Who Is The Venture Capitalist’s Customer?
Venture capitalists always talk to their portfolio companies about how important it is to define your customer, understand their needs, and create a compelling value proposition for them. Though, if you talk with enough VCs, we have a hard time defining the customer for our own business. I was having a recent discussion on this topic with some colleagues in the industry and no unified consensus emerged. It is always a debate between our limited partners (“LPs” – those who invest in VC funds) and entrepreneurs. We all know that we ultimately get “paid” by LPs. But, we also know we don’t survive if entrepreneurs don’t want to work with us. So, who is the venture capitalist’s customer?
To try and get some feedback, I decided to ask my twitter friends: Who is the VC’s customer? I specifically asked VCs to respond. Somewhat surprisingly, no VCs responded, but I got a slew of responses from entrepreneurs. They were quite aligned:
- apsinkus: “institutional investors are real customers of VCs (in my opinion). Entrepreneurs are merely suppliers. No LPs, no money.”
- brandonhaskins: “Although not one myself, a VC is ultimately in investment management, so customers are investors – entrepreneurs are products!”
- muhammadkassim: “VCs’ customers are investors into the fund. Entrepreneurs are VCs’ business partners.”
- gmsheehan: “their investors”
- AppStruck: “The VCs customers are the institutional investors you raise money from.”
- meetthestreet: “LPs…pension funds and endowments are clearly VC customers. In money management the people who give you money are your customers.”
- CameronHerold: “unfortunately for entrepreneurs the Investors are the VCs customers. The entrepreneur is the VCs product.”
- EdLoessi: “the VC’s customer are the people who gave them the money the tool is the company invested in and sometimes you break your tools!”
I’d say 85%+ of the respondents said the VC’s sole customer is the LP. Not a single responder said that the entrepreneur is the VC’s principal customer. So, in an unexpectedly round about way, I got my answer from entrepreneurs, not from VCs. If entrepreneurs are the VC’s customer, surely entrepreneurs would know that. Since they don’t know that – either VCs are doing a terrible job taking care of their customer (which is possible) or in fact the entrepreneur is not the end customer of the VC.
My personal belief is that the VC’s primary customer is the LP. There is a clear and constant relationship between VCs and our investors which is consistent with the traditional definition of a vendor/customer relationship – they pay us for providing a product/service to them. We have to provide a great product/service to our LPs and service them well as our customer or they can take their business elsewhere.
Then what are entrepreneurs to VCs? First of all, entrepreneurs should be no less important to VCs than LPs. Without LPs, VCs are out of business. Without entrepreneurs, VCs are out of business too. Entrepreneurs can take their capabilities elsewhere, same as LPs. So, while entrepreneurs and LPs are equal in importance, it is a different relationship. I do not have a vendor/customer relationship with the entrepreneurs I work with. In my mind, the entrepreneur is not the VC’s customer any more than the VC is the entrepreneur’s customer. Nor do I think describing entrepreneurs as the VC’s product or supplier is accurate. Neither of these lines of thinking fit for me as the right way to describe the relationship.
I think the best term to describe the relationship between VCs and entrepreneurs is partners. The official definition of partner is: “a person who shares or is associated with another in some common action or endeavor”. I view the entrepreneurs I work with as my partners. I think they view me as their partner as well. I am sure that any of my CEO’s will tell you the effort that I put in towards being a value-added partner to them. We partner together for the common end goal of building great companies and creating value for shareholders. So entrepreneurs are not customers, suppliers or products for VCs, they are partners. We work side-by-side as partners at the end of the day. I wouldn’t have it any other way.
College Optional
I have always believed that a great education is invaluable. The ability to learn new things, grasp new concepts and retain information are all important ingredients of success. But, how valuable is a college education – which is only one form of education? In the business world, I think a college education is extraordinarily nice to have, but not a must have. I’d certainly recommend that everyone get a college education, but if for some reason you can’t or you didn’t – perhaps your best bet is to go find a career in business.
