Thinking About Thinking

Why I Did Not Join Bain Capital

Posted in Pop Culture, Venture Capital by larrycheng on January 13, 2012

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 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.

When The Majority Is Wrong

Posted in Pop Culture, Venture Capital by larrycheng on November 21, 2011

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:

  1. High Group Cohesiveness
  2. Group Insulation
  3. Lack of Impartial Leadership
  4. Lack of Norms Requiring Methodological Procedures
  5. 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:

  1. 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.
  2. 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.

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Venture Capital (VC) Blog Directory – 2011 Edition

Posted in Technology, Venture Capital by larrycheng on January 19, 2011

This is the 4th edition of the Venture Capital Blog Directory (1st edition, 2nd edition, 3rd edition).  This directory includes 149 venture capital, microVC/seed, and growth equity blogs.  The imperfect statistic used to rank these blogs is their average monthly uniques in Q410 from Compete (more methodology info below).  Blogs that have seen increased traffic over Q409 by 1,000+ uniques/month are highlighted in bold.  There is an additional list below of VC blogs below that had insufficient Compete data.  To subscribe to the top 15 VC blogs through Google Reader, click here: Top 15 VC Blogs.  As always, if there is any information missing or incorrect, please leave it in the comment field.  Many thanks to my colleagues at Volition Capital for their assistance with this directory – we hope it’s a useful service for everyone.   

The Global VC Blog Directory (Q410 Avg. Monthly Uniques)  

