The Lower-Risk Startup: How Venture Capitalists Increase the Odds of Startup Success

DAV ID TETEN, ADHAM ABDELFATTAH, KOEN BREMER, AND GYORGY BUSLIG

DAVID TETEN ur goal is to understand how ven- METHODOLOGY is a partner at ff Venture ture capitalists (VCs) can system- Capital and founder and atically help startups increase their Our study draws on a wide range of Chair of Harvard Business odds of success, beyond simply research: in-depth interviews with more than School Alumni Angels 50 investors, entrepreneurs, of Greater New York Oproviding more capital. The primary levers of in New York, NY. a VC to do this are team building, operational startup incubators, and advisory service pro- [email protected] improvement, perspective and strategic guid- viders; a proprietary database and survey of ance, skill building, customer development, VCs’ portfolio value creation practices; a wide ADHAM ABDELFATTAH analytics, and the VC firm network. We will scan of academic and practitioner publications is the founder and CEO focused on the topics of entrepreneurship and of CircleVibe, a mobile discuss the range of philosophies we found startup in the crowd- among major VCs in their approaches. We venture investing; and the authors’ personal sourcing space and a find that certain operationally oriented VCs experience working in venture capital, ear- consultant on leave from are hiring unusually large teams of operators ly-stage technology companies, and strategy 1 McKinsey & Company and that the firms with this strategy typically consulting. in New York, NY. We should emphasize a key caveat. For [email protected] have top-quartile returns (above 20% IRR in the relevant time periods). We then def ine our study, we wanted to analyze whether the KOEN BREMER a blueprint for how investors can assess their Portfolio Operator strategy led to higher returns. is a consultant with strengths in order to meaningfully help port- Sadly, this is virtually impossible to do rigor- the Boston Consulting folio companies succeed. ously, for several reasons: Group in Amsterdam, We believe that developing and insti- The Netherlands. • This strategy is relatively new, so insuf- [email protected] tutionalizing management techniques that

The Journal of 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. enable better startup success rates will increase ficient data are available for the small GYORGY BUSLIG the availability of disruptive technology, while number of funds pursuing this strategy. is a consultant with also increasing investor returns and entrepre- • Returns data for VCs are difficult to It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. McKinsey & Co. in neur success rates. Given the mediocre median obtain and difficult to compare with one Budapest, Hungary. another across inconsistent fund sizes, [email protected] returns of the VC industry (4.41% end-to-end pooled for the 10 years ended March 31, 2012, check sizes, and strategies. according to the Cambridge Associates U.S. • VCs with higher returns naturally have Venture Capital Index) and the high failure more cash, feel more self-confident, and rate of the typical entrepreneur, techniques therefore are more likely to invest the to improve the odds of success are highly money needed for the expensive Portfolio needed. Operator strategy.

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JJPE-TETEN.inddPE-TETEN.indd 7 22/14/13/14/13 4:48:464:48:46 PMPM We can only say with reasonable confidence that • Team building: designing and recruiting for a start- most of the funds with well-developed portfolio operator up’s most important asset, its human capital base. strategies have returns in the top quartile (above 20% • Operations: enhancing administrative, accounting, IRR) for the time periods during which they have used legal, and technological capabilities. that strategy. We obtained data on returns from Preqin, • Perspective: strategy, competitive positioning, Fortune, and sources at funds of funds. Our thesis that defin ing the target market, and scoping the greater participation correlates with higher returns is con- product. sistent with two other formal studies: “Returns of Angel • Skill building: building the right skills, especially Investors in Groups” (2007), by Robert Wiltbank and for senior management. Warren Boeker, with funding and support from the Ewing • Customer development: identifying and gaining access Marion Kauffman Foundation, and “Prediction and Con- to the right customers. trol Under Uncertainty: Outcomes in Angel Investing” • Analysis: how entrepreneurs measure, understand, (2009), by Robert Wiltbank, Stuart Read, Nicholas and report the performance of their early-stage Dew, and Saras D. Sarasvathy. The studies were based on companies. entirely distinct datasets. Both found that higher levels of • Network: the cheapest and sometimes most value- angel participation in investments, as measured by number added service that an investor can provide is access of hours per week interacting with a portfolio company, to his/her network, particularly to potential inves- correlates with higher returns. tors and acquirers.