Reinforcing that point of view is the sheer fact that there are many successful CEO’s that do not have college degrees. Some of these include but are not limited to:
- Richard Branson, CEO, Virgin Group
- Michael Dell, Founder and CEO, Dell
- Barry Diller, CEO, Interactive Corp
- Bill Gates, Founder and Chairman, Microsoft
- Paul Allen, Founder and Chairman, Vulcan Group
- Dean Kamen, Founder and Chairman, Segway
- Mark Zuckerberg, Founder and CEO, Facebook
You could say that they are outliers, and you would be completely right. They are outliers in their lack of formal education – but also outliers in the magnitude of their success. Even if you look at my portfolio of six emerging technology companies, two of the CEO’s do not have college degrees. And both of those companies are going gangbusters.
At the end of the day, I’m not sure that the traditional college educational process of reading a textbook, listening to a lecture, and then taking a test is a process that is often replicated in the real world of business. Sitting in a classroom listening to a teacher every day for four years in so many ways is exactly the opposite of what someone with an entrepreneurial DNA should want to do.
After seeing many talented executives come in without a college education, there seems to be a blueprint to succeed if you don’t have a college degree:
- Learn how to sell.
- Find a problem you’re passionate about solving.
- Be courageous and more willing to take risk.
- Make a lot of friends.
- Develop instincts by failing quickly.
And perhaps the most fundamental thing you need to learn to succeed in business whether you have a college education or not is to learn how to take $1.00 and turn it into $1.10 (without lying, cheating, stealing, swindling, etc.). I don’t mean that in a theoretical way. I mean literally, take a dollar bill out of your pocket right now, and figure out how to get someone to pay you $1.10 for it a week from now. Usually that means you take the $1.00, go buy some stuff, package it up in a value enhancing way, and see if you can sell the end result for $1.10 to someone other than your mom. If you can do that with $1.00, you’re off and running. The same principles that enable you to turn $1.00 into $1.10 are the ones that will apply for turning $100 million into $110 million. That ability is what some call business instincts – and instincts aren’t always learned in college.
Leave Something On The Table
One of the best lessons I learned early in my career about negotiation is simple: always leave something on the table for the other party.
To many, being a skilled negotiator means expertly and ruthlessly optimizing your self-interest. Negotiating is about winning, or even better, beating the other party. Satisfaction is knowing that you have left nothing on the table – you got everything the other party was willing to give and one more pound of flesh thereafter. You have squeezed out every last dime. I do not agree with this approach.
I think we all have to decide whether our primary objective is to win the negotiation or to win the relationship. You can choose to go through life leaving a trail of dust comprised of those you interact with – seeing people as transactional resources to be drained at every opportunity. Alternatively, you can go through life being fair and reasonable, not losing sight of the other party’s needs and appreciating that a good deal is one where both parties probably have given a little more than they wanted going in. Both parties have left something on the table because they value the relationship as much as anything else.
I really respect and prefer to work with those who adopt the latter approach. I would say that all of my portfolio company CEO’s are of this mold. They are people for whom a handshake still means something. There is some old fashioned sensibility about them which is a high compliment in my mind. They have the character to start off a negotiation with, “What’s important to you?” There is no front-end posturing because that’s not necessary among friends and colleagues. And they ultimately hope that as many people as possible become friends and colleagues over time.
I’d like to think that operating in this manner, while perhaps not necessarily optimizing every short-term economic matter, does enhance long-term fiduciary value. I guess it’s hard to know until you’ve seen a full body of work – but at least the ride will be an enjoyable one.
It’s Hard To Get The News From The News
This post may be a statement of the obvious, but it’s an observation I had this morning. As is typical, I skimmed the Kindle versions of The Boston Globe, The New York Times, and The Wall Street Journal on my subway ride to work. I thought it was very interesting how the three papers described the audience at President Obama’s town hall meeting in New Hampshire last night.
First up, The Boston Globe:
Obama’s audience at Portsmouth High School gymnasium was tame. The bleachers teemed with Obama supporters… The president wound up preaching to the choir, which applauded wildly at his calls for action on healthcare – at one point breaking into a chant of “Yes we can!”
Next up, The New York Times:
Unlike many of Mr. Obama’s town-hall-style meetings, usually filled to the rafters with supporters, Tuesday’s meeting included skeptics from whom he sought out questions. At one point he asked that only people who disagreed with his approach raise their hands to be called on. There were plenty who responded.
Finally, The Wall Street Journal:
Inside Portsmouth High School, Mr. Obama faced a friendly crowd, so much so that he sought out some tough questioners.
