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Sex And The Single Zillionaire

Posted on Friday, Mar 17th 2006

This is the title of a new book by Tom Perkins, one of the pioneers of Silicon Valley, whose name is on the esteemed firm Kleiner Perkins. This week, the MIT alumni association honored Tom at the Spotlight ’06 event, and Tom delivered a screwball speech which had the entire audience rolling with spontaneous laughter. With great stories, he took us through his life, and some of the history of venture capital, made fun of himself, others, and us.

Long ago, in a galaxy very close to us, the largest venture fund, Kleiner Perkins, had $8 Million to invest. And with that, the pioneers of Silicon Valley, built companies like Cisco, Apple, Genentech, and much later, Google, Yahoo, and Amazon.

As I sat in the audience, listening and laughing, some random thoughts flew through my mind …

In 2006, the classic venture capitalists have pretty much shunned the notion of risk capital, in favor of growth capital.

Today, there is a lot of activity in very early-stage, built-to-flip venture capital, where from the get-go, the assumption is not to build a company, but to focus on making a quick million or two. This happens to be the territory of Angels and very small venture funds. Even VCs do this sort of investing on the side, with permission from their partnerships. If, however, the seed investors don’t succeed in flipping the deal quickly, and it ends up requiring more money, they often get washed out. Typically, these kinds of deals don’t have a lot of barrier to entry, and there are about 5-8 of each kind fighting it out. These “Built-for-Google” type deals are everywhere in the valley right now. Ron Conway and Reid Hoffman are its best practitioners.

In this mature market, also, those companies that have reached revenues above $15 Million, and in their history, have already burnt $20-$30 Million, but do not have the built-in scalability to get too much beyond $50-$75 Million, are in no-man’s land. The large companies don’t like acquiring these businesses, because they are too expensive. On the other hand, they are too small to become sustainable public companies. Cases in point: CoWare in EDA, Chordiant in Enterprise Software.

Enter Private Equity. String together some deals of the first category, and call it Venture Buy-Out. If the roll-up can open up a large new market opportunity, that’s one way to build a real company.

For the second category, however, life continues to be more difficult and complicated. Private Equity investors don’t necessarily want to buy businesses whose growth is slowing. If there are smaller, “micro-capitalized” companies out there that can add some throttle to a slowing business, then, again, a Venture Buy-Out may turn out to be the best route to take.

Finally, the entrepreneurs out there who have the ambition to build a real, large, multi-billion dollar company – should know that Silicon Valley has changed fundamentally. Highly speculative, capital intensive deals that require 5-7 years to build, are less popular these days. Especially, if you have a contrarian, one-of-a-kind business idea that goes against the grain of the prevalent trends, investors will ask you to find ways to either diminish the capital requirements, or reduce the startup risks.

Your answer may well lie in that category of “Built-to-flip” or “Built-as-an-accident” deals, from which you weave together a Venture Buy-Out quilt.

I am working on one of these right now. In some strange way, my motivations are similar to the growth investors: leverage!

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There goes my dream of an EDA startup :((
But seriously, there has been so much,much buzz about Web 2.0 et. al. Here in New Delhi, we had a barcamp, where most of the words were about AJAX, RSS, Ruby-on-Rails, etc.
I believe in creating a company or product with a significant value proposition, which in turn translates into barrier to entry. A barrier to entry is creativity itself – like 37 signals , but so is a new approach to place-n-route.
But by them I’m ready to set up shop, I dont think anyone’d wanta invest.

Sandeep Srinivasa Saturday, March 18, 2006 at 11:34 AM PT

Sandeep,

Barrier to entry is good. Barrier to entry that is achieved with little money is better, although often difficult to achieve. If you can achieve it in EDA, try to follow the built-to-flip model, and you and your investors will all make a great deal more money.

EDA has a very expensive SG&A model, which makes it very difficult to build new, independent large companies.

