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Probably too much ink is spilled over VC funded companies.  It’s curious… given that these companies represent such a small minority of the entrepreneurial activity in this country.  Perhaps it’s because the stories of ambitious entrepreneurs pitching their dream to mysterious VC’s make for good, sexy fodder.

It’s great to celebrate startups, but the imbalance of press received by VC backed companies misguides some first-time entrepreneurs into thinking that the only path to success is through institutional funding.  But this can be very dangerous.  VC’s typically only invest in companies that have the potential to return a meaningful % of their fund.  This means that either the size of the opportunity must be massive, or the VC’s ownership must be substantial (or both).  Not all businesses are going to naturally fit the $100M++ profile, and it’s tough for an entrepreneur to pitch this kind of a vision when it might not be the right risk-adjusted path for the business.  It also can lead entrepreneurs to think that they have to sell large portions of equity early on in lieu of establishing a cash generating business model. Instead of scrambling to launch a free product and trying to get tons of scale early, some companies have done quite well bootstrapping for years and charging from day one (Squarespace is a great example).

So I’m pleased to see that there will be a panel at the next WebInno on “Self Funded Success Stories” featuring some of my favorite tech entrepreneurs.  It’s a great panel of folks who have built successful businesses that received no VC investment.  These companies are all in typical VC sectors of online advertising, e-commerce, and SAAS, but chose to take different funding routes for various reasons.  Below is a quick thumbnail of each, but definitely come out and see them in the flesh on Sept 13.

Steve Conine - Co-Founder, CSN Stores

Steve Conine is a serial entrepreneur who co-founded CSN stores with Niraj Shah in 2002.  CSN is the company behind ecommerce properties like cookware.com, strollers.com, and allmodern.com.  With over 400 employees and hundreds of millions of dollars in revenue, CSN is truly one of the great self-funded success stories of recent times. 

David Hauser - Co-Founder and CTO, Grasshopper

David and his co-founder Siamak founded Grasshopper in 2003 while still undergrads at Babson.  They have grown their first product, a virtual phone system, to over 100,000 users.  Most of their customers are entrepreneurs themselves, and David and Siamak have gone on to launch other software products designed to empower entrepreneurs launch and scale businesses more easily.  

Todd Garland - Founder and CEO of BuySellAds

In 2008, Todd was a designer and SEO specialist at HubSpot (always great to learn entrepreneurship by working at successful startups).  He was also a blogger and advertiser, and saw unnecessary friction in the process of buying and selling online advertising at the scale at which he was operating.  He started BuySellAds on the side to scratch his own itch, but quickly shifted to full-time to keep up with the network’s rapid growth. 

I’ve been reading the book “The Black Swan” recently on the recommendation of my two partners.  I had heard about the book for years, but it never made it off my “to-read” list until now.

One of the concepts that the book discusses is the way we think of risk differently when we are generating profits vs. when we are minimizing losses.  The simple illustration goes something like this:

If someone gave you the offer of $100, no strings attached, vs. flipping a coin for the chance of winning $200, what would you choose?  Although both options are mathematically equivalent, most folks would choose the $100.

On the flip side, if things were reversed, and you could either lose $100 for sure, or have a 50% chance of losing $200 or nothing, what would you choose?  Most people in this situation tend to prefer the possibility of losing nothing, even though there is the 50% chance of a larger loss.  

This illustrates a simple point that we tend to be irrationally risk tolerant in protecting capital.  Social scientists call this loss aversion.

This has major implications for the venture business in the realm of follow-on investment decisions.  It’s a part of the business that doesn’t get much attention, but consider this:  I think it’s safe to say that well over 50% of a typical venture firm’s capital actually comes in after the initial investment round of financing for a company.  So even if a fund is supposed to be “early stage” focused, the reality is that the bulk of their capital is going into the follow-on investments in the B, C, D and later rounds. 