And just to round it out, I checked out Fox News once I got to work:
Obama faced no disruptions at his meeting, instead taking questions from supporters who soft-balled him opportunities to knock down criticism.
….and The Huffington Post:
The encounter was so friendly, in fact, that by the end Obama was even asking for skeptical questioners to come forward – to no avail.
After reading all five characterizations, I am inclined to think that The Huffington Post had the most accurate portrayal with the Wall Street Journal a distant second. The other sources seemed to emphasize parts of the interaction as perhaps unfairly representative of the whole.
This reminds me of a thought about what it means to be accurate in what you say. To portray a situation accurately, it’s not just about making factual statements – which I think all of these sources did to an extent. Accuracy involves more than isolated facts, but complete representation with – importantly – fair and proper emphasis. This is as true for representing the news in journalism as it is in representing the Bible from the pulpit or representing a company in a Board meeting.
Memorizing v. Understanding
I went to a Red Cross CPR training class last night and it brought up some more thoughts on educational philosophies. The methodology of teaching for the class was very much based on memorization. The entire class was taught in the following pattern: If X happens, then do Y. After you do Y, then do Z. After Z, check for A – if A exists, then do B. By the end of the class, after sufficient repetition, you pretty much had it drilled into your memory. But, interestingly, the teacher made a passing comment at the end that everyone would forget most of the training after a few months. Having taken the class before, I can attest to that fact.
It did occur to me on the way home that while we were taught the steps of administering CPR, we were never taught why we were doing the steps. It was never thoroughly explained to us why you give 2 rescue breaths when you don’t see signs of breathing. It was never really explained why you administer chest pumps in the first place let alone why you do it 30 times at a relatively fast rate. We were taught to memorize the steps, but we were not taught to understand why the steps are needed or effective. I really believe that had the latter happened, more people would remember the steps months later. To oversimplify, in my experience, memorization tends to more consistently deposit information in short-term memory, but understanding transfers that information into long-term memory.
In addition to recall, I think the utility of understanding something is generally superior to the utility of just memorizing something. For example, any undergraduate finance student has learned a basic equation like: revenues – cost of goods = gross margin. But, few seem to understand what gross margin tells you about a business. What does a high gross margin mean? What does a low gross margin mean? What does it say about a business when the gross margin is growing over time or declining over time? And to pay homage to the Internet bubble – what does a negative gross margin mean (many equity research analysts of that era seemed to forget this one too)? Understanding what gross margin means is a different plane of knowledge than just memorizing the equation to calculate it.
This is not a pure critique of memorization as an educational philosophy. I just don’t think memorization should be applied in such a way as to exclude or trump the teaching of understanding. Both working together are key components to building knowledge. With that said, I still highly recommend that people take a CPR training class because remembering anything from the class is better than not having any idea what to do. I doubt the victim you’re helping will really care if you understand what you’re doing as long as you memorized the right steps!
Don’t Teach Kids To Play Music, Teach Them To Love Music
My favorite part of the TEDx Boston event yesterday was the themelet on music. There were three musical performances all involving the younger generation topped off by the Youth Orchestra of the Americas (YOA) led by Benjamin Zander. I don’t think it’s humanly possible to love classical music more than Benjamin Zander – he’s infectious.
Benjamin Zander’s presentation of music made me think about my own personal musical journey. As a child, music came quite easily for me – both the piano and the violin. Once my parents saw that I had some proficiency in music, they sacrificed a lot of time and money to get me great teaching and equipment. I practiced a fair amount and learned to play a number of the great works by Beethoven, Bach, Mozart, Chopin, etc. And, at a young age, I even started competing. Despite my improving capabilities, there was one major flaw in the whole program. I never really fell in love with music – and that would ultimately be the limiting factor.
There was a brief moment in my short music career where I could have really fallen for music. For a few weeks, I got to take a break from classical music and had the chance to try my hand at jazz piano. What’s unique about jazz is in its truest form, it’s about improvisation. You don’t play jazz off of sheet music – it comes from within yourself. I learned that for me, playing the notes on a page of sheet music was not playing music at all. Ironically, it wasn’t until I threw away the notes, that I really started to feel like I was playing music. Playing other people’s music was all well and good, but I had the best time making my own. I always wondered if my brief flirtation with jazz had lasted longer, if I would have ultimately come to love music.