  1. Paul Graham (@paulg), YCombinator, Essays (97,227)
  2. Fred Wilson (@fredwilson), Union Square Ventures, A VC (81,483)
  3. Mark Suster (@msuster), GRP Partners, Both Sides of the Table (53,655)
  4. Brad Feld (@bradfeld), Foundry Group, Feld Thoughts (38,821)
  5. Chris Dixon (@cdixon), Founder Collective, (20,988)
  6. David Skok (@bostonvc), Matrix Partners, For Entrepreneurs (14,173)
  7. Charlie O’Donnell (@ceonyc), First Round Capital, This is Going to be Big (13,970)
  8. Larry Cheng (@larryvc), Volition Capital, Thinking About Thinking (13,215)
  9. Dave McClure (@davemcclure), 500 Startups, Master of 500 Hats (11,127)
  10. Ben Horowitz (@bhorowitz), Andreesen Horowitz, Ben’s Blog (10,686)
  11. Jeremy Liew (@jeremysliew), Lightspeed Ventures Partners, LSVP (9,344)
  12. Bijan Sabet (@bijan), Spark Capital, Bijan Sabet (8,256)
  13. Ryan Spoon (@ryanspoon), Polaris Venture Partners, (7,828)
  14. Albert Wenger (@albertwenger), Union Square Ventures, Continuations (7,469)
  15. Roger Ehrenberg (@infoarbitrage), IA Capital Ventures, Information Arbitrage (7,182)
  16. Rob Go (@robgo), NextView Ventures, (6,934)
  17. Josh Kopelman (@joshk), First Round Capital, Redeye VC (6,778)
  18. David Cowan (@davidcowan), Bessemer Venture Partners, Who Has Time For This? (5,993)
  19. Mendelson/Feld (@foundrygroup), Foundry Group, Ask The VC (5,963)
  20. Bill Gurley (@bgurley), Benchmark Capital, Above The Crowd (5,428)
  21. Jeff Bussgang (@bussgang), Flybridge Capital Partners, Seeing Both Sides (5,223)
  22. David Hornik (@davidhornik), August Capital, VentureBlog (5,157)
  23. Seth Levine (@sether), Foundry Group, VC Adventure (4,858)
  24. Eric Friedman (@ericfriedman), Union Square Ventures, (4,706)
  25. Andrew Parker (@andrewparker), Union Square Ventures, The Gong Show (3,854)
  26. Mark Peter Davis(@markpeterdavis), DFJ Gotham Ventures, Venture Made Transparent (3,602)
  27. Lee Hower (@leehower), NextView Ventures, AgileVC (3,459)
  28. Christine Herron (@christine), Intel Capital, (2,484)
  29. Will Price, Hummer Winblad, Will Price (2,348)
  30. Jon Steinberg (@jonsteinberg), Polaris Venture Partners, Jon Steinberg (2,318)
  31. Jason Mendelson (@jasonmendelson), Foundry Group, Mendelson’s Musings (2,171)
  32. Marc Andreesen (@pmarcablog), Andressen Horowitz, (2,151)
  33. Jon O’Shaughnessy (@j_oshaughnessy), Dace Ventures, (2,095)
  34. Sarah Tavel (@sarahtavel), Bessemer Venture Partners, Adventurista (1,968)
  35. Ed Sim (@edsim), Dawntreader Ventures, Beyond VC (1,948)
  36. Mike Hirshland (@vcmike), Polaris Venture Partners, VC Mike’s Blog (1,910)
  37. Dan Rua (@danrua), Inflexion Partners, Florida Venture Blog (1,510)
  38. Rob Hayes (@robhayes), First Round Capital, Permanent Record (1,509)
  39. Matt McCall, DFJ Portage Venture Partners, VC Confidential (1,430)
  40. Mo Koyfman (@mokoyfman), Spark Capital, Mo Koyfman (1,422)
  41. Fred Destin (@fdestin), Atlas Venture, Fred Destin’s Blog (1,405)
  42. David Feinleib (@vcdave), Mohr Davidow Ventures, Tech, Startups, Capital, Ideas. (1,353)
  43. Rick Segal (@ricksegal), JLA Ventures, The Post Money Value (1,308)
  44. Alex Taussig (@ataussig), Highland Capital, Infinite to Venture (1,239)
  45. Christopher Allen (@christophera), Alacrity Ventures, Life With Alacrity (1,188)
  46. Nic Brisbourne (@brisbourne), Esprit Capital Partners, The Equity Kicker (994)
  47. Chris Fralic (@chrisfralic), First Round Capital, Nothing To Say (844)
  48. Ouriel Ohayon (@ourielohayon),, MYBLOG by Ouriel (799)
  49. Multiple Authors, Highway 12 Ventures, Highway 12 Ventures Group (780)
  50. Martin Tobias (@martingtobias), Ignition Partners, Deep Green Crystals (723)
  51. David B. Lerner (@davidblerner), Columbia Seed Fund, David B. Lerner (716)
  52. Baris Karadogan, ComVentures, From Istanbul to Sand Hill Road (615)
  53. Dan Grossman, Venrock Associates, A Venture Forth (614)
  54. Jason Caplain (@jcaplain), Southern Capitol Ventures, Southeast VC (599)
  55. David Aronoff (@dba), Flybridge Capital Partners, Diary of a Geek VC (539)
  56. Mike Speiser, SutterHill Ventures, Laserlike (490)
  57. Tomas Tunguz (@ttunguz), Redpoint Ventures, Ex Post Facto (441)
  58. David Beisel (@davidbeisel), NextView Ventures, GenuineVC (427)
  59. Eric Ver Ploeg (@everploeg), Metric Ventures, Pocket Watch (403)
  60. Allan Veeck (@aveeck), Pittsburgh Ventures, Pittsburgh Ventures (353)
  61. Ryan McIntyre (@ryan_mcintyre), Foundry Group, McInblog (314)
  62. Satya Patel (@satyap), Battery Ventures, Venture Generated Content (310)
  63. Saul Klein (@cape), Index Ventures, (306)
  64. John Ludwig (@jhludwig), Ignition Partners, A Little Ludwig Goes A Long Way (296)
  65. Pascal Levensohn (@plevensohn), Levensohn Venture Partners, pascalsview (251)
  66. Derek Pilling, Meritage Funds, Non-Linear VC (250)
  67. Kent Goldman (@kentgoldman), First Round Capital, The Cornice (217)
  68. Rob Finn (@robfinn), Edison Venture, Ventureblogalist (215)
  69. Rich Tong (@richtong), Ignition Partners, Tongfamily (190)
  70. Jeff Joseph (@venturepopulist), Prescient Capital Partners, Venture Populist (137)
  71. Chip Hazard (@chazard), Flybridge Capital Partners, Hazard Lights (131)
  72. Paul Fisher, Advent Venture Partners, The Coffee Shops of Mayfair (122) 
  73. Jason Ball (@jasonball), Qualcomm Ventures Europe, TechBytes (47)
  74. Ted Rogers (@vcbrazil), PPI Ventures, Venture Capital Brazil (35)
  75. Greg Foster, Chrysalis Ventures, SouthernVC (15)
  76. Michael Cichowski (@mcichows), Edison Venture Fund, Digital Goggles (14)

Other VC Blogs

This list includes other VC blogs that didn’t make the primary directory for one of the following reasons: (1) They don’t have any Q410 Compete data due to insufficient traffic, (2) There was insufficient data on the blog subdomain, or (3) They are a hybrid blog/corporate website meaning the actual blog traffic is hard to decipher.  They are in no particular order.

