This is Part 2 of our two-part series summarizing our findings from the first-ever research study on best practices of VCs in helping to boost startup success through operational support. Part 1 is here. The full study is in the the current issue of the Journal of Private Equity and a slide deck is at the bottom of this post.
In Part 2, we discuss three common categories of VCs in terms of attitude and practices towards investing and portfolio company support: Financiers, Mentors and Portfolio Operators. Ranked in order of increasing level of operational involvement, the categories are as follows:
1. Financiers: “I’m a banker, not an operator.”
The Financiers are the most traditional group of venture investors. One said he viewed venture capitalists as “glorified commercial bankers.” Financiers believe that the most value added by a VC comes from carefully scrutinizing early stage companies, generating leads, conducting a thorough due diligence process and eventually investing the right amount of capital at the right valuation and structure.
Financiers are not completely detached from what is going on in their portfolio companies, but they tend to focus more on formal interaction. Examples include: VCs taking board seats, suggesting structures for board meetings and providing monthly reporting templates.
A prime example of a Financier is Correlation Ventures, which some have called the “Moneyball” of venture capital. Even though the firm’s two managing partners are both former entrepreneurs, they never take board seats and have only modest operational involvement. They gain access to investment opportunities by offering a very rapid investment decision (two weeks or less), with a very low-hassle process, leveraging their large investment in predictive analytics.
2. Mentors: “I try to be the CEO’s consigliere.”
Most VCs can be classed as Mentors. The most important asset Mentors bring to the table is their personal and professional network — for example, introductions to potential customers, suppliers, partners and executive-level employees.
What distinguishes Mentors from Portfolio Operators is that they deliberately choose not to institutionalize the support they give to their portfolio companies. With Mentors, support is almost always initiated by the entrepreneur and does not involve preset systems or processes. As one Mentor said, “My entrepreneurs have my cell and email address — and I always answer them.” As a result, Mentors assessing a new investment need to be comfortable that their input will be heard by the companies — that the CEO is coachable.
3. Portfolio Operators: “We have a structured, standard process for adding value.”
Whereas Mentors tend to be re-active in their support, Portfolio Operators proactively look for ways to improve the performance of their investments through systems and processes. We know of numerous instances in which companies took lower valuations to win Portfolio Operator VCs as investors because the entrepreneurs so valued the resources a Portfolio Operator could bring to bear. In other cases, entrepreneurs have offered board options or other sweeteners to highly attractive Portfolio Operator VCs.
The most common service Portfolio Operators offer to portfolio companies is recruiting assistance. Most VCs in this category not only provide personal references to interesting candidates, but they can also use their own websites as job boards for portfolio companies.
We find that Portfolio Operator VCs are building teams of employees that are unusually large for the VC industry and include many people with strong operational backgrounds.
These larger teams tend to be accompanied by a transition toward pyramidal organization, which is increasingly becoming the norm in Portfolio Operator funds. As Harvard Business School Professor Noam Wasserman writes, VCs have long been structured as “upside-down pyramids,” in which general partners outnumber more junior employees. This is attributable to the fact that VCs are “knowledge-intensive firms in which esoteric expertise predominates over standard knowledge.”
The need to exchange rich information in the course of pre-investment activities (for example, due diligence) serves as a disincentive to expand the firm beyond a certain size or adopt formal, pyramidal structures. Pyramids are, to a certain extent, an emergent property of large and/or complex organizations, in which workers become specialized and need to structure their interactions more. Although later-stage VCs have the luxury of concrete quantitative data, early stage VCs rely on more tentative information for which analysis cannot be easily delegated.
Post-investment activities such as operational support for portfolio companies, however, can be delegated and benefit from economies of scale. Pyramidal structures are the most efficient means of systematizing and delivering this support due to the benefits of leverage, delegation and specialization.
Trends Driving Change
We think that three trends are accelerating the transition to pyramidal models and operational focus.
- First, the cost of starting a company has come down dramatically, and as a result young entrepreneurs with modest capital and only angel/Series A investors can find themselves leading significant businesses beyond their management capacity.
- Second, the rate at which startups can scale has increased dramatically, so the judicious application of VC resources can have an exponential impact.
- Finally, we have moved to a more transparent world in which both VCs and entrepreneurs are easier to diligence. This puts pressure on VCs to differentiate themselves substantively.
The pyramidal model ultimately won out in other, more mature knowledge-intensive-industries, such as law and investment banking, and the same may occur in venture capital.
A prominent example of a Portfolio Operator VC is Andreessen Horowitz, which has raised $2.7 billion since it was founded in 2009 and has invested in Airbnb, Facebook, Skype, Twitter, Instagram, and many other highly successful startups. The firm gives portfolio companies structured support through one of four operational support teams, which are focused on executive recruiting, marketing/PR, technology and business development. The fund has seven partners and employs more than 40 operational staff, helping portfolio companies with preparing negotiations, making client introductions and providing preferred suppliers.
First Round Capital is another prominent example. First Round has seven partners, more than $400 million in assets under management and 22 full-time employees. It has a wide range of initiatives to support portfolio companies. For example, it organizes annual CEO, CFO and CTO summits in which executives of all portfolio companies in certain roles come together, as well as a related online community. Because of the internal, closed nature of the platform, it has become a trusted source for advice. (For example, “Our finances are out of control and we need a CFO yesterday. What should we do?”) First Round offers the portfolio free access to a “venture concierge,” a lightweight consulting and research service that helps entrepreneurs save time on research-related tasks.
Also on the Portfolio Operator list is Google Ventures, which has over 115 portfolio companies, makes 60 to 80 investments per year and invests north of $100 million per year. It leverages Google’s vast resources and has a dedicated 54-person team, including 10 partners. Google Ventures Partner Joe Kraus observed, “We believe helping companies plays more of a role than most people give it credit for.”
My firm, ff Venture Capital, pursues a similar strategy. It has made over 160 investments in over 60 companies since 1999. As of October 2011, the firm had $38 million in assets under management, and today has 16 full-time employees (including three general partners). We offer a broad suite of resources portfolio companies, including a job board, recruiting assistance and strategy consulting.
Given the economic constraints of the industry, how else can VCs systematically increase the odds of startup success? Let us know what you think.
About the authors:
This guest post was written by David Teten, Adham AbdelFattah, Koen Bremer, and Gyorgy Buslig. Teten is a partner at ff Venture Capital and founder and chair of Harvard Business School Alumni Angels of Greater New York in New York, NY. His email is email@example.com. AbdelFattah is the founder and CEO of CircleVibe, a mobile startup in the crowdsourcing space and a consultant on leave from McKinsey & Company in New York. His email firstname.lastname@example.org. Bremer is a consultant with the Boston Consulting Group in Amsterdam. His email is email@example.com. Buslig is a consultant with McKinsey & Co. in Budapest. His email is firstname.lastname@example.org.
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