I have always carried a broader lesson with me from this experience: it’s one thing to be good at something – it’s entirely another thing to be good at something and to also love it. Anyone know a good jazz teacher?
Missionary CEOs v. Mercenary CEOs
I have always had an affinity for a particular “type” of CEO. I never really bothered to try and define this “type” – I just knew it when I saw it. Until last year, in an MFG.com board meeting, Jeff Bezos articulated the framework that captured my sentiments better than I could myself. He called it: “missionary CEOs v. mercenary CEOs”. If I had to oversimplify this framework I’d say that missionary CEOs are principally about the mission and mercenary CEOs are principally about the money. If you met the CEOs of my portfolio companies, you’d find one missionary after another. Watching Jeff Bezos’ recent video to Zappos reminded me of this nugget of wisdom and reminded me that Jeff is perhaps the perfect example of a missionary CEO.
Jeff’s wisdom notwithstanding, I do not believe that he coined this framework. After some research, I think he probably heard it from one of his venture investors – John Doerr of Kleiner Perkins who adapted it from The Monk and the Riddle, by Randy Comisar. Here is John Doerr speaking at Stanford in 2005 articulating how Kleiner views the difference between missionary CEOs and mercenary CEOs.
Over this past year, I have come to appreciate why you invest in missionary CEOs. Despite one of the most challenging economic times in a century, all of my CEOs exhibited incredible leadership, drive, and passion through thick and thin. In the darkest moments of this past year, they all demonstrated unwavering commitment and enthusiasm that carried their companies through. While I don’t know what the future holds for these companies or for the economy, I do know that I am very proud to be associated with each and every one of my CEOs. They are all great leaders and even better people – worthy of being called missionary CEOs.
[Another piece of wisdom from Jeff Bezos: How Can We Double Down?]
The Learning Test
I have found that there’s a simple test for whether you are learning in your career. Look back 3–5 years from today and ask yourself if you could have been substantially more effective at your past job in your present form. If you look back a few years and feel like in comparison to who you are today, you had little idea of what you were doing and would have done things a lot differently given what you now know, that’s a telltale sign of learning and growth.
I have been in the venture business 11 years now, and whenever I look back even a few years, I feel like I was pretty clueless. Now, it’s not to say that I was actually clueless (though perhaps some of my partners or CEOs would disagree!), but the differential is just a testament to the slope of the learning curve that takes place every day, month, and year in this business. I was sharing this with Mitch Free, founder and CEO, MFG.com, and he said that he feels that way in all the important things in life. After thinking about that, I have to agree.
I used to think that looking back and feeling like you’ve made so many mistakes is not such a great thing. Now I’ve come to believe that the thing to really be worried about is looking back a few years and being impressed with your past self. If that were to happen, it probably means your learning has stalled altogether.
Relative Value v. Absolute Value
I have been reading a book called Predictably Irrational by Dan Ariely which has raised some thoughts I’ve had for awhile about why human nature tends to define value on a relative basis rather than on an absolute basis. The first time I started thinking about this was when I would ask friends to pick which scenario they’d prefer:
- You make $80,000 in a world where everyone else makes $50,000.
- You make $90,000 in a world where everyone else makes $150,000.
Most people I asked that question to, after thinking about it, preferred scenario #1 despite making more absolute money in scenario #2. It shows that in this instance, they value relative wealth over absolute wealth. It’s clearly an imperfect example because it’s too theoretical, but it does start to uncover the issue at hand. Let’s take a more practical example – imagine you had to rate the “value” of the fish and chips on the following two menus:
- Fish and Chips: $15, Grilled Chicken: $7
- Grilled Chicken: $29, Fish and Chips: $15
My guess is if you conducted a study, the fish and chips on the second menu would be rated as a better value than the fish and chips on the first menu – despite the same absolute price. While not using this example, Predictably Irrational does leverage compelling studies that show that a highly effective technique to sell a given product at a given price is to put another product at a higher price right next to it. Again, this plays to our sense of relative value. Another example - imagine you had to rate the attractiveness of the second person in each scenario:
1.
2.
