. But it pains me when entrepreneurs push to go to the moon, when they could have a great outcome within a smaller company context. Angels have made it totally okay for companies to aim for that.
David: When you look at something like Instagram—they had that $500 million financing round, and that’s great—that’s amazing, but it’s lightning. It’s not very often that that happens.
Rich: Patrick, what response do you have to these lean things—it’s not just one or two that have happened—how does it affect you guys internally?
Patrick: I think the rise of micro VCs is wonderful because it’s helped a lot of entrepreneurs who wouldn’t have been able to get off the ground before. But there’s the early offramp problem—you’re going to have smaller investors who are financially incentivized to get you to sell before you’re ready. Then there’s the drain away from talent—people who maybe shouldn’t be starting companies will have their own company, where a few years ago those people might have failed. And then the scope of ambition is very different—in my view it’s plateaued. A generation ago, Bill Gates had no choice but to build a big company because there was no Microsoft to buy him. Now there’s someone saying “sell, sell, sell” because there’s a Google or Microsoft to buy you—and it’s a shame.
Rich: As an entrepreneur, I like to hang out with other entrepreneurs. The risk is that we lose sight of what we want to do. For me, I want to change the world in a big way. My concern is that other entrepreneurs are thinking of the $20 million exit.
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Joined Vator onEntrepreneur. Early Stage Venture Capitalist. Dad. Founder of Tugboat Ventures, Good Technology and Drugstore.com. Early backer of Blue Nile, Education Elements, richrelevance, and Successfactors.
Joined Vator onTrevor began his venture capital career in 1997. Prior to co-founding Correlation Ventures, Trevor was a Managing Director of Newbury Ventures, a technology-focused venture capital fund.