I didn’t realize this before I went into VC, but most VC firms are lifecycle investors, meaning that they have large reserves and expect to participate in most of the follow on rounds for companies that are doing reasonably well.  One would think that the follow-on investing decision for VC’s would be an easy one.  After all, no one has more information on a company than the existing investors and board directors.  Therefore, they should be very well equipped in figuring out which companies deserve follow-on capital, and which ones don’t.  Even though the follow-on capital is usually at a higher cost base than the earlier investments, this should be concentrated in the “best” companies, and should perform very well from a risk adjusted basis (even before considering the protection from being higher up in the preference stack).

Case closed right? Wrong.  There are a lot of reasons why follow-on financings might happen when they shouldn’t, causing VC’s  to “pour in good money after bad”.   

• Loss Aversion.  As discussed above, the uber-reason this happens is that one is irrationally risk tolerant when trying to preserve capital.  Or put another way, once you have a vested interest (time or money) into a company, you are willing to take irrational risks to protect your investment.   

• Delayed Gratification.  No investor wants to see a “zero” on their track record, and no investor wants to report “zeros” to LP’s.  This is true even though a small -100% return today might be much much better than a big -80% return in 5 years.  The pressure of needing to raise a future fund, looking good in front of your partners, trying to get promoted, trying to look like a clever guy in the twitterverse, etc leads to unnecessary risk-taking in follow-on financing decisions.  Even though almost every firm says they evaluate follow-on rounds like “new deals”,  I think this is actually far from reality.

• The Signaling Death Spiral.  Let’s take the hypothetical case of a company raising a series B that is doing ok, but not great.  The existing investors will often say they will support the company but have an outside lead price the round.  The new investor will ask the existing investors if they are “in” for their pro rata as a signal that it’s worth investing.  If an outside lead is willing to price and lead a round, it’s very very hard for the existing investor to say “you know what, I don’t believe in this.  I’m going to pass on this investment and risk that the whole deal blows up” (note that this is different than the follow-on dynamics of VC led seeds, where the investor will have a much smaller % of capital at risk and knows that they are buying 5 options to make 1 true investment.)  So in this scenario, a follow-on round gets done, and both parties are heavily influenced by the fact that the other is investing.  Puzzling no?

• Confirmation Bias.  This is the tendency for people to favor information that confirms their preconceptions regardless of whether that information is true or complete.  When layered in with Loss Aversion, it creates a deadly combination.  Because an investor is averse to losses, he/she is biased against any data that suggests that the initial investment decision was a mistake and will gravitate towards information that supports a follow-on investment.  

• The Bridge to Nowhere.  Even if a company is really struggling, the following logic is very appealing: wouldn’t you be willing to spend $2M to save the last $8M?  Because investors usually buy preferred stock, they get paid first and so they only need the company to sell for the value of the preferred stock to get their money back.  As a result, you often see struggling companies raise inside rounds under this logic (often crushing the employee’s equity in the process).  But many times, this round of “bridge” financing ends up being a bridge to nowhere.  

So, follow-on investing ends up being a much more complicated endeavor than it would first appear.  Clearly, there are some firms out there that have a great deal of discipline about follow-on financing and have been very successful.  But I think that this is a very very easy way to falter as an investor because it’s so natural to fall prey to these pitfalls.  As some super-angel funds increase in size, it will be interesting to see how they deal with these hurdles as well.  It’s easy to say that one will “pile in on their winners”, but the ability to do so will cut both ways. 

The NextView team went away for a couple days recently for a strategy offsite.

One of the major topics we discussed was firm culture.  It’s an elusive idea. 

Usually, culture happens TO you.  You inherit it when you join a firm based on the personalities and decisions of those who came before you.

Even if you are a founder, I think culture can still happen to you.  Without knowing it, you can establish a firm culture that might reflect some of the undesired idiosyncricies of your personality or the incentive systems that are in place within the founding team.  

I think it’s important to be intentional about culture.  It impacts the strength and efficiency of the team, it enhances your ability to hire well, and it helps to build an enduring organization over time.  

Although culture stems from within, you can help to shape it through your actions, processes, and language.  We spent a ton of time talking about the language of NextView, how we will talk internally and externally about entrepreneurs, investing partners, team members, etc.  We’re working to codify this into something that is concrete.  Hopefully it isn’t just a hokey and generic list of values that we put on our office walls, but something authentic and unique to us. 