Web 2.0 is and will continue to be full of “built-to-flips”. Building barrier-to-entry is much harder in web 2.0 than in EDA. Look at Simply Hired, for example. All it does, is it scrapes a bunch of job leads from other job sites. Where is the barrier-to-entry? I bet you, there will be 16 others doing the same thing. Kind of ridiculous businesses …

Sramana Mitra Saturday, March 18, 2006 at 8:34 PM PT

Here is the part I still don’t understand, Sramana. There is a well-known cycle in private equity: successful partnerships keep raising ever-larger funds. A firm that was content to put in $2 million from a $100 million Fund I can’t do that any more when Fund III is $500 million. So if they don’t like capital-intensive deals, how will they ever put all that money to work?

Phil Anderson Monday, March 20, 2006 at 8:30 PM PT

Ah, Phil – good question.

They don’t like to do capital intensive deals from scratch. In other words, if an entrepreneur has managed to bootstrap a deal to some scale, and has thereby eliminated all the startup risks, then the big VCs are waiting with big smiles and big checks to fund the growth phase.

The question that remains unaddressed in this model, is, “Who is going to bell the cat?”

Bootstrapping is not viable in all deals. Chips, Hardware, Content, Material Sciences – these kinds
of deals, typically, cannot be bootstrapped.

And not all entrepreneurs with big ideas will be able to access the private equity world, following my advice above.

Sramana Mitra Monday, March 20, 2006 at 8:39 PM PT

There is one other “trend” that is worth mentioning – the movement of hedge funds into what has formerly been the province of venture and private equity firms. It’s an interesting development (if it continues) for two reasons: 1. enormous additional amounts of capital (more money, fewer ideas???); and 2. as I understand it, the financial model for the fund managers is superior to that of the typical general VC partner – which would lead to a bit of poaching of the best young partners to the hedge funds. Not clear what the patterns are yet of what these new guys might wish to invest in.

Dave Nagel Wednesday, March 22, 2006 at 1:20 PM PT

Dead on, Dave. That’s precisely what is going to happen, as the VCs become growth investors, the savvy entrepreneurs would want to also mitigate startup risks by doing roll-ups of existing micro-cap deals.

Who knows how to structure those? The Hedge Fund & boutique Private Equity guys !

Bit of a role-reversal going on here … You go startup with a Private Equity Investor, and then go back to Sequoia and Benchmark for the Series B.

Sramana Mitra Wednesday, March 22, 2006 at 6:22 PM PT

[…] When I read the title of this post I thought maybe I might want to read it in outside of my office, then into the first paragraph I realized that it was a play on Tom Perkin's new book and I realized that maybe Mr. Perkins was in fact gunning for his ex-wife on the literary charts. Only after I read the entire post did I realize that neither were true, what Sramana was writing about was the fundamental shift in venture capital that we are well underway with now. I wrote a post a while back about angels investors and the changing economics of that slice of private equity as a second order effect of cheap infrastructure. In retrospect I realized that it's not so much that private equity is changing but rather the gulf that is often referred to as the "tweener stage" is widening and that is compressing the ends of the spectrum. Like in geology, when you compress something you increase the heat as a byproduct, and quite often you come out with something very different than what you started with. This notion of build-to-flip has always been an anachronism to me, primarily because it's so irrational. If you architect something with the goal of it being acquired by a single company, or small group of companies, and that doesn't happen or in parallel several other ventures have the same plan and they execute better than you, well then you are kind of screwed. If you build a business where the outcome is a successful and self-sustaining business, then at least your destiny is in your own hands. However, it is clear that there are some very successful ventures that have been build with the sole purpose of being acquired at a young age, thereby enriching the founders and the limited number of investors to a degree that is disproportionate with later stage ventures where the common shareholders have been diluted through successive venture rounds. I mentioned the "tweener stage" phenomena among startups. What this represents is the stage of a company's life where the easy fast growth is done but before the stage where a truly defensible business exists. In enterprise software that has been the point past $30m a year in revenue but less than, for the sake of the argument, $70 million. It's never easy to grow any startup, but the hard fact is that getting from $0-15m a year is a lot easier than going from $15-30, and after $30m it is a tough slog because you have to build out the infrastructure that much larger companies already have in place and is the ante for the game. Acquirers quite often aren't interested in the tweener stage companies for reasons I don't fully understand, or accept, but exist nonetheless. What acquirers see in this stage of company is a business that is facing slowing growth rates, higher burn rates, and the potential for increased turbulence. Both the anecdotal and statistical evidence would suggest that acquirers like 'em very small or very big, and as an outgrowth of that companies in this stage look for merger partners in their quest to get through that tweener stage as quickly as possible. In an effort to tie together these disjointed thoughts, where I am going with this is that private equity hasn't really changed all that much, but what has happened is that the "risk capital" investors that angel investors and "swing for the fence" venture investors represent have moved farther to one end of the spectrum, while the growth capital investors have moved farther to the other end. As a result of this movement, if I were a CEO of a startup I would be strategizing my fundraising through several rounds much more carefully than in years past, at least to the degree that entrepreneurs even can direct the financing side of their businesses. angel+investors, finance, startups, VC, venture+capital Posted in Venture Business || […]