Somehow I think the results would show a higher rating for the middle picture in the second scenario than the first. In fact, Predictably Irrational talks (semi-seriously) about how if you’re going to a bar – the best advice they have to optimize your personal attractiveness is to make sure your wingman is slightly less attractive than you. OK, one more example, and then I will in fact relate this to the venture world and technology. This one is from the book – imagine you had to select in both cases whether you would make the drive:
- Drive 10 minutes to save $5 on a $15 pen.
- Drive 10 minutes to save $5 on a $500 suit.
Despite the same absolute economic savings and same cost (driving 10 minutes), a substantially higher percentage of people would make the drive in scenario 1 rather than scenario 2, because of its higher relative value. You get the drift.
OK, this dynamic does in fact play out in the venture world more often than one might expect. I’ve seen it in many different instances, but most classically during an acquisition process. Consider how supportive you would be of taking the deal in the following two scenarios:
- You have a $20M revenue software company. An acquirer comes along and offers you $20M and says you are worth 1x revenues. Then through your shrewd negotiating and creation of a bidding war, you’re able to walk up the price offered by that acquirer up to $100M. You have increased their offer by 5 times!
- You have a $20M revenue software company. An acquirer comes along and deems the company strategic and offers you $200M. But, then through the diligence process they uncover some issues and decide your company is “only” worth $100M – an insulting 50% less than their original offer.
In my experience, despite the same absolute value at the end, boards would more likely be celebrating in scenario 1 and angrily walking away in scenario 2. Why? Again, it’s all about the relative value against the starting bid.
While I’m not trying to make relative value seem irrational (because I don’t think it is) – it’s worthwhile to recognize how human nature can sometimes inappropriately define value exclusively on a relative basis to the neglect of all other reasoning. Perhaps we need to learn how to put aside our need to compare, and just be happy with what we’ve got. In an orthogonal way, this reminds me of a quote I heard years ago, “Being rich is not about how much you have (or how much more you have), but it’s about how content you are with what you have.”
Does It Occupy Your Shower Time?
For 3+ years now, I have had the continued pleasure of serving with two luminaries of the VC industry – Bob Kagle of Benchmark Capital and Jim Breyer of Accel Partners – on the Board of Directors of Prosper. Bob is most noted for having served on the boards of eBay and Ariba among many others. Jim is most noted for being on the boards of Facebook and Wal-Mart among many others. Both are great guys who have been as kind as they have been insightful throughout the Prosper experience.
A conversation yesterday reminded me of my first meeting with Bob Kagle just prior to our investment in Prosper. It was January 2006, and Bob happened to be in Boston for a ZipCar board meeting. We decided to have breakfast at the Nine Zero hotel which is right by Boston Common. As we got to know each other over the breakfast, I took the opportunity to ask Bob about his key learnings over what has been and continues to be a very successful venture career. What he said was rather simple. He said that he has learned over time to only invest in what he’s truly passionate about. In his own words, if a company does not occupy his “shower time” – i.e. he can’t stop thinking about it even if he’s in the shower – it’s not the company for him. When a company consumes his thoughts 24×7, that’s when he knows.
With each successive year in this business, I appreciate Bob’s lesson more and more. Earlier in my career, I would sometimes unconsciously support investments in companies that I had only fallen “in like” with. You know, it’s the good company, with the good market, with the good team, with good performance. It’s the good opportunity. I have learned that the odds of success aren’t great for those companies. One of the key disciplines in this business is learning to wait until you see the great one, where you have fallen “in love” with a company. The company that occupies your “shower time” and many other waking moments – those are the investments to make.
The other thing I appreciate about Bob’s lesson is that the shower represents alone time (no snide remarks please). In investments, there are two competing forces at work. You have to want as much quality information, advice, diligence, and external wisdom on a prospective investment as you possibly can get. You need to be relentless about turning over every source of information you can acquire and to listen to as many reputable voices as you can. And, then at some point the switch has to flip. You need to shut everyone else out, hear your own voice, and have complete conviction around that. At the end of the day, if you make decisions based on how other people think, there’s no constancy. Your true north can’t be the moving target of someone else’s point of view – it has to ultimately be informed by others but come from within yourself. And, if it takes a hot shower to figure that out – that’s time well spent.
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