The unit of measurement in the venture capital industry has long been the “fund”. A fund is typically a discrete pool of capital that a firm raises around a particular strategy, and then deploys by investing into companies aligned with that strategy. The fund has had longstanding significance in the venture industry because it’s how returns are calculated. LPs calculate their returns based on multiples and IRRs of the fund. GPs calculate their carried interest based on how the fund performs. And research firms like Cambridge Associates have been built around comparing the relative performance of various funds.
But, the utility of the fund as the metric of measurement for the venture capital industry relies on a fundamental assumption which is slowly, but increasingly not true. That assumption is simply this: that you can invest in that fund, and only that fund.
Let me elaborate. There have been two parallel trends in the venture capital industry that are eroding the utility of the fund as the unit of measurement in the industry. The first trend is that LPs increasingly are consolidating their positions around the branded venture capital firms. More dollars are flowing to fewer firms. Prior to and in parallel to that trend, the branded venture firms are creating a menu of different types of funds with distinct strategies with which to deploy that capital.
Ten years ago, venture capital firms were making new investments out of one fund at a time. Now it is not uncommon for the largest firms to have their seed fund, their early stage fund, their growth fund, their China fund, their India fund, their specialty fund [mobile, data, etc.], and on and on. Here is the key point: some of these firms will not allow LPs to select the fund that most interests them and invest in that fund on a discrete basis. They force a broader asset allocation into multiple fund vehicles in order to invest with that firm.
The logic works in one of two ways. Sometimes the GP will hold out the most attractive fund – the fund that every investor wants to get into – and stipulate that in order to get into that fund, the LP must invest in their other funds as well. Other times, the GP will say that the LP isn’t investing into a “fund”, rather they are investing in a “franchise”. This means they allocate capital to the firm, and the firm may decide the relative allocations to the various funds. It’s another approach to the same end result.
How does this all net out? It simply means that fund-level returns aren’t always relevant because LPs never had the opportunity to invest in that fund discretely. If LPs had to invest in a basket of funds to invest with that firm, then the true unit of measurement of returns is the basket, not an individual fund. But, it’s impossible to know how these baskets take shape so the individual fund persists as the unit of measurement, despite its increasing irrelevance with a number of the largest and most branded funds in the industry which may slowly but surely portend a broader trend for the overall industry as well.
Coming out of college, without even really knowing what they do, my dream job was to one day work at Bain Capital. Their reputation was that they took the very best of the young investment bankers and management consultants a couple of years after college. Since I was headed into the management consulting world after school, I always kept in the back of my mind that maybe I’d have the chance to work at Bain Capital one day. Having grown up in the 80′s, I viewed Bain Capital as the “Top Gun” of investment world. It’s where the best of the best went.
Nearly a couple of years into my management consulting experience, I called up a friend at Bain Capital. I said what much more informed candidates today would never say, “I am very interested in venture capital and wonder if there are any opportunities at Bain Capital.” That statement is the equivalent of looking for a job at an ice cream store because you like frozen yogurt. My friend politely informed me that Bain Capital was not a venture capital firm (at that time), rather they were a leveraged buyout (LBO) firm. Not knowing the difference, and considering they still wanted to interview me, I went along for the ride. For the next few months, I went to several interviews at Bain Capital’s pristine offices in a downtown Boston skyscraper. I started to learn about what LBO firms do. I was impressed.
At around the same time, I randomly saw a job posting on a website called CapitalVenture.com about a role at Bessemer Venture Partners. I had never heard of Bessemer, but they said they were the oldest venture capital (VC) firm in the country. That sounded good to me. I decided to apply and for the subsequent few months, I went to several interviews at Bessemer’s “office” in Wellesley, MA. Their office was a converted two story home. I am pretty sure I interviewed in what would have been the guest bedroom, the master bedroom, the library, the kitchen, and the kids’ rooms. Nearly every step I took in that office, the floors creaked because the house was old. It was no Bain Capital in appearance. But, I started to learn about what VC firms do. I was also impressed.
