Editor's note: Our Splash Health, Wellness and Wearables event is coming up on March 23 in San Francisco. We'll have Mario Schlosser, Founder & CEO of Oscar Health, Brian Singerman (Partner, Founders Fund), Steve Jurvetson (Draper Fisher Jurvetson), J. Craig Venter (Human Longevity), Lynne Chou (Partner, Kleiner Perkins), Michael Dixon (Sequoia Capital), Patrick Chung (Xfund), Check out the full lineup and register for tickets before they jump! If you’re a healthcare startup and you’re interested in being part of our competition, learn more and register here.
Venture capital used to be a cottage industry, with very few investing in tomorrow's products and services. Oh how times have changed. While there are more startups than ever, there's also more money chasing them.
We've spent the last couple of years talking to these funds and venture capitalists that run them, finding out what kinds of investments they like making, and how they see themselves in the VC landscape. But what happens after they invest? How do these funds get to continue with their companies even when they reach the later rounds, where they command higher valuations and larger checks?
That's the problem that Alpha Venture Partners is seeking to solve, by helping early stage VCs remain with their best companies, and get the same recognition, and reward, as the later stage investors.
Steve Brotman is founder and Managing Partner at Alpha Venture Partners.
Prior to Alpha Venture Partners, Brotman was the co-founder and Managing Director of Greenhill SAVP, Greenhill & Co’s venture capital unit/ Prior to GSAVP, he founded Silicon Alley Venture Partners with $15 million assets under management. At his prior funds, Steve invested in 30 portfolio companies and was among the first institutional investors in LivePerson and Medidata Solutions. Brotman was also the co-founder of online classified advertising platform AdOne.
He received a joint M.B.A. / J.D from Washington University / Columbia and a B.A. in economics from Duke University.
VatorNews: What is your investment philosophy or methodology?
Steve Brotman: What we are is a pro rata rights co-investment fund.
Historically, when venture firms raised capital in their funds, they would sometimes leave reservcs for their A and B rounds, but once a company got to a C or D or E round, they'd have to pass. While some early stage VCs may put together a special purpose vehicle, 95 percent of the time their pro rata rights would go unexercised.
In terms of the venture landscape, there are over 800 VCs in the U.S. Of those VCs, 50 have north of $1 billion under management and 300 have north of $100 million. Those are the ones that don't need any money and don’t want anyone else's money. For firms with less than $100 million, and there are over 500 of them,, they don't have the capacity and the capital, nor often times the mandate, to do those later stage deals. In the late 90s, when I first started my career, the time to an IPO was three to four years. Today that time is 11 to 12 years. Back then, VCs didn't have to worry about a C round, much less an H or an I round.
We’re here to help small and mid-sized VCs do their pro rata rights that expire in these C and D and E and later rounds that are in particularly interesting opportunities. We're willing to compensate them for that. This is relevant because those 500 VCs make their living doing early deals.
Let me give an example of that.
When I first started my career I had a $15 million fund. It was called Silicon Alley Venture Partners. We invested $1 million in a company called Metadata Solutions. The company had no revenue, it was seven guys in a loft in New York City, and they had a proposition that I thought was pretty interesting: they were going to shorten the clinic trial cycle for drug delivery by a year. That's what their aspiration was. They'd come out of the pharmaceutical clinical trial arena as professionals and scientists and IT professionals to go after this opportunity. My $15 million fund invested $1 million and we bought 20 percent. Four or five years later, the company was doing north of $10 million in revenue and had probably $25 to $50 million in bookings ready to go, which hadn't been booked as revenues but it was clear that they were quickly becoming the leader in the sector.
