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Your Personal Assistant: Rearden Commerce CEO Patrick Grady (Part 2)

Posted on Thursday, May 21st 2009

SM: Valuations seldom work out in favor of the entrepreneur. I have written extensively about this.

PG: There is a book called “Venture Capital at the Crossroads” which documents a lot of these issues. The book has case studies which showed that the average entrepreneur wound up with 3% of their own company at the time of an exit. The entrepreneur, who has come up with the idea, who has taken the risk, who is working 80–100 hours a week, who may have put their family at risk, and who recruited all of the employees, is ending up with 3%. The venture capitalists are getting paid 2% management fees, plus 20% carry, and they have a portfolio approach so they are fundamentally hedged.

SM: Speculator versus value creator.

PG: Exactly. I was sitting there realizing that something was inherently wrong. I started analyzing and disaggregating the pools of capital and how venture capital was structured. I quickly realized that funds had two primary sources of capital: endowments and pension funds. Those folks had money managers internally who could be managing a $26 billion fund. They would simply allocated $1 billion to venture, $3 billion to private equity, $4 billion to alternative assets, and $10 billion in US equities. There was layer after layer before it got to the entrepreneur.

Those endowments and pension funds are comprised of individuals. I wrote a 100-page business plan in which I called for the disintermediation of the traditional venture capital structure. Why not go directly to the executives at these pension funds? My hypothesis was that by getting rid of the middle men, the cost of capital would be lowered, and that if it could be lowered it would release a lot more capital. That would result in greater competition and everyone would benefit in that case.

I was very proud of myself for writing this business plan. I started networking with everyone I could at age 19 and 20, and I connected with some very successful investment bankers and former and current venture capitalists who believed in the same idea. Full disclosure: they warned me that it would not work.

One  person told me that what I was attempting to do was noble, important, and would never work because in order to do it effectively I would need to scale up to thousands, tens of thousands, and then hundreds of thousands of high net worth investors, and the moment you begin to do that you will begin to deal with regulators. Rules around general solicitation go back to the securities acts of 1933 and 1934, which were written in response to the abuses and speculation of the 1920s. That was a reasonable position to take, except I was 19 years old. I thought that it was a very noble idea and that the folks in DC were going to embrace the idea.

SM: Did you actually go out and do it?

PG: I went out and painstakingly started building an angel network. I found a small investment bank that I was guided to. I was told I had to prove it out before it could scale up. This investment bank gave me a desk and a phone, and I started smiling and dialing. I had to get a critical mass of prospective investors as well as a critical mass of good ideas or business plans.

One of the moments when I felt I was on to something is when I came out here and through the networking process met Bernie Vonderschmitt. He had taken multiple rounds of venture capital with the traditional gestation periods before the IPO and ended up with about 3% of his own company. When I spoke with entrepreneurs who had gone through this and had no other funding mechanism, I had an incredibly receptive and enthusiastic audience. They not only sent me the business plans of other entrepreneurs but also gave me contacts for other would-be investors.

This segment is part 2 in the series : Your Personal Assistant: Rearden Commerce CEO Patrick Grady
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