I came to appreciate that Bain Capital and Bessemer Venture Partners had commonalities and differences. These traits would be true more generically of any LBO firm relative to any VC firm. Their commonalities were clear: they both invest in businesses, help shepherd businesses, and ultimately aim to generate good financial returns for their investors and the other shareholders of these businesses. Their differences came in how they generated financial returns.
Bessemer, as a proxy for the VC industry, did well on investments if those companies grew, and grew aggressively. They bet on being right on trends, technology leadership, and new markets emerging. Bessemer pushed me hard on my risk tolerance during the interview process. Bain Capital, as a proxy for the LBO industry, principally relied on sound financial engineering to generate returns. They emphasized things like terms on debt, balance sheet structuring, and predictability of cash flow. They pushed me hard on my quantitative and modeling skills throughout the interview process. I came to appreciate that the VC and LBO worlds were two very different worlds.
The question the political world is grappling with this week is whether Bain Capital created jobs during Mitt Romney’s tenure. I hope that through that discourse, the difference between VC and LBO firms comes out. I am convinced that successful venture capital firms create jobs as a byproduct of their investment practice. The companies VC firms invest in have to grow to be successful, and a byproduct of growth is jobs. I also believe that while LBO firms don’t have to create jobs to have a successful investment, the great ones like Bain Capital probably have done so in meaningful ways over the long run. I don’t have any numbers, but that’s my belief.
What I am sure of for both firms is that they have been successful over long periods of time because they have generated good returns for their investors. In Bain Capital’s case, their investors probably include many state pension funds, corporate pension funds, university endowments, sovereign wealth funds, and insurance companies. It would not shock me at all if a surprising number of the readers of this blog have at least someone in their extended family who has benefited in some way from indirectly (and probably unknowingly) investing in a Bain Capital fund or working at a Bain Capital company. That value can not be under emphasized when it comes to understanding the contributions of any investment firm.
Back to my personal story. I remember the day that I turned down the offer from Bain Capital. I called the same friend and said with surprise in my own voice, “I feel like I’m turning down my dream job, but I’ve decided to go to Bessemer.” When people asked me how I could possibly turn down Bain Capital, I told them the truth. Working at Bessemer and doing venture capital investments just sounded like more fun to me. What could be more fun than coming to work every day and investing in companies that are trying to change the world in some way? And, with that call 14 years ago, I started my venture capital career. I certainly respect the work of LBO firms like Bain Capital, but have had such a great time in the venture capital world. The last 14 years have absolutely flown by. I guess time flies when you’re having fun.
Your company just went public and the lock-up period is over. Your company got acquired and your share of the proceeds just hit the bank account. (Or, you’re wealth managers from Greenwich, CT, and you just won the lottery.) For some fortunate folks, any one of these events can lead to a sudden influx of sometimes substantial wealth. What you’ve been thinking of as paper wealth for months and years, is now real. So, what do you do? This question was posed to me recently, and I thought I’d share my thoughts as I’ve seen this scenario play out for many individuals through the years.
My general guidance is pretty simple: Try not doing much of anything different for one year. Stick the money in your bank in some cash-like instrument and forget about it for a year.
Some ideas of things not to do in that first year:
- Go on a shopping spree and buy new cars, homes, planes, gadgets, clothes, etc.
- Give the money to any number of money managers calling you offering their assistance to “manage” the money.
- Get into financial arrangements with family and friends.
- Quit your job because you’re rich.
- Hire personal staff.
- Buy a country club membership.
- Change how you travel or vacation.
- Become an angel investor.
- Go to Vegas.
- Change your friends or social circle.
The point of raising these items is not to make an implicit value judgment on any of them. What I do think is valuable, though, is letting there be some breathing room from the time your new found wealth hits your account, and the time you start engaging with it. Any number of these items you can still pursue just the same one year later if it’s still important to you.