Insight, which is a later stage VC, came in at that point and bought a third of the company for $10 million. When we came in 2002, the company went public in 2009. Silicon Alley Venture Partners returned 30 times its money on that $1 million. Insight returned 20 times their money on their $10 million investment. For us at Silicon Alley Venture Partners, we doubled our fund; we went from $15 million, and returned $30 million to our investors. We did pretty well on that deal, but who really killed is was Insight, because they made $200 million for their LPs. They made far more than we did. If Silicon Alley Venture Partners could have put in that $10 million in, and created its own SVP to go do that, we would have made a whole lot more money as an early stage VC. In fact, we would have made 5 to 10 times more money participating in our later stage deals than doing early stage deals alone.
This is important to early stage VCs because we can double or triple or quadruple their profits from their funds to them for running their fund. Oftentimes it takes 10 to 15 years to get to liquidity. We help VCs do their best early stage deals that they can't do themselves. We make it more lucrative to be an angel investor, to be a seed stage investor, to be an accelerator, because all these small funds are giving up 95 percent of the upside to the later stage funds when they have to pass on those opportunities.
VN: What do you like to invest in? What are your categories of interest?
SB: Every VC tends to have their own specialty. We're a VC's VC, so we don't have our own specialty. We're really relying on the opportunity sets that those VCs are focused on.
We tend to go off the beaten path and we will go into sectors that might be a little bit more out of favor. This last year car sharing of any sort was out of favor, because it was perceived that Uber was going to win and take everything. We tend to disagree; we think that there are more opportunities out there. We invested in Careem and Getaround and Vroom last year. Careem is a car sharing company in the Middle East. We think that Uber has problems with the regulatory environments, and that these local competitors, like Didi in China, have a pretty good shot at dislocating someone like Uber, given their knowledge of the local market and relationships to the regulators. We think that's a little contrarian, but a lot of folks in Silicon Valley might not have invested in those three companies.
VN: What would you say are the top investments you have been a part of? What stood out about those investments in particular?
SB: Careem is about 33 percent to 50 percent bigger than Uber in the Middle East, depending on what measurement you want to use. We would never have heard about this company if it weren't for BECO Capital. It's a $60 million fund, based in the Middle East, that you probably never heard of but it's been doing early stage investing in that region for four or five years. In this last $350 million round, Beco had a pro rata right to do $10 million $20 million of that round, which they couldn't use. They're a $60 million fund, so they don't have $10 or $20 million laying around. Their LPS don’t have that kind of capital and their LPs are fund investors, not direct investors. In addition, oftentimes VCs have to move very, very quickly. You might have only two or three weeks. Once a company has a term sheet, and you have an allocation, you might only a few weeks to do it. When BECO Capital heard what we do, we got on phone right away with them, they educated us about the sector, about what Careem was doing, how quickly they were growing, how capital efficient they were. BECO was the reason we at Alpha were able to invest with confidence, because our partner, BECO, is one of the experts in this sector and geography.
Another is Vroom, which is innovating on selling cars online. They were a big competitor to Beepi, which went out of business. Similarly, Getaround is kind of a hidden gem, in that they're an Airbnb for cars. Cars sit idle 98 percent of the time. Where a home probably gets used good portion of the year, cars are not used the same amount. And they're less personal, in a way. Allowing someone to use a car for a couple of days isn't as big of a deal as them sleeping in your bed.
We were also an investor in Wish last year. It's probably one of the bigger e-commerce companies in the country, and in Silicon Valley, that no one's ever heard of. The company grew from zero to $2.5 billion in a few years. Essentially, they're the Alibaba for the rest of the world. E-commerce has been out of favor a bit in Silicon Valley and we've taken advantage of that opportunity set.
Some of the other companies are less consumery, so less sexy. We're an investor in a company called Cloud Technology Partners, which helps corporations move their data structure management from in-house to the cloud. It's a pretty big business. CTPs’ founders also were the founders of Cambridge Technology Partners. While some of it is software, a lot of it's consulting, which is also looked down on, to a degree, by many VCs. This is a company that's growing very, very quickly. They just did a strategic round and demand is voracious for what they do and we don't see that stopping for a long, long time. I think it's $2 billion or more that gets spend on transitioning software to the cloud every year, and these corporations need help managing that process.