In the meantime, one way I tangibly see our culture being formed is around respect for time. I attribute this to my partner David who is remarkably punctual.  Being on time isn’t industry standard in venture (probably an understatement). I think every entrepreneur will attest to stories of VC’s showing up 30 minutes late, cancelling major meetings at the last minute, etc.  I’m certainly guilty of this.  But working with David has made me better, not great yet, but certainly better.  Surprisingly, this change has actually come pretty easy, almost naturally, because it’s getting ingrained into the culture of our firm.  

Many thanks for Eric Dobkin for helping us remember how important this is, and how lucky we are to be able to craft this during the early days of NextView. Also to Jo and Eric at Kepha who gave the same advice and put there mission and operating principles front and center. 

Hi, I’m a tech VC on Twitter. I’m @xyzvc

My icon is cool.  It’s a painting/cartoon/wacky photo.  Shows that I’m hip and approachable.  But when I meet with you, I’ll still crush your dreams. 

I tweet about technology, but occassionaly post personal stuff.  Important to show I have a sensitive side and care about more than just making tons of dough. 

I use # tags, sometimes as a funny form of emphasis.  Kind of like a wink and a smile ;) #donttakethisposttooseriously

I love Twitter because I can broadcast my blog posts.  Otherwise, no one would read them!  I blog at xyzvc.com!

I tweet blog posts with advice on fundraising, customer acquisition, and company building.  Usually, someone really smart has said it before and said it better.  But I haven’t been in Hacker News for a while, so I figured there is no harm reinventing the wheel. 

Retweeting is fun.  It’s like a virtual high-five.  I retweet the posts of my partners, coinvestors, and entrepreneurs I’ve backed.  Oh, I also retweet posts from guys whose butts I’m currently kissing so that they will like me.  I really hope @fredwilson retweets this… I’d get so many new followers!

My portfolio companies are the best.  I will share so much of their good news with you it will make you want to unfollow me (unless you are a co-investor, in which case you will probably RT and add a #)

If a portfolio company is doing bad, no Twitter love.  It’s like going to Disneyworld and trying to find Hercules or Mulan.  It’s like they never existed.

I also tweet about the cool places I’ve been (via Foursquare and Gowalla), things I buy (via Swipely and Blippy), and the cool places I’m going to go (via Plancast).   

Wow, that’s a lot of tweeting! That’s why I also tweet about how busy I’ve been and how little I’ve slept. It’s a tough life. 

Full disclosure, I’ve been a tech VC and I’ve done most of these things. 

I was a huge fan of comic books growing up, but what I always found amusing is that there tended to be certain archetypes of super heroes that would keep showing up.  For example - the “simple-minded strong dumb guy” is well represented by the Hulk, The Thing, Collossus, and Mr. Incredible.  

As early stage investors will all tell you - the quality of the founders is incredibly important.  Some investors have pretty methodical ways to determining the quality of a founder, others go more by gut feel.  But I think all investors have some set of entrepreneur “archetypes” that they tend to like, and they gravitate towards entrepreneurs that fit some or many elements of these archetypes.  

So for fun, I thought I’d share a few archetypes I often think about.  Some of these come up regularly in NextView discussions. So here they are:

The Talent Magnet

Some folks call these “pied pipers”.  In a resource constrained company, building a team is incredibly difficult when you have limited financial resources, stability, and certainty about the businesses future.  But there are truly remarkable entrepreneurs out there that a) bring with them excellent teams that are deeply loyal to the founder or b) are really amazing at developing a company culture and a story around the business that makes great people gravitate towards them.  This is critical both in the early stages of a company, but also in the later growth stages of the company where the financial reward might not be as significant.  Companies like Twitter are just black holes of talent, and the roots of that culture were set very early on. 

The “Force of Nature”

I think we all know folks like this.  They just do whatever it takes to get things done, and pity the fool who gets in their way. Investors like this archetype because they are decisive, are usually really good at selling and closing, and instill a hard driving and intense work ethic in their companies. These folks are particularly important when a company’s early success is dependent on some very hard-to get deals or customer relationships that mere mortals would be too intimidated to pursue. 