What’s the value of the year “waiting period”? You remove yourself from the pressures, expectations, and emotions of the moment. That dynamic can often lead down a road where wealth is lost, relationships are injured, and a positive experience turns into a bad one. So many bad decisions are made in that first year when you and your wealth are most vulnerable due to the confluence of so many factors. There’s a reason so many lottery winners end up unhappy. There’s a reason professional athletes end up bankrupt at alarming rates. While accruing wealth from a successful start-up is a different process than winning the lottery or being an athlete – some of the pressures and dynamics of sudden wealth remain the same and unfortunately some of the end results are the same as well.
A few important caveats. I’m not making a suggestion on whether you should sell your stock if that’s the currency of your wealth. That’s a personal decision and perhaps a topic for another post. But, whether you choose to sell your stock or hold on, these suggestions remain largely the same. Additionally, two things I’d consider doing in that first year, if it didn’t open the floodgates on items listed above, are: (1) pay down debt and (2) give to charity.
Is this incredibly boring advice? Yes, guilty as charged. Is it unnecessarily ascetic? It definitely comes off that way, but I’m hardly an ascetic person. I just view pursuing such a path as a lot of upside and no downside, while doing the reverse is a lot of downside without much upside. What you do in that first year of having new wealth may ultimately be the most important investment decision you make.
Despite the fact that often times the majority rules, that doesn’t mean the majority is right.
The most poignant example comes from a premier venture capital firm I once worked for. One of the opportunities they gave their investment professionals was the opportunity to invest personally and on a discretionary basis in each round of each financing the firm participated in. You didn’t have to invest, or you could “max out”, or you could do anything in between. There was a maximum amount you could put into each round based on your level in the firm.
Most interestingly, after each financing round closed, they would publish to the entire investment team how much each person invested for their discretionary investment in that round. There is no better way to tell how a person feels about an investment than to see the size of their personal check. It was the most honest moment of the entire investment discussion. There were certainly cases when everyone in the firm maxed out their personal investment (e.g. the “max out scenario”). And, there was a similar frequency of cases when nearly everyone didn’t participate except the individual partner sponsoring the deal (e.g. the “zero out” scenario). These decisions were always made after individuals would talk to each other behind the scenes to discuss how much they were going to put into each investment – they were rarely made in isolation.
What I learned from watching these personal investment decisions made over and over again was somewhat surprising. A great predictor of failure for an investment was when the max out scenario took place. If everyone loved a deal and backed up the truck on their personal investment, it was more than likely to not succeed. In fact, those deals often failed in quick fashion. The inverse was surprisingly true as well. More often than not, for those investments where the zero out scenario took place, they often became successes – sometimes the biggest successes. At the other firms I have worked at, various forms of this experiment have taken place and this observation holds true through different economic times, different investments, and different firms.
Why? How can it be that when a group of intelligent, seasoned investment professionals agree – they are often wrong? The answer is simple: investment partnerships are the perfect breeding ground for groupthink. Groupthink according to Wikipedia is: “a psychological phenomenon that occurs within groups of people…. Group members try to minimize conflict and reach a consensus decision without critical evaluation of alternative ideas and viewpoints.” There are important cases in history where groupthink played a material role such as in Pearl Harbor and the Bay of Pigs.
The reason venture partnerships foster groupthink is best articulated by Irving Janis, a pre-eminent researcher on groupthink. He suggests that certain contextual ingredients make groupthink more likely including:
- High Group Cohesiveness
- Group Insulation
- Lack of Impartial Leadership
- Lack of Norms Requiring Methodological Procedures
- Homogeneity of Members’ Social Background and Ideology
Venture partnerships are often cohesive, insulated, and homogeneous groups – a perfect breeding ground for groupthink.
How do you protect against groupthink? I think you simply ask yourself two questions trying to be as impartial as possible:
- Ask yourself – could the dissenting opinion be right? Listen to and fully understand the point of view of the person expressing a dissenting opinion, especially if that person is the sole voice in the room. Fully consider their point of view as it may very well be the right one. Give it weight in your mind.
- Ask yourself – could your majority opinion be wrong? Have you arrived at your opinion without sufficient critical analysis? Are you basing your position on assumptions that you presume to be true, but that perhaps are not sufficiently tested or researched? Be humble, don’t think too highly of your own point of view.