We also invested in a company called LiveIntent, which is also in an unloved sector; some would call it ad tech, some would call it a media ad network. They place real time ads live in publishers' e-mail feeds. It's not spam. Live Intent is an ad server and media network that display ads in real time in e-mails that consumer subscriber to. About half of all publishers in U.S. use LiveIntent software and ad placement. It's pretty powerful as they target consumers via their email address and can uniquely target prospects on a 1:1 level, the holy grail of advertising. Via your email address, each of us has a data trail of LinkedIn, they can go to your website by your URL, your Twitter, Facebook feed, all your social media feeds, and that information based is pretty rich. Also, all your purchases made online are often keyed off that e-mail address. They're building a pretty valuable asset with that. They're starting this process of targeting down to the e-mail. That's pretty cool.
VN: What do you look for in companies that you put money in? What are the most important qualities?
SB: We’re looking for the very best companies so we're looking for leadership in the sector, as well as consistent performance on a financial and organizational basis. We're looking for great governance, and new VC leads and opportunity. We're not only looking for scale and growth, but a working business model. There are so many opportunities that sound great on paper but as you dig into them, don't have solid businesses.
We're somewhat valuation sensitive. Just because a company can sell stock at a price, that doesn't mean you should buy it at that price. We are sensitive to that because, depending on where you are in the cycle, we're looking for reasonably priced companies that are the next world-beaters. The only way we can get to these opportunities is through out network of over 100 VCs that we work with today, who represent over 4,600 companies. About 500 of those companies do a new round every year. We've got a shot at a good percentage of those opportunities.
VN: What kind of traction do you look for in your startups? And can you be specific? Are you looking for a number of customers or order volume?
SB: Typically we're looking north of $20 million, and growth of 50 to 100 percent or more. That's sort of the threshold, because if you're going to hit the top one percent of opportunities you almost always are going to have to hit these two key metrics. It depends on industry, but generally, from the things that I mentioned, you're already down to top 10 percent.
VN: How long does it take before you meet a startup and make an investment and how do you conduct your due diligence?
SB: That can be as short as a couple of days.
While diligence is important, remember that these are companies that are in the process of doing an E or F or G round. Wish just raised money from Temasek, which is the sovereign wealth fund of Singapore, and Careem raised $200 million from Rakuten. Before they came in, there are three or four other institutional rounds that have conducted a massive amount of due diligence. For us to do a background check on the CEO, by this point it would be redundant.
It's much more about is the business working, the financials and the sector, because you can tell a lot about a company when it's more mature than at the early phases. I'd love to invest in a virtual reality company, or an artificial intelligence company, or whatever the hot new thing coming out of Silicon Valley is. We tend to wait until they're doing north of $20 or $30 or even $100 million or more because it's hard to say if it's really just a great idea or a business proposition. When a company's doing $100 million in revenue, that's a lot of money. Someone is voting with their money to buy that company's products. Earlier stage venture firms are more focused on more telltale signs of this type of real metrics but by the time we get involved it's pretty well set that the company is established.
VN: These days a seed round is yesterday's Series A, meaning today a company raises a $3M seed and no one blinks. But 10 years ago, $3M was a Series A. So what are the attributes of a seed round vs a Series A round?
SB: It used to be said that these companies are very capital efficient. They are, but the problem is, everyone else is capital efficient as well. If you really are pursuing something that's pretty unique, it's important to get out there quickly. Sales and marketing cost money to build. You can't produce a product and it just sells self itself. Those things, sales and marketing, are still really expensive.
I think everyone knows there's a little bit of overfunding on the early stage. It's like advertising, where 50 percent of the advertising doesn’t work. It's hard to say which startups don't require that amount of capital.