(Methodology:  We aggregated the unique visitors for each blog on for Oct-Dec 2010, and then divided by three to get a monthly unique traffic score.   If blogs only had data for one or two of the months, it was presumed that the missing months had no traffic and the aggregate number was still divided by three.)

The Small Fund Advantage

Posted in Growth Equity, Venture Capital by larrycheng on May 13, 2010

Silicon Valley Bank came out with a report today, called Dialing Down, that puts some data around the commonly held belief that better returns come from smaller funds.  In this case – conventional wisdom is clearly true.  Their fundamental conclusion is that venture capital funds are getting smaller – and that’s a good thing because it’s the small funds that generate outsized returns.  The most compelling statistic compared the returns of large funds versus small funds (large funds being defined as above the median size for their vintage year).  The result:

  • 2% of large funds returned 2.0x or better.
  • 48% of small funds returned 2.0x or better.

Volition Capital is committed to a small fund model precisely for this reason.  But, why is it more likely for a small fund to succeed?  I think there are a number of reasons – some more obvious than others.

1.  The law of large numbers. Take a typical large VC firm with a $750M fund that averages 20% ownership in each portfolio company.  For that fund to return a 3x, the portfolio has to be worth over $11 billion.  And that is before accounting for fees and carry.  A good fund is lucky to have one billion dollar company, but 11 of them?  Not likely.

2.  Small fund GPs are more aligned with their LPs. It’s pretty simple really: small fund GPs make their money from carry whereas large fund GPs make their money from fees.  Large fund GPs still want to generate carry, but they don’t have to in order to create wealth.  Small fund GPs need to make great investments to generate wealth.  Who do you think is more hungry and will work harder to find and make those great investments?

3.  Small funds are more focused. When you have a small fund, you can’t make every investment under the sun.  You can’t be a late stage & early stage & PE, tech & cleantech & healthcare, US & Europe & India & China… fund.  You don’t have a lot of capital to deploy so you get razor focused and develop the culture, methodologies, domain knowledge, and accountability – around a specific type of deal.  You get good at something – and that makes better returns more likely.

4.  Small fund GPs like each other more, probably. If you could start a firm, are there 10–15 people you would be willing to call “partner”?  Someone you’re willing to bet your career on, whom you trust implicitly, whom you don’t have to ask and you know they will do the right thing?  Are there even 10–15 people that you’d want to spend 50–70 hours per week with every week making joint decisions?  Unlikely.  Since large funds have grown their partnerships – the resulting 10–15 partners are more likely to just work together rather than be true partners at the core.  Small fund partnerships don’t have the pressure to grow the partnership making it easier to preserve the “partner” in partnership.

That all being said – there are some great larger funds out there and I’m fortunate to have worked at some of them.  As the stats show, 2% of large funds did well.  It’s harder, but it can be done.  But as the stats also show, your odds are much better with a small fund.

Why Growth Equity Is The Best Risk/Reward in Private Equity

Posted in Growth Equity, Venture Capital by larrycheng on April 17, 2010

There are really three general asset classes in private equity: buyouts, growth equity, and venture capital.  So why is growth equity the best risk/reward among the three in my estimation? 

1.  The downside protection of leveraged buyouts is exaggerated.  The lure is that LBO firms are buying highly profitable companies with consistent cash flows, levering up the balance sheet, and ultimately trading the business while covering the debt for multiples on its equity.  The challenge with the model is that the equity of the LBO firm is not the senior security on the cap table.  Clearly, the debt is senior.  Every LBO investment is a bad quarter away, a tripped covenant away, or a bad economic cycle away from being under water from an equity perspective.  That’s the reason so many LBOs of all different sizes and shapes have been written off completely during this down cycle.  As it turns out, despite the perceived safety in leveraged buyouts, in reality, there is little room for error.  The loss ratios in LBO portfolios are higher than one might think. 

2.  The upside potential of venture capital is exaggerated.  By venture capital, I mean traditional early stage venture capital.  Firstly, the large venture funds run into the law of large numbers – no matter how good you are, turning a good multiple on a large fund is hard especially when you have modest ownership levels in your portfolio.  Secondly, traditional venture models justify their investments based on upside scenarios (i.e. swinging for the fences).  The reality is the vast preponderance of venture-backed exits are at modest outcomes so often times the investment case is divorced from the reality of where exits tend to take place.  That’s why venture capital has become more dependent on bubbles to make the math work.  Thirdly, venture-backed companies often take multiple rounds of financing thereby diluting both the ownership and governance of the early investors.  Finally, venture investments are often done at the very early stages of a business’ lifecycle where the risks are high and little is proven.  It’s a high risk asset class with moderate reward potential at the fund level. 

3.  So, why is growth equity such a great risk/reward in comparison?  Growth equity doesn’t run into the problem that LBOs have being junior on the cap table to the debt.  These are mostly non-levered equity only investments thereby making sure the investment is senior on the cap table.  Growth equity investments are traditionally done in companies that haven’t taken prior institutional investment and don’t require future institutional investment.  Therefore, the problem traditional venture firms have of diluted ownership and governance generally does not apply.  In addition, growth investments are traditionally made at a point in time when strong financial growth is proven in the business – this removes much of the early stage concept risk.  Finally, growth equity investments are, to state the obvious, growth companies.  So, they have tremendous upside potential, but the investment case is not dependent on the upside scenario happening like is often the case in venture. 

There will be winners in all three asset classes for sure.  And for full disclosure, Volition Capital is building its franchise in growth equity.  Nonetheless, I’ve seen winners and losers in my career in all three asset classes, and in my opinion, the best risk-adjusted asset class of the bunch is growth equity. 

The Tension Between An Optimistic CEO And A Conservative CFO

Posted in Growth Equity, Organizations, Venture Capital by larrycheng on March 12, 2010

From what I can tell, in nearly every Volition portfolio company, the CEO is more optimistic than the CFO – and usually by a wide margin.  Certainly, part of this structure is by design.  But in reality, you just don’t find a lot of optimistic CFOs to hire, and a conservative CEO probably doesn’t inspire investment.  So, there is some self selection far before we get involved. 

But, there is a natural and necessary tension that exists when the CEO and CFO, with completely different risk orientations, have to report to a single board of directors. 

  • What if the CFO thinks the CEO is being way too optimistic on the budget?
  • What if the CEO thinks the CFO isn’t selling enough to get investors interested?
  • What if the Board is holding the CFO accountable for spending, but the CEO is pushing hard on the accelerator?
  • What if the CFO disagrees with the CEO in front of the Board, is that considered disloyal and a career limiting move?
  • What if the CFO drags down the energy inside the company by always focusing on the downside? 
  • What if the CEO’s financing plan presumes everything is going to go right, when the CFO doesn’t think that will take place?

These types of questions and dynamics take place in many of the companies we’re involved with.  There aren’t easy answers, but there are some principles involved to help make things work. 

1.  There has to be mutual respect between the CEO and CFO. 

Young companies need optimistic CEOs.  Every young company will have its dark days when you wonder if things will work.  Every young company has to believe it can defy the odds, and build something great from nothing.  Employees who work at young companies trade off cash compensation for equity – they only do this if they believe their equity is worth something.  Someone needs to inspire them with the vision of the company – with the upside.  In fact, in many ways, the optimism of the CEO for a young company is the spirit of the company.  It’s absolutely necessary.  You never do great things if you don’t believe you are great.   

Good businesses need conservative CFOs.  Optimism doesn’t meet payroll.  Optimism doesn’t make the financial covenants on debt.  Weak balance sheets aren’t made up by optimism.  Every company has a downside scenario, and someone needs to think about it to prevent it from happening.  Someone needs to point out the warts, so they can be fixed.  If great ideas don’t translate into numbers, then it’s a great idea that doesn’t work.  A CFOs conservatism is critical to a success of the business.  Good CEO/CFO combinations appreciate the different perspectives that are brought to the table.  Not only do they appreciate it, they insist on it.

2.  The CEO needs to support the CFO having a direct and structured line to the Board. 

It’s presumed that the CEO has a direct and regular line to the Board.  But, that does not negate the need for CFOs to have a structured channel to the Board.  Why?  The CFO has a unique and personal fiduciary obligation to the shareholders.  The CFO uniquely reports to the CEO and to the Board.  I often think of the CFO as the “CEO of the finances” – and to execute that responsibility, board access is necessary – and expected by the Board.  For some CEOs, they are comfortable with the CFO talking with the Board on an as-needed basis.  Certain CEOs find this threatening.  If that’s the case, a structured email or call, on a predetermined interval, is appropriate.  I often receive an email directly from the CFOs of my companies after the month-end to report financials.  This should be used to raise any issues worth noting.  The structure of it should give the CEO confidence that the CFO is not lurking behind his/her back talking to the Board, which is counterproductive.

3.  The CFO needs to be loyal to the CEO. 

Loyalty doesn’t mean agreement.  Loyalty doesn’t mean blindly following every course – e.g. a loyal friend doesn’t let their friend drive their car 100 mph off a cliff.  Loyalty, in this case, simply means openness and honesty in all circumstances.  Loyalty means always trying to make the company and the CEO successful. 

The dynamic between a CEO and CFO is a delicate balance between people often with very different DNA.  It’s a necessary balance that if managed well is often the basis for very successful companies.  I’d appreciate other ideas on how others have made this work as it’s clearly an art, not a science. 

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Single Unit Value Is More Important Than Growth

Posted in Growth Equity, Venture Capital by larrycheng on March 11, 2010

The pressure for revenue growth has hurt a lot of young companies.  It starts with an entrepreneur representing a growth story to an investor.  Then the investor represents the growth story to his firm to gain support for the investment.  And then the investment happens.  Then the company takes the investment, invests in sales and marketing, and the company grows.  Everyone is committed to growth, gets used to growth, and expects more growth in the future.

This is all well and good – if and only if – the single unit value is there, especially in mass market companies that service consumers or small/medium size businesses.  There are two aspects to single unit value: (1) single unit satisfaction and (2) single unit economics. 

Single Unit Satisfaction

The fundamental question is if you take a single customer, do they derive sufficient value from using your product or service? 

  • For a consumer social web service, maybe the key value measure is whether a user will tell two friends about it. 
  • For a SAAS company, the key value measure might be renewal. 
  • For a transactional company, the key value measure might be a repeat transaction rate. 

This is not intended to be rocket science.  Companies need to focus on a single customer, that is in their target market, and make sure they can deliver sufficient value to that customer to drive the right behaviors (referral, renewal, repeat usage).  It goes without saying, trying to build a great business on the backs of customers that don’t perceive sufficient value in your product or service is impossible. 

Single Unit Economics

The fundamental question now is if you now take that satisfied customer, can you make money based on your business model?  Companies need to fully burden the cost of servicing a single customer to understand single unit profitability.  This includes marketing, sales, cost of goods, capex, servicing, overhead, etc.  The question therein is whether that single satisfied customer is profitable given all that it costs to acquire and service them?

  • Many online video sites excelled at single unit satisfaction, but they got hammered on the economics because they didn’t generate enough ad revenue to cover  a single cost component such as bandwidth to deliver the videos. 
  • Some mass market companies that can cover sales and marketing costs, get caught up in the cost to service customers on the back-end.  The old local food delivery service, had this issue. 
  • Infrastructure oriented companies, like wireless service providers, that have up front capex to deploy new customers, need to be crystal clear on lifetime value of customers – to cover capex.  Otherwise growth is in fact detrimental.
  • It goes without saying that if your selling your product for less than what it costs you – some of the early online retailers like faced this.  You can’t make up negative gross margins with volume.

Sometimes the pressure for growth obscures the importance of single unit value.  In reality, there is no reason to invest for growth if the single unit value is not there.  It’s more prudent to wait, get customer satisfaction and economics nailed right, and then push for growth.  Pushing for growth prematurely at best will waste money unnecessarily, and at worst, will accelerate the demise of the company.  On the flip side, if the economics and value are there, rather than tiptoe forward on the growth plans, it’s prudent to invest aggressively for growth.  That’s when great companies are built, but it often requires patience in the early days. 

Independent Firms With Single Limited Partner Histories

Posted in Venture Capital by larrycheng on March 5, 2010

A breakfast conversation with Fred Wilson this morning prompted the thought of how many independent venture firms come directly or indirectly from firms that had a single or captive limited partner structure (one source of capital).  Just thinking out loud:

  • Union Square Ventures was formed by Fred Wilson and Brad Burnham.  Fred came from Flatiron which at the time was all J.P. Morgan money.  Brad came from AT&T Ventures which was all AT&T money.
  • Bessemer Venture Partners through most of its history was Phipps family money through Bessemer Trust.
  • Venrock was historically all Rockefeller family money.
  • Norwest Venture Partners was and may still be Wells Fargo money (not sure). 
  • Flybridge Venture Partners came from IDG Ventures previously captive to IDG.
  • Fairhaven used to be TD Fund which was captive to TD Banknorth.
  • Scale used to be BofA Ventures which was captive to Bank of America. 
  • And, of course, Volition Capital was formed by the U.S. team of Fidelity Ventures. 

I am sure there are many others if I just thought about it more.  I think if I continued to think about it – I’d probably be surprised at how many independent firms today have some roots in the single LP model, and I’d also probably be surprised at the consistent quality of the independent firms once they are formed.  We can only hope and expect that Volition will follow in the footsteps of some of these fine firms.  If there are others firms you know of, I’d be interested to hear about it. 

The Money Behind The Money

Posted in Growth Equity, Venture Capital by larrycheng on February 25, 2010

Where does the money come from that private equity (venture capital, growth equity and buyout) firms invest?  It might indirectly come from you.  Key constituents include the likes of government employees, employees of large corporations, trade organizations (e.g. teachers) and wealthy families.  Here’s the quick synopsis:

Wealthy Families / Foundations. The original investors in venture capital firms were wealthy families.  The Phipps family was behind Bessemer.  The Rockefeller family was behind Venrock.  These wealthy families often invest out of vehicles like family offices or foundations.  From those roots, many wealthy families have played impactful roles in backing some of the best names in private equity.  As the asset class has became more known and attractive, the sources of capital grew to include more institutional sources.  But, behind every institution are regular people.

Endowments. One of the most aggressive investors in venture capital has historically been school endowments.  When you make that annual class gift to your college, if you designate it for the endowment, some of your gift just might be put into various venture capital and buyout firms.  Typically, universities are charged to protect your endowment gift, so they invest it, and use the returns generated from the investment to fund various school initiatives.  Major universities like Harvard, Yale, Stanford, MIT, etc. have been big proponents of investing some of that endowment principal into private equity firms.

Pension Funds. Another prominent investor in venture capital has been corporate and public pension plans.  Pension plans (of the defined benefit variety) are just another type of retirement plan used by state governments, labor/trade unions, and large corporations.  As you work at a company or state government and thereby accrue pension benefits, the company or organization funds a pension account based on actuarial models tied to its potential pension payout obligations.  A portion of these funds are often allocated to the private equity asset class.  Major states investing in this asset class include New York, New Jersey, California, Oregon, etc.  Major corporations like AT&T, General Motors, etc. have also been active investors.

Fund of Funds. Many foundations, endowments, and pension funds lack the capacity or resources to evaluate and monitor different private equity firms.  Hence, the fund of funds industry has sprung up to pool capital from these sources into funds and then invest on their behalf.  Unlike the other sources of capital, fund of funds have to raise their capital from third party sources, just like the firms that they invest in.

So, if you follow the money through, your child’s college financial aid package or your pension plan – might be tied to a couple engineers working on some project in Silicon Valley or tied to the big buyout you read about in the Wall Street Journal.

If A Board Meeting Was Like The State Of The Union

Posted in Venture Capital by larrycheng on January 28, 2010

The CEO would make his way to the board room through a processional in the company’s hallways, flanked by clapping employees, shaking hands and giving thumbs up to the staff along the way.

The meeting would start with the CFO announcing the entrance of the CEO, and all board members standing and applauding.

The CEO would stand at the head of the table, with the CFO and CTO sitting in oversized chairs on a raised platform behind him.

All powerpoint slides and the projector would be replaced with a teleprompter.

When the CEO talked about cutting spending, lowering the burn and a hiring freeze, investors on both sides of the table would stand up and applause.

When the CEO talked about changing the healthcare plan to cover all employees and shareholders, the investors on the left side of the table would stand up and applaud while the other investors sit stoicly.

Thereafter, the CEO would have to remind all investors that their job is to represent the shareholders, not their own partisan interests.

Rather than talking during the meeting, the CTO and CFO would convey their opinion by smirking, giggling, and giving standing ovations as the CEO spoke.

Meanwhile, outside legal counsel, sitting in the first row facing the CEO, would never applaud and would be generally expressionless throughout.

At the appropriate time, the CEO would give a carefully calculated shout out to his wife who is sitting at the outer edge of the board room next to some carefully selected key partners and customers.  She waves at the mention of her name.

The CEO closes the meeting by saying God Bless this company.