Until you’ve understood how your majority opinion could be wrong, you should strongly question whether your opinion is right. Until you’ve understood how a dissenting opinion could be right, you should strongly question whether it is wrong. A great and simple test is whether you can argue both the majority and dissenting opinion well – irrespective of which one you hold.
The best venture partnerships understand this dynamic and take it into account in their decision-making. One firm I used to work at mandated a dissenting partner on all deals. Another firm always allowed for a single champion to carry a deal through rather than requiring partnership consensus. While groupthink may ultimately exist within the partnership model, it doesn’t have to be nor should partnerships let it be the deciding factor at the end of the day.
Given Volition’s focus on bootstrapped high growth technology companies, we meet company founders every week that have built amazing companies with very little resources. It never gets old hearing stories of how founders put companies on their backs and will them to survive and succeed.
Yet, in the process of meeting with founders week-in and week-out, I have begun to notice that with some regularity, certain founders refer to their company as “I”. Often, I will hear phrases like, “I will reach $20M of revenue,” or “I will grow 100% next year and hit breakeven,” or “I will have the best technology platform in the market.” On the face of it, it might seem objectionable to refer to the collective efforts of many people in a company with a first person, singular pronoun. Yet, candidly, I don’t entirely begrudge the practice, but it also reflects a company that is still in the process of maturing.
I don’t begrudge it because there was a point in time when the company was quite literally just the founder. If anything was going to get done, the founder was going to do it. Even in the early days of a company where there are other employees, it’s not uncommon to have the founder be the senior person for every functional aspect of the business. The founder is both the head of sales and by default the top salesperson. The founder is the product visionary, product developer, and only QA person. The founder is effectively the chief financial officer and the chief financier of the company. And, of course the founder is the energy and spirit of the company. I don’t begrudge use of the term “I” to refer to the company because for many of these companies, without the founder, there would be no company.
But, it also refers to a company that has some maturing to do. Even if a founder is seemingly indispensable to a company – like Steve Jobs, Jeff Bezos, or Sergey Brin – a company must grow to the point where the center of the company isn’t the founder, but the center of the company is in fact the company itself, and its mission for its customers. Ironically, the person best positioned to help drive this transition in a company is the founder.
Some founders adopt a mentality to keep things comfortable for themselves – the strategy, people, and practices of the company stay within the comfort zone of the founder. The founder structurally builds a company where they are at the center and in many ways the company exists not only because of the founder, but to serve the founder as well. Other founders aim to build something bigger than themselves. The company is not defined by their own comfort zone, but by the vision of what the company can achieve. The company exists not for any single individual, but for its greater mission and purpose. The company transitions from an “I” to a “we”. This can be an uncomfortable process for some founders, but often times it’s a necessary one in order for the company to reach its fullest potential.
I have immeasurable respect for founders. Day-in and day-out, I’m rooting for the founders of companies that we invest in and even the founders of companies that we don’t invest in. There are many people that work at a company, but only one founder or founding team. It’s a special and unchangeable position. But, for companies to truly succeed, they can’t just be about the founder. They need to be about something more. And, that’s perhaps a goal all founders can aspire towards.
This is only one data point but I thought it was interesting. About a month ago, my wife launched a website called Activity Yard. It’s a website community where parents rate and review activities for their kids. The URL was submitted to Google and Bing on the same day in August. Out of sheer curiosity, I started to check the rate at which the two search engines spidered the site. Fast forward about 4 weeks, and the results are interesting – Google spidered 3,000 times more pages than Bing.
You can see in this image – Google has spidered “about 12,000″ pages on a site search of Activity Yard.
Now, here’s Bing’s result taken on exactly the same day (today). It only registers “4 results” for the same site search of Activity Yard. It would have almost been better if Bing’s result was at 0. Again, only one data point, but if this data point is directionally correct – Bing’s not even in the same galaxy as Google when it comes to spidering pace.
