One of the moments that stood out in Josh Kopelman’s PandoMonthly talk last week was his comparison of his seed fund First Round Capital to a baby nurse.
He was talking about how First Round’s partners only take board seats for two years — the time when they think they can most help a startup learn the basics of life, the way a baby nurse gets an infant on a good eating and sleeping schedule. Other VCs are more like babysitters, he said.
It was an analogy that seemed to resonate with a lot of the New York audience — I heard more than a few times it made people in attendance or watching the video wish they’d had First Round’s cash in the beginning. But I also got a few angry emails from people in the Silicon Valley venture community who found the comment patronizing and condescending towards entrepreneurs.
Culturally, the divergence was a great example of how entrepreneurs viscerally react to the concept of a venture capital firm’s “value add.” That’s bad news for VCs as “value add” is increasingly what the industry is competing on once again now that capital has flooded stages that were neglected six or more years ago. “We’ll give you value add” is a lot harder of a marketing message than “We’ll give you cash at a stage no one else will.”
Particularly given some raw memories of the marketing phrase.
Back in the late 1990s, when venture capital was just becoming a household term “value add” was one of those terms that VCs always used to describe what it was they did, and justify why they frequently made more than entrepreneurs when a company went public. In the best of cases, it referred to coaching, mentoring, making important introductions, and helping turbo charge a company’s growth.
VCs liked to say all of this was more valuable than the cash they offered, and indeed, at the peak of the bubble when cash was cheap and interchangeable, they needed a way to market against each other.
But the term “value add” became a tainted remembrance of an era of broken promises, along with “eyeballs” and “first to market.” It became code for meddling, grappling for control, ousting founders, or seeding the board with people more loyal to investors than entrepreneurs.
Starting in the mid-2000s, when the earliest VCs started to get interested in backing consumer Web companies again, the earliest ones celebrated the emerging cult of the founder by not taking board seats — or taking them but giving the founders a lot of latitude to stay in control of the company and call the shots. Founders were encouraged to stay in control of the company, and prestige was no longer how many industry vets you could stack your board with, but how few seats you had to dole out.
You saw companies like Facebook make it to relative maturity with just two board members other than Mark Zuckerberg, who had multiple seats. People openly said the best investors were those who gave you money and went away, waiting for you to call them. And many new VCs to the market exploited the mood to curry favor. Yuri Milner famously doesn’t meddle with companies and doesn’t want to be on the board. Many of the new seed and angel funds adopted a spray-and-pray investing discipline that meant they couldn’t “add value” to all their companies even if they wanted to.
Meanwhile, many traditional VCs stubbornly stuck to their roots, among them Benchmark and Sequoia who are probably the most traditional even of the big firms.
Well, here we are in 2013. There’s a bizarre market reality going on where public stocks have been demolished, but there are as many jobs in Silicon Valley as there were during the bubble and San Francisco rentals are at greater than 95 percent occupancy with rents again soaring. A lot of funding levels are glutted with capital, but it’s spread unevenly throughout the pipeline. Only now, the gluts are in different places than they were six to eight years ago.
Back then, there were two areas that were short on cash, representing huge opportunities. The first was the space between an angel deal and a series A. That gap has been more than filled by a raft of institutional seed funds, of which First Round was a pioneer. Not only that, but VCs increasingly started their own seed funds to compete.
It’s become so glutted with capital, in fact, that the shortage now is at the series A level — not because there will be fewer series A deals done this year. That’s a common misconception about the so-called “series A crunch.” In fact, there may well be more series As done in 2013 than there were in 2012. The point is there’s not enough firms that do Series A deals to give follow ons to even half of the companies that have been funded in angel and institutional seed rounds.
The other gaping hole was at the pre-IPO stages, as companies were putting off going public as long as possible. Milner was the first to spot this one, and again, many others flooded in to fill the vacuum including the then-struggling Elevation Capital, mutual funds, a handful of venture funds that raised mega-growth funds. As we first reported just last week, venerable hedge fund Coatue now has $1 billion to invest into this space too.
Suddenly it’s traditional VCs doing series As and Bs that are in short supply– mostly because the rest of the market is so flooded with capital by comparison. How are those seed investors competing with one another?
Part of it is saying who you shouldn’t take seed money from– let’s call that playing defense. Every independent seed fund will tell you it’s a risk to raise money from VCs because they’ll only continue to invest in a few deals and the negative signal if they don’t pick you can be devastating. Likewise, they’ll say it’s a risk to raise money from individual angels who don’t have the deeper institutional investor pockets of a micro-VC fund. In other words, seed funds are the porridge that’s just right.
When it comes to offense, increasingly, we’re back to value add. We got a good picture of how First Round is doing this last week. It’s using software to connect entrepreneurs and CTOs and developers with each other and the press, trying to leverage the collective wisdom across their portfolio more wisely.
