July 19, 2012

The Rise & Fall of Great Venture Firms [Part 2]

Last week I wrote about some of the common factors that have led great VC firms to stumble
or even fade from existence entirely.  I wanted to follow-up with some
observations of paths to greatness for a select group of firms.  Also
it’s also worth noting a few clever hacks that some firms have taken
which may not assure greatness, but can help avoid the pitfalls that
have ensnared past firms.

First and foremost, it’s worth emphasizing that greatness as a VC
firm is derived primarily from helping exceptional entrepreneurs build
enduring companies.  While it’s possible to gain notoriety and even
economic rewards for GPs in other ways in the short to intermediate
term, the firms we regard as “great” over the long run derive their
superiority from investing in and helping businesses grow… that’s where
success for all of a VC firm’s constituents (LPs, entrepreneurs, GPs)
flows from.

So assuming a VC firm is able to fulfill its core mission with distinction, what are some factors that can make it great?

1) Self-Awareness & Humility - These
are of course virtues that transcend venture capital or even
professional pursuits broadly.  And yes… great firms are self-confident
too.  But being able to recognize and admit when you’ve slipped and then
course correct as needed is often key to a firm’s ascent to or
continued greatness.  This is true not only in a firm’s dealings with
entrepreneurs but also with it’s limited partners and even within the
firm among its partners.

A good example of this was Charles River
Ventures experience with their 11th fund.  Back in the 2000-2001
timeframe, a flood of LP capital was coming into the VC asset class
given the strong returns of the mid-late 90s tech boom/bubble.  Like
many leading firms CRV used this opportunity to raise a huge $1.2
billion fund (CRV XI), though the firm’s roots were modest (Rick Burnes
started CRV back in 1970 with a $4M first fund) and until then CRV had
mostly stuck to its knitting of early-stage investing with small-mid
sized funds.  In the midst of the internet & telecom meltdown at the
beginning of the 2000s, as a firm CRV realized there were insufficient
opportunities to profitably invest $1.2B.  Though there might have been
short term benefits to continuing to manage this fund, the long-run
success of CRV would be hurt by doing so (there’s an HBR case on this).
 CRV ended up returning the vast majority of CRV XI to it’s limited
partners (ended up being a ~$450M fund) which started a trend among some
other VC firms and ever since they’ve stuck with early-stage IT
investing out of funds in the $250-$375M range (they’re on “Charlie 15″

2) Be Willing to to Experiment –  I described the risks of strategy drift in Part 1,
but often great VCs still display a willingness to experiment in their
business model.  Even when sticking to your core strategy, there are
lots of ways to change up a firm’s model with the goal of delivering
better value to entrepreneurs, LPs, and the firm’s GPs.

In recent years firms like First Round
Capital and Andreessen Horowitz have experimented with creating a
“platform” of services for entrepreneurs that go beyond the traditional
investor / board director relationship between VCs and startups.  For
example FRC launched a founders equity exchange fund and various
programmatic forms of knowledge sharing like list serves, CEO summits,
conferences, etc.  The point isn’t that FRC was necessarily the first
firm to do any one of these things, but rather they’ve had a willingness
to experiment.

In eras gone by, VC firms experimented
with other concepts which seem commonplace today.  Entrepreneurs in
residence (EIRs) and in-house recruiters were a novel thing for most VC
firms back in the 80s and 90s.  Even the notion of hatching / incubating
a company was once unusual.  One of the earliest examples of this
turned out pretty well when one of Kleiner Perkins’s
young investment professionals (29yr old Bob Swanson) bugged a UCSF
professor in the last ’70s about starting a company to develop medicines
using recombinant DNA.  Genentech of course pioneered what we now know
as the biotech industry and KP made >200x on their investment.

A willingness to experiment also means
you’re prepared for the risks of failure or looking silly in the
ecosystem.  Rightly or wrongly, Sequoia has received a lot of flak about their “scout” program recently.  But one has to respect their willingness to experiment in this fashion before other firms did the same.

3) Competitive Intensity -
At both an individual partner and a firm level, great VCs find a way to
retain an intense drive to win.  Winning in the sense of finding the
most promising startups and earning the right to invest in them.
 Winning in the sense of helping entrepreneurs they’ve backed build
great companies.  That being said the venture business is a multi-turn
game… good firms will often work with teams of entrepreneurs or certain
co-investors multiple times over their history, so a healthy competitive
desire is not the same thing as being a jerk just to “win” in a
particular situation.  And internal competition within a partnership can
be a double edged sword.

But when a firm or a meaningful group of a
firm’s partners has lost that hunger and drive to win, day in and day
out, their days of greatness are usually numbered no matter what their
prior successes.  Keeping those competitive fires stoked requires a
sustained commitment by the firm’s partners and also a fair yet honest
reckoning when individual partners find their hunger is dulled whether
by age, life changes, or interest in other pursuits.  In addition
partnerships have to keep pushing their boundaries of risk tolerance
since the natural tendency of any organization as it matures is towards
risk aversion.

4) Hacking Potential Pitfalls -
Another approach is to simply find a way to avoid potential pitfalls
like generational succession.  Foundry Group is one such firm which has clearly and publicly stated
that the four founding partners will continue to invest together for
the balance of their VC careers, but after that Foundry essentially will
be no more since they never plan to add additional partners.  Though
they only started in 2006, Foundry’s obviously off to a great start with
investments in Zynga and AdMeld and a promising portfolio of others.
 While their model isn’t necessarily to create a firm that endures after
the founders, they have avoided at least one of the biggest reasons why
great firms fail.

5) Don’t Be A Victim of Your Own Network’s Success
– A byproduct of a VC firm’s success is the creation of a strong
ecosystem around it of prior and would-be entrepreneurs and long time
co-investors (in fact this can be cultivated intentionally too).  This
is obviously a good thing since it creates opportunities to back
experienced serial entrepreneurs and work with a trusted group of other
VC firms as co-investors.  The downside is it has the potential to close
off a firm from newer entrepreneurs.  Also while you might be able to
use the same “playbook” for a game or two, in the quickly changing and
highly competitive world of technology innovation VC firms risk blindly
following a template beyond it’s useful life.

A firm that’s continuously managed to
look beyond it’s network has been Sequoia.  While they’ve also invested
in repeat entrepreneurs they’ve previously backed, Sequoia realized many
moons ago that their biggest successes were often by first time
entrepreneurs.  Think Apple, Cisco, Yahoo!, Google, Dropbox, AirBnB.  So
the firm assiduously finds ways to form these new connections through
and beyond their existing network even relying on that existing network
would be an easy thing to do.

Again #1-5 don’t guarantee greatness for a VC firm… only investing in
and helping transformative companies does.  But in observing great VC
firms over the decades, all of the above both support the core mission
of backing great entrepreneurs and distinguish great firms from the rest
of the pack.

Lee Hower is a Partner & Co-Founder with NextView Ventures.  You can find this blog post, as well as additional content on his blog called AgileVC.  You can also follow Lee (@leehower) on Twitter by clicking here.