Note that in the image below, I used the Grey Hulk, who unlike the Green Hulk was actually very smart, but had a bad attitude. 

The Heat Seeking Missle

Early stage companies end up pivoting all the time - whether it’s the business model, customer segment, or something else.  Some great entrepreneurs are especially adept at entrenching themselves in interesting markets and quickly gravitating towards areas of promise.  These are the entrepreneurs who look like fast followers, but in my opinion are leaders in disguise. 

These entrepreneurs are especially effective in rapidly evolving markets or in grabbing hold of markets that are exploding (ie: social gaming, online ad exchanges and DSP’s, etc).  These are the kinds of entrepreneurs that investors think will “figure things out” and will spend capital wisely in that process. 

**Honorable Mention: The Knife Fighter

One of the entrepreneurs we’ve backed calls certain folks “knife fighters”.  This is a great archetype for early team members, maybe more so than founders.  

Often, you’ll hear of companies with great executive leadership that fail in early stage situations because they are used to operating with large budgets, a staff, an assistant, a strong brand behind them, etc.  Then you hear about a competing company with unproven but scrappy 20-year-olds that have an unbelievable level of output and somehow crank out double the output with 1/5th the staff. 

Or another example - some companies have very well groomed, high-brow Chief Revenue Officers or Marketers who struggle to deliver meaningful traffic or monetization in the early days of a company.  Then you hear about a guy who looks like a dwarf, stares at his computer all day, and somehow gets 200K uniques to a brand new site.  Sure, some of this traffic may be low quality, but sometimes, you need to knife-fight your way to early scale for more traditional, high-brow customer acquisition tactics to start working. 

Thoughts?  Any other archetypes you see and admire among entrepreneurs that you know?

There’s a cool new service I heard about recently called TurningArt.

In a nutshell, it’s “Netflix for art with the option to buy”

As a consumer, I love the idea, and like this segment of the art market in general. When I got married, my sister gave me a gift certificate for $888 for Wentworth Gallery.  It was more money that I ever spent for art, so I was excited about all the pieces I was going to be able to buy.

To my dismay, I went to the store and found that I could afford all of 5 pieces.  It was then that I realized that there is a huge bgap between cheap, commodity art.com prints and stuff at galleries like Wentworth (or even more expensive than that).  There is no art for the “Banana Republic” market segment. 

On top of this, I have also realized that consumers like me have very little confidence buying art.  You don’t want something that everyone else has, but at the same time, I need some social re-enforcement to buy something unique.  That’s why I think 20x200 is interesting in the social dynamic is creates between scarcity and social proof.

So I’m excited about TurningArt - it’s a cool service and I’ve always liked how big corporations can have rotating artwork in their offices.  Now I can have it in my living room!

I used to hold “Open Office Hours” when I was at Spark.  It was a great way to make space to meet any and every entrepreneur that wanted to connect.  A few months later, it seems like Open Office Hours are all the rage in Boston. It’s a great thing that investors are making themselves more accessible to entrepreneurs and it’s great that the Venture Cafe and NEVCA is helping to coordinate this (not sure why I wasn’t invited, guess I didn’t make the cut ;)

But I remember early on when I was doing this, I got the feedback from Rafael Corrales that the term “Office Hours” was pretty condescending.  Often, talking to an investor is intimidating enough as it is, and it doesn’t really help to describe it in terms of the teacher-student relationship. 

Not everyone agrees I’m sure, but I see his point.  Especially since I learn a ton from these meetings, I prefer thinking of it as a “startup chat” vs. “office hours”.

So I’m announcing a my next set of “Startup Chats” on Friday August 6th from 9AM-Noon Details below:

• Each chat is 30 minutes long
• Location is: http://www.andalacafe.com/
• We can chat about anything, but since time is short, let’s try to make it as productive and possible.
• For scheduling, I’m trying: http://tungle.me/robgo
• Please only schedule one 30 minute session between 9AM and NOON on August 6. Other signups will be ignored.  If anyone knows how to create a Tungle link for just one block of time, let me know!  I know this isn’t the best format.