Across later investing stages you have the agency model, as pioneered by Andreessen Horowitz. A whole army of professionals are there to help startups with their biggest problems. Legendary angel and Greylock partner Reid Hoffman recently penned a post that took one of the biggest whacks out of the cult of the founder, by arguing that sometimes a new CEO does need to be brought in and how to best do that. He argued that while it should be up to the founder, VCs can actually help here.
Little by little, investors are starting to humbly suggest that founders don’t have all the answers. Like little trial balloons carefully released in an ecosystem that’s still — amazingly– burned and suspicious.
Floodgate, too, is taking this approach with a renewed focus on “company building” within its portfolio. Like First Round, Floodgate launched six years ago or so with the same observation a lot of these seed funds had: It cost way less to build a company and startups needed a round between a $50,000 friend and family check and a $3 million series A. That was the hole.
Now, Maples, says the hole is that companies in this stage aren’t focused on building companies, they are focused on product and features. “This is going to be the role of the micro-fund in the future,” Maples says. “Five years ago we had to exist because of a funding gap in the market. In the next five years the micro fund will be responsible for how you put the seeds in place for the first twenty employees of a company to get on the right trajectory. Greylock and Andreessen Horowitz may have some awesome resources but if the company is already pathologically bad at twenty-five employees, that’s really painful to fix.”
This is at odds with another cultural hangover of the early, cautious Web 2.0 days where new startups were seen as iterative experiments. Throw something out there and see if it works. Don’t get too committed before you know. The result, says Maples, is that people have gotten focused on being lean and don’t talk about the importance of how to run a board meeting or set a company culture from the beginning. A product may take off, but now knowing what the company building it stands for limits the trajectory. Or worse: Entrepreneurs feel in over their heads and flip quickly for a small amount of cash.
“A lot of entrepreneurs– even great entrepreneurs– are not exposed to the specificity of how you define a culture,” Maples says. “Do you have a meritocracy? Are you going to have team based bonuses? Because you can’t have both. Don’t run around telling everyone you are a meritocracy if you don’t feel strongly enough about it for it to rule compensation. Building a culture is about more than just feel good statements. Are you a product centric company? An operational excellence company? Or a customer centric company? Do you value consensus or going with what the smartest person on a given topic thinks?”
Cultural decisions like these are defined not only around compensation and who startups hire early on, but who is on your board, how you run those meetings and how you do reviews and 1:1s. This all sounds very Dilberty to a lot of young founders with a raw idea. And in recent years the thinking has been these are things companies can get to later, once they know they have something.
Maples argues it can’t wait. Indeed, we’ve seen even successful companies like Twitter and Etsy get stalled because of deep internal issues and painful cultural resets. And those two are the exceptions. Hundreds of weaker ones die from those issues.
Never afraid to call it like he sees it, Maples calls out Groupon and Zynga as two such examples. “They never had the chance to create an enduring culture with their first twenty employees because they went for traction before anything else. They couldn’t realize their full potential as a result,” he says.
To address this, Floodgate is pulling in coaches like Bill Campbell to push even young entrepreneurs on these questions early on. It’s a far more analog way of adding value than what Kopelman is doing with First Round’s in-house Quora. But just as the two were early to spot a funding gap years ago; both have been early to spot a gap in substantial value add now. Maples feels confident in the differentiation. “Most of these angels are pretenders who can’t give you five pieces of advice on how to run a board meeting effectively,” he says. (Ouch.)
Expect more of this. It’s not for every entrepreneur– repeat ones who know the drill likely won’t need it. And that’s fine, say both Maples and Kopelman. But many first timers are lapping it up, thrilled there’s no longer an expectation they should have all the answers. And many of those raw first timers don’t have the same stigma against “value add” that we’ve seen over the past few years, particularly in younger ecosystems like New York and LA.
Although Maples cautions, it’s a fine line. If an entrepreneur wants too much hand-holding, it may be a sign they backed the wrong person. “The funny paradox of the venture business that most would never admit is that the more useless you are the more useful you are,” he says. “The board didn’t make Facebook happen. Kleiner Perkins didn’t make Google happen.” It’s a delicate dance: Good VCs don’t micromanage their companies, but good entrepreneurs don’t assume they know everything, Maples says.
As I wrote before, a lot of the very ways to add value that were championed in the late 1990s and subsequently abandoned have come back in different forms over the last year or so. Kleiner Perkins’ bubble idea of the Keiretsu isn’t too different in theory from First Round’s Quora-like network for entrepreneurs. But increasingly, it’s only old people like me who remember those days.
It’s a far messier, harder to quantify and potentially radioactive way to differentiate your firm than, “Hey, we’ll give money at a stage no one else will.” But at least it’s a way to differentiate yourself. In an industry everyone associates with Lemmings that’s a perennial challenge.