Venture Chronicles Friday, March 24, 2006 at 12:07 AM PT

[…] Sramana Mitra writes: […]

Pascal Rossini » Blog Archive » VC mood in Silicon Valley Friday, March 24, 2006 at 1:31 AM PT

A few more pointers on the topic:

Jeff Nolan: How to find your Angel & his response to this article

Peter Rip: Traditional Venture Capital Sure Seems Broken – It’s About Time

Bill Burnham: Hedge Funds Venture Capital and the 25% Solution 

Sramana Mitra Friday, March 24, 2006 at 2:56 PM PT

Sramana interesting post. As someone who bootstrapped a tech startup out of Bangalore (and nearly died multiple times) before getting to break-even and a finally had a successful M&A event, I find it interesting how VCs in India (in as much those that can be termed that way), have skipped several intermediate decades their counterparts in the valley went through.

Much like India skipping over the whole wired infrastructure development (remember 0.5 phoneline per 1000 people) to become a global driver for the wireless business (which was good), Indian VCs seemed to have skipped the whole we-fund-seed-and-series-A, across a wide spectrum of startups (the Apple, Sun, Intel, any number of semiconductor startups) to being Series C &D investors or even investment bankers (which IMHO is not a good thing). While investment bankers and late stage funds play critical roles, the challenge that today’s Indian tech entrpreneur is facing is three fold –
[a] good old ‘cash of course, while this is a hard thing to get enough of, it is the easiest to solve of the three
[b] experienced teams – every Valley startup that I have encountered has incredibly strong experienced technical teams even at early stages; typical Indian tech startups at seed or bootstrapping stage, have a couple or more highly motivated creative individuals, but pulling a team of say six folks with 12-20 years of experience is very non-trivial; there is a critical chicken/egg problem today — folks with the 5-8 years experience have just bought their first house or brought home that first baby, so need that salary – the 15 years+ who can afford the financial risk are so well ensconced, its hard to get ’em out (sure there are exceptions but if we wanted to fund a 1000 seed stage companies, we just don’t have the bench depth today)
[c] real world market perspective – if you are young enough to take the risk, or if you are strong with tech then its likely that you don’t have the market exposure that can complement this – of course [b] can fix [c] even if your target market is India.

Typically a old-world VC such as Sequoia (disclaimer I have no connection real or perceived with these folks), in addition to cash, brought three critical value components in early series (in the “old” days at least), – [i] knowledge of the industry – semiconductors for instance and what the life cycle is and hence long term investment perspective, rather than a flip-it mentality [ii] a rolodex to get executive teams in place as and when needed [iii] keeping the team honest (as would any meaningful Board) by guiding/questioning strategy, getting strategic partners interested/aligned and ensuring if not spearheading subsequent investment rounds. None of this even remotely exists for the Indian tech entrepreneur, despite the much vaunted appearance of first world VCs not just home grown ones. And that was before many valley VCs themselves, as you state, began looking at shorter term flippable opportunities. I suspect the tech entrepreneur in India is better off looking at a whole slew of paper, pharma and mechanical engineering companies that grew the old fashioned way even as they build strong, viable and today globally competitive business on a combination of good old bootstrapping, friends & family and debt.

Keep the faith
srikrishna
https://designofbusiness.blogspot.com/

K. Srikrishna Friday, March 14, 2008 at 5:11 AM PT