Thanks!

It’s a little in vogue these days for seed stage investors to bash on larger VC’s.  It’s kind of fun, and in many cases, the criticisms have merit.

But most folks agree that having home run potential almost always means raising VC money to the tune of tens of millions of dollars.  Large VC’s fill this capital need, and also can add a lot of value through the lifecycle of the company.  Also, some of these partners and firms have been in the investing game for a long time and have had success in different economic cycles, so there is a lot to learn from them.  

Here are a couple practices I admire.  Full disclosure, I’ve worked at one VC firm (Spark Capital) and haven’t seen the inner workers of any of the others, so these thoughts come from my own external observations. 

Bessemer’s Road Mapping Discipline

David Cowan described the road mapping process for Bessemer in an old blog post. Talking about being thesis driven is easy, actually doing it is a lot of work.  It’s one thing to be interested in general themes and navigate towards “heat” in the market.  Many many investors do this and claim to be “thesis driven”.  But that’s not accurate, and that’s not what road mapping is.  It’s actually doing real work to develop an independent point of view on where markets are going and what technological innovations will help make this happen. 

I think this leads to very smart investing, but also is a huge benefit to the entrepreneur.  It’s great to know that your investor has a lot of depth in your area to offer, and it also helps smooth out the fundraising process when a partner has already pre-sold their roadmap internally and can quickly say “no” when it’s clearly not a fit.  

As a side note, I think this is why Bessemer has had such a great track record of developing and training very thoughtful entrepreneurs and investors over the years (for example: Chris Dixon, Larry Cheng, Waikit Lau, etc). 

Spark’s Tenacity and Conviction

I debated whether to include something from Spark since I’m biased.  When I was interviewing with Todd and Santo, one of the attributes they really focused on was my level of tenacity and conviction (I ultimately told them the story about winning over my wife after many years, but that’s a different tale altogether). 

The venture business is very competitive and it’s challenging for new entrants to compete against heritage firms that have been around for many years.   But in 5 years, Spark has emerged as a very strong player across the country.  This comes from deep conviction that there is no reason why they can not gain access to the best investments (regardless of location) and the tenacity to prove to entrepreneurs that they would be the best partners for the long haul.  I’ve heard other East Coast investors say “I’m not going to pursue that west coast deal… I don’t think I have a realistic chance to win it”.  But I never once heard anything like that at Spark.  

What’s particularly impressive is the firm’s deep activity in NYC.  Long before it was in vogue for Boston VC’s to hop on the Acela, Spark was already pounding the pavement and building a strong reputation in New York.  Over the past four years, Spark has been one of the two or three most active investors in the city with over 15 portfolio companies.  It’s difficult to have the tenacity and conviction to lead, but that’s the only way to separate yourself from the pack. 

Accel’s Barbell Strategy

Quite a few firms talk about employing a “barbell strategy” where the firm focuses on very early stage investments as well as participating in later rounds of high-fliers.  The skill set for identifying and evaluating these investments is pretty different, so I think firms tend to be a little better focusing on one end of the spectrum or the other.

But I think elite early stage firms do have an unfair advantage compared to later stage investors in winning great late stage deals.  Often, these firms have stronger brands and a stronger networks of portfolio companies and entrepreneurs to draw from.  Making late stage investments can be very lucrative in a world of discontinuous returns.  Greylocks’ investment in Facebook seemed crazy to many at the time, as did Benchmark’s Twitter investment (although both will probably work out quite nicely for each firm).  

But the firm that has been in the news the most recently at this stage is Accel. Of course, there was Groupon at $250M (they went from crazy to genius pretty quickly).  But more recently, there was Altassian and Squarespace.  But Accel is obviously a very strong early stage investor as well (Cloudera, Facebook, Playfish, etc)  Very impressive. 

***

Of course, there are many other firms I admire but this post is already starting to look like an overly long love-fest. Would love to hear other people’s thoughts on admirable VC practices in the comments!