While there is more capital, the number of companies that go on to the next round is declining. It's around 10 percent now, whereas five or 10 years ago I think it was closer to 20 or 30 percent. I think there's a lot more money at the early days, where things are whittled down much faster. Instead of having 500 companies funded, you have 1,000. I think that's net good for the economy and for society, and good for our ecosystem to have more seeds planted. But inevitably you're going to have more wipeouts. That's the nature of the beast and, within these sectors, a lot of times there's only one or two winners.
The good news is that if you look at the set of acquirers set it's bigger than it’s ever been. It includes not just tech companies, which are among the biggest companies in the world with the biggest cash and stock currency, but now all industrial companies now have to seriously think what is their technology angle in the future. 20 or 30 years ago, it was unheard of for a technology company to be bought by a non-technology company. Today, it's, 'of course.' As technology goes mainstream, that's inevitable. I think you're going to see more of that, not less.
VN: Tell me a bit about your background. Where did you go to school? What led you to the venture capital world?
SB: I started my career in the mid-90s. I was getting out of law and business school in 1995 in New York City and there was this thing called the Internet that was on the cover of Forbes, and every publication was talking about how the Internet was going to be the future.
At that point in time, less than one percent of the population had e-mail access. Yet, when I was thinking about starting business in the classified ad arena, and I called one hundred New York Times classified advertisers and asked them if they'd like to buy an online ad, 15 percent would buy one. Even though they didn't even have access to the Internet. Which is crazy, if you think about it. That was a unique point in time. My core DNA is as an entrepreneur, and what we are doing is a very different and entrepreneurial take on venture capital.
Just as a side note, when I started AdOne, we competed against Elon Musk. He has a company called Zip2, which is the online yellow pages. He offered to acquire us, but our board decided that it wouldn't be a smart thing to be acquired by a private company on the West Coast. We ended up selling to Hearst and Advance and Scripps. Elon sold for $200 million to Compaq. We would have ended up probably in the same financial place, but it was interesting time to have met Elon at that point in his career.
I got into venture because I was looking around and trying to decide what I wanted to do next. Thinking about starting a new company is hard. If you've sold your business as a startup entrepreneur, there are not that many great opportunities. It’s incredibly hard to find a great opportunity that no one's ever thought of that's doable. The more I thought about it the more I was like, 'Well, I'm pretty good at sales, I'm pretty good at recruiting, I'm pretty good at strategy, and I'm pretty good at raising money. What does that qualify you to do?' I wasn't a particularly good operator. At 28, what can you really do?
I started a seed fund with some of my own capital, and our first investment was in LivePerson, and it went public 18 months later. We ended up raising a $15 million fund, and about half the capital came from other VCs, guys like Tim Draper, Steve Jurvetson and John Fisher. I think part of the reason was that they were trying to get their heads around this phenomenon called the Internet and I was uniquely placed because I was an entrepreneur in that arena and there weren't that many of us around at that point. We felt like we had a bit of an edge because we knew a bit about the industry, like we knew where it was going, and, clearly with my LivePerson investment, that was true. Little did I know that the laws of venture capital apply even to me. When you're in your 20s you don't think that's the case, but early stage VCs lose about two-thirds of the time.
We were pretty successful with Silicon Alley Venture Partners Fund I, as we invested in Metadata and LivePerson. On the back of that, we sold the firm to Greenhill, and we went out and raised $100 million early stage fund at that point. It was in 2006 when we closed that fund. After we deployed that money I was effectively halfway through my career, and I was thinking, 'Do I want to raise a third fund?' I realized that there was this trend towards later stage rounds and I was getting older; I was in my 40s, and waiting 10 or 15 years for my investments to return, I was not that excited about doing that. It's also really hard to lose two-thirds of your companies. I think VCs get lionized in the press, but it's really from the reflected glory of their companies. This is hard to say but, if two-thirds of the companies you invest in wipe out, you spend most of your time digging graves for them. I don't think VCs get much credit for that. Being a VC is not a get rich quick endeavor, it takes a long time, a lot of work, and you're rarely recognized for it. Certainly some VCs are, and you certainly have your moments of glory, if you will, but it's really reflected glory in the companies that you back.