WHO SHOULD BE INTERESTED A company’s need for the TOPSCAN services is IN THIS RESEARCH greatest in its earlier life. However, even among private equity funds that invest in late-stage, stable, established Venture capitalists. With the increasing competition companies, we see some such funds building portfolio in the startup funding space, providing distinctive sup- operations groups. These firms clearly believe that their port to portfolio companies can be a strong competi- portfolio companies benefit from a similar resource. tive advantage for VCs in deal sourcing as well as for Venture capitalists are financiers of a special nature. improving returns. They fund highly uncertain projects that usually operate Entrepreneurs. Our f indings help startups assess who within a very fast moving environment with constantly the most value-added investors are. Furthermore, this shifting technological paradigms. The teams they work study allows entrepreneurs to understand how they can with are entrepreneurs trying to engage in extensive extract more value from their current investors. product and customer development efforts for a product Large corporations. Almost every large company is or they don’t typically have a full vision of, for a customer it should be thinking about new, disruptive businesses it whose needs are opaque, and for a use case that is ambig- can incubate and/or buy. Our findings provide insight uous. This is a very different world from traditional on how to successfully gestate new businesses. corporate lending or investing. We believe that partially due to this unique con-

The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. WHY AND HOW VCs SHOULD BE ACTIVELY text—quite distinct from that of other asset managers INVOLVED IN PORTFOLIO COMPANIES like private equity investors, hedge funds, and commer- cial banks—VCs can and should add tremendous value It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. The conventional school of thought is that inves- by supporting their portfolio companies more actively tors generally should create value by selecting the “right” beyond writing them checks. Almost all VCs say that companies, business plans, and teams in which to invest. they respond to portfolio CEO requests and make intro- This article argues that in addition to that selection func- ductions to people in their network when asked. We tion, venture investors have a wider role to play—the view that as the minimum level of appropriate support. value-creation function. Our research shows that many leading VCs have VCs can add more value to their portfolios through the invested significant resources in building out portfolio following seven elements, the “TOPSCAN” framework: operational support, based on a fundamental belief that their companies are typically incomplete in multiple

8 THE LOWER-RISK STARTUP: HOW VENTURE CAPITALISTS INCREASE THE ODDS OF STARTUP SUCCESS SPRING 2013

JJPE-TETEN.inddPE-TETEN.indd 8 22/14/13/14/13 4:48:464:48:46 PMPM ways and will benefit by systematic support. It is rela- • Industry network: One entrepreneur observed about tively easy for most VCs to do this, as VCs typically one of the most prominent VCs in America, “[X]’s enjoy a strong network and many have significant opera- default response to all problems is to e-mail intro- tional experience in their focus industries. duce you to 3–10 people in his network who can The Portfolio Operator strategy has potential to help.” See VC Profiles 1 (NextView Ventures) and boost returns, as discussed previously. In addition, VCs 3 for examples. (particularly those focused on internet investments) live • Funding network: Later-stage VCs pay careful atten- in a social-media-enabled world where almost every tion to who the earlier funders in a company are, investor has a very visible public resume on LinkedIn; using the reputations of the funders as a proxy for many have a public blog; and blogs and rating sites such as their own diligence. The next-best asset to a large TheFunded.com closely track their behavior. Social media pool of capital in-house is the ability to easily help footprints make it exceptionally easy for entrepreneurs to raise more capital in later rounds from past syn- assess precisely how much value a potential investor can dicate partners. See VC Profiles 7 (First Round add, and reach out to those investors specifically. Capital) and 9 (ff Venture Capital). • In-house expertise: VCs can provide consulting, ANALYSIS OF CURRENT PRACTICES accounting, or operational resources, both directly from their own staff and from preferred service We have identified three common categories of providers. See VC Profile 9 (ff Venture Capital). VCs in terms of attitude and practices towards investing and portfolio company support: Financiers, Mentors, All of the resources listed here are synergistic, that and Portfolio Operators—ranked in order of increasing is, more success creates more cash, which strengthens the level of operational involvement. brand, which increases the industry and VC network, Where each VC lands on the spectrum is the result of which strengthