I have been having this discussion with a few people whose analysis of the venture capital industry I respect. The exercise is not just to assess who are the top investors, but more, to assess where the industry is going, and where the next generation of venture scale companies are going to come from. In this post, I will provide a framework for the discussion. Please weigh in with your thoughts.
Let’s start with a few over-riding trends:
Now, let’s look at what it takes to run a successful venture firm (once you have raised a fund). You need to do five things:
Visibility and Brand
One trend we see in the market today is that venture firms are marketing themselves aggressively, primarily to aid in (1) and (3). This actually began a long time back. Kleiner Perkins, with its high profile partners John Doerr and Vinod Khosla, was always marketing themselves heavily. That, coupled with strong bets like Netscape, Amazon, Google, and many others, they established themselves as one of the top ‘brands’ in the Valley’s VC landscape. Today, however, this positioning has eroded. The current top runner on the ‘brand’ front is Andreessen-Horowitz (a16z), run by former entrepreneurs Marc Andreessen and Ben Horowitz.
Early on, a16z hired PR maven Margit Wennmachers, founder of Outcast, a top agency, as a partner. Presumably, this was not for Margit’s prowess in choosing investments or negotiating deals. It was to establish a16z as a top brand. And, to leverage her expertise across the a16z portfolio to help the entrepreneurs they back get high levels of exposure in the media.
Both objectives have been met abundantly. Today, a16z is the No. 1 venture capital brand in the Valley. You will find many of the hottest companies in the business in their portfolio. The brand of the firm has reinforced the portfolio companies, and vice versa. The net effect is a snowball.
So, a16z is now able to execute on (1), (3), and (4) very well. Entrepreneurs need visibility, a16z can get it for them. Hence, they seek the firm out, and the firm delivers.
Other firms who have both strong brands themselves, and the ability to help their portfolios gain visibility are Sequoia, Benchmark, Accel, Greylock, and True Ventures. Sequoia and Benchmark are long time big brands in the VC business with strong track records, and the media pays attention to them. Accel too is a long term brand, and they have also reinforced that with investments in media properties like Pando Daily. True Ventures, a relative newcomer, has this leverage due to their close relationship with GigaOm, a key voice in the tech industry. Greylock leverages the celebrity status of Reid Hoffman, founder of LinkedIn, now a GP at the firm.
Many of the VCs at these firms blog themselves, btw. Bill Gurley (Benchmark), Chris Dixon (a16z), Ben Horowitz (a16z), Marc Andreessen (a16z) – all blog, tweet, and engage heavily with the startup community. Another couple of VC bloggers with some success are First Round Capital and Union Square Ventures.
An interesting conclusion you could draw from the discussion so far is that to run a successful VC firm today, you need to either have a tie-in with a media property with a large following, or establish a blog of your own with a strong readership. Dave Hornik at August Capital was the first to champion blogging among VCs a long time back.
From an entrepreneur’s point of view, the ideal VC firm to select (if you have the choice, that is), would be one that can help you get tons of leverage in establishing your own brand. Most top-tier VCs will bring you some of this leverage, btw. Bootstrapped companies suffer a distinct disadvantage over funded companies because the media largely covers funding announcements and news from funded startups.
Then come the more complicated aspects of venture capital: what do you invest in, how much, at what stage, what valuation?
On this subject, one of the clearest investment thesis I have ever seen is from Emergence Capital. The firm was unknown and started during the downturn after the dot com crash. I did a comprehensive interview with Brain Jacobs, one of the firm’s founders, in 2008, that traces their founding thought process. At a time when SaaS was unknown as a category, Emergence decided to bet on it. The bet worked. They became one of the top SaaS / Cloud domain experts, and boast a fabulous portfolio, including solid exits like SuccessFactors, Yammer, and Veeva.
Emergence is also very clear in terms of stage: they want entrepreneurs to get to $1M in revenue and demonstrate the metrics on customer acquisition cost, and a credible analysis on growth rate and TAM before they would invest. They don’t pretend to invest in seed or series A. The fund size is $575 million across three funds.
I like the clarity of their positioning, and in 2008, when I did the interview, I was impressed by their willingness to make a contrarian bet. I am always impressed by people who think originally. I am glad their bet has paid off.