Historically, the measure of success in the venture business has been consistent top quartile performance at the fund level. Each firm generally compares their fund level performance to funds that started the same year or vintage, and if they beat the top quartile threshold put out by Cambridge Associates, they feel good about their performance. This got me thinking about whether being top quartile in other avenues of life would even be considered as “good” as we generally do in the VC/PE business. Here’s a little sampling:
From professional sports
- Major League Baseball Batting Average: There are 750 MLB baseball players making the top quartile threshold 188. That batter is Alfonso Soriano with the Chicago Cubs with an inconspicuous batting average of .270.
- NBA Scoring: There are 452 NBA players making the top quartile threshold 113. That player is Jordan Crawford of the Washington Wizards who averaged a respectable 11.7 points per game.
- U.S. State Populations: There are 50 U.S. states, with the top quartile spot being the state of Washington with 6.7 million people (with the top spot being California at 37 million).
- Country Nominal GDP: There are 181 countries listed in Wikipedia with the top quartile threshold occupied by Czech Republic with $192 billion (with the top spot being the US at $14 trillion).
With increasing frequency, I hear about people in the Boston community going to work at CSN Stores. This is the mega furniture and home goods e-commerce company that everybody likes to describe as “the biggest e-commerce company you’ve never heard of” – even though now I think everyone’s heard about them. It used to be once every 6 months, I’d come across someone joining the Boston-based company. But, over the past 2 years, it’s increased to about once every 3-4 weeks.
Interestingly, there are some common characteristics of the people joining CSN Stores. They are young, bright, well-educated – and perhaps most conspicuously, they have no e-commerce experience (how could they being in Boston?). And, that’s why CSN Stores could be transformative for this town. You have former private equity professionals, recent college grads, rising stars in corporate america, and other walks of life all going to CSN Stores to learn the nitty gritty of building an e-commerce business from a company that is succeeding to the tune of $380M of revenue growing 56% per year.
In the same way DoubleClick taught a generation of New Yorkers about online advertising and fundamentally transformed the start-up community in that region, CSN Stores could teach a generation of Bostonians about e-commerce. I say “could” because the story of CSN Stores is still being written. If CSN Stores stays independent, goes public, and grows from ~1,000 employees to 10,000+ employees. I fully expect that 5-10 years from now, the legacy of CSN Stores will be a vibrant community of next-generation e-commerce companies started by CSN alumni. And, that’s exactly what Boston needs.
I had the privilege of spending this afternoon with the founder of a very promising educational software company. I was intrigued with the background of the founder as it’s not every day that I run into entrepreneurs with an accomplished and extensive background in child psychology.
Given his expertise, I couldn’t resist asking the following question: “If you could snap your fingers, and have all the parents in the world do one thing differently for the betterment of all humanity, what would it be?” After a short pause, his response was: “Catch your kids doing good.”
I asked what he meant by that phrase. His response was simply to praise children when they do things that are good. Apparently parents are quick to give negative feedback to children when they do something wrong, but the more impactful and beneficial approach is to give positive feedback when our children do something good.
I thought that was a pretty profound answer from an individual who has spent his life’s work understanding and helping children.
I believe this could be a true statement by the end of 2011 if it was Groupon’s intent to do so (which it may not be).
It’s very simple math. Many industry sources put the number of Groupon sales reps at 3,000+. The high end of the range is 4,000.
A typical rep using an auto-dialer will probably call 250–300 companies a day. You have to use an auto-dialer to get those kinds of numbers, which I have to presume Groupon uses.
Usually of those calls, the rep connects with a live person 40–50 times per day. Most of the calls result in a short conversation leading to a hang-up, but that’s the life of an inside sales rep.
Figure that there are 225 business days in a year when you subtract out weekends and holidays.
So the math is: 3,000 reps x 40 connects/day x 225 business days = 27 million businesses called.
According to business databases like Cortera and the US Census, there are about 27 million business establishments in the United States. This is a generous number as only about 7.4 million businesses have payroll – but either way you look at it Groupon could very well call every company in the US this year, if they wanted to.