That's why I started Alpha, because I was thinking, 'Is there any way that I can make it better to be an early stage VC?' What better way than by continuing to invest in your best companies, stay on the boards, stay involved? Because, right now, most early stage VCs come off their boards, because they don't have money to follow on to be an active member. That's one of the other things that Alpha provides; it's not just capital to participate. Yes, they can make more money doing that, but many of the VCs we work with can continue to stay on boards and continue to grow with those companies. In your career, if you have two or three funds and you're successful, you might have 40 or 60 companies that you work with. But only two or three are going to be really special and to be able to work with those companies more is incredibly gratifying. That's what Alpha’s about: how do we help small and mid-sized VCs benefit in a variety of ways and grow to become bigger VCs over time?
VN: What do you like best about being a VC? What makes you excited?
SB: I get to work with small VCs that will have 20 companies in their portfolio. In every portfolio there might be one or two lifetime deals, and every day I get to work with VCs, our partner's, lifetime deals. In every quarter we get to invest in one of those companies. That's pretty cool, to have a front row seat to the best companies in the world.
To be able to allow our VC partners to continue to participate, that's also pretty cool, because we know how it feels when the D round party is happening and you're not invited. When you were there for the first five or seven years of the company's life, and then it becomes like, 'Oh, he was the guy who seeded them.' As a journalist you might have called up an early investor and said, 'What's going on with the company?’ and they go, 'I don’t really know.' It's kind of sad. So, for us to enable VCs to continue with their companies, I can't ask for more rewarding situation. It's really fulfilling as a VC to be able to do this.
I really believe in the American dream. I think it starts with entrepreneurs, but entrepreneurs can't get where they’re going without folks like the early stage backers, and the angel stage backers. We often talk about our entrepreneurial ecosystem in the U.S., and in Silicon Valley, and how vibrant it is, but we take for granted people who are not only willing to risk their own capital, and risk their own careers, but ask other people to risk their capital and their careers. That's what VCs do. They're a critical component of all that, and without that agent actively out there encouraging people to take some risks that maybe aren't the most prudent at the time, you don't get any progress in society. That's what I like about being a VC, at least at this stage of my career. I get to help the up and coming VCs and angel investors in ways that I never thought possible, and to participate in their best deals. How cool is that?
VN: What is the size of your current fund?
SB: We manage $50 million, and we're current raising a $100 million fund.
VN: What is the investment range?
SB: We'll invest as little as $250,000. At this point, though, it's probably closer to $1 to $2 million minimum, and we'll invest up to $15 to $20 million over the life of the deal. We're partnered with over 10 investment groups and family offices that have appetite to invest, not just in our fund, but also in co-investments that we bring to them.
VN: Is there a typical percent that you want of a round? For instance, do you need to get 20% or 30% of a round?
SB: No, we're not built that way. We just want to invest in great opportunities. We're targeting a 2x or 3x return, so we don't have the kind of math that very large funds have, which drives them to own 20 to 30 percent of a company.
VN: Where is the firm currently in the investing cycle of its current fund?
SB: We are two-thirds of the way through fund I, and we're current raising a $100+ million fund II.
VN: What percentage of your fund is set aside for follow-on capital?
SB: It's probably about 25 percent. It's small because it's later stage. A lot of times our companies don't have any follow on, or it's a valuation or an opportunity when we're going to pass. So we don't need to reserve for that much. Reserves are really important if the company's going to have multiple rounds in the future, and that there's a chance that one of those rounds is going to be a down round. You need to reserve more capital if there's a high probability that your companies are going to have a down round. For later stage companies that's not really the case.
VN: In a typical year how many startups do you invest in?
SB: We make three to five investments per year, so we're pretty concentrated. As we scale that number will probably go up to seven.
VN: Is there anything else you think I should know about you or the firm?
SB: In a nutshell, we allow our partner VCs to double down on their best opportunities. There's nothing better than that.