It appears that a16z is currently making such a bet on the BitCoin phenomenon. And given their leverage in the media, they will leave no stone unturned to give the trend huge tailwind to develop in their favor.
Looking back in time, Benchmark did well by betting on eBay, and have since developed strong expertise in marketplaces. Mike Moritz at Sequoia leveraged his expertise as a journalist and did Yahoo! and Google, leveraging the former to get the latter to a position of great strength.
Less visible, but a superb investor at Greylock is Asheem Chandna who does primarily infrastructure investments. These are ‘fat startups’, and often, he invests at a concept stage. To me, that is real venture capital, and Asheem Chandna is great at it. He has had IPOs like Palo Alto Networks, and his investments like Delphix are doing extremely well.
Also less visible, but a great firm is Trinity Ventures, with expertise across several categories. Their most interesting investment by Gus Tai was in an e-commerce company, Blue Nile, to sell diamonds online. In 1999, that was a bold bet that required real insight and appetite for risk. Trinity has continued to perform well with a steady stream of IPOs and acquisitions. It’s a smaller fund ($350 million) which allows them to do some formation stage investments – in other words, true venture capital.
Finally, Scott Sandell at NEA has shown consistent ability to identify companies that have gone on to be very successful. He invested in both Webex and Salesforce.com that established SaaS / Cloud as a category, as well as many other public companies. Investors who can do that over a long period of time are worth watching.
There is an escalation in valuation currently, and the market says, scarcity of strong, fundable deals drives up valuations. Dangerous, but true. Nerve-wracking for the VCs who have to win deals in the face of tough competition in hot domains. If you overpay, and the exit doesn’t measure up, you are in trouble.
So what do you do?
Either, you build a great reputation so that entrepreneurs want to work with you. Visibility and brand help. Savvy entrepreneurs would often take lower valuations to work with people they trust.
Or, you look ahead and find contrarian investments that are not yet hot, and practice real venture capital. Deals are not expensive at that stage, and the upside can be huge. Very hard to do, few have succeeded, but the industry truly rewards this kind of investment. You can also do formation stage investments in contrarian areas, even harder to do, but again, if you get it right, it’s lucrative.
They are, of course, rare. So, we see experiments.
One experiment, also from Andreessen-Horowitz, is to do series A, B, and C in one go. In other words, they put in a much larger amount of money in a series A than traditional venture capitalists would think fit, take a large percentage of ownership, deploy more capital, and tell the entrepreneur that they don’t have to go out to raise any more money anytime soon. ‘Go focus on execution,’ they say.
This may work if the entrepreneur is disciplined and can keep his/her head straight while swimming in large amounts of money. The strategy may fail often, because rookie entrepreneurs tend not to be able to keep their heads straight and manage execution when flushed with capital. Andreessen-Horowitz is run by entrepreneurs and seasoned operators. I can see why they think they know how to deploy the large amounts of capital. But do the newbies know how to do so? How much can you micromanage?
The trend is new, so we have to wait and see how it plays out.
Accel is practicing a different strategy of going across stages, including doing private equity style financial engineering. Large funds can do this kind of cross-stage investing, and it is true that there are interesting opportunities at the cross-road of private equity and venture capital. Oak, NEA, TCV have been known to do such deals.
Let me call out the firms I have mentioned in the post so far: Sequoia, Benchmark, Emergence, Trinity, Greylock, and Accel are proven. Andreessen-Horowitz is exciting and somewhat proven. The returns of the fund are not yet proven entirely, but the fresh thinking is great. I have also mentioned True Ventures, First Round Capital, and Union Square Ventures as interesting players in this new wave of venture capital. All three have established themselves as great allies of entrepreneurs.
As for individuals, I have talked about Scott Sandell at NEA in particular.
I hope you will add your thoughts to this post and cover what I have missed. Please feel free to outline your own experiences and analysis about the industry and the firms, people, strategies you have observed.
Note: Just as this article was published, AlwaysOn published a list of the top 25 venture firms based on the exit value for 2013. It’s an interesting summary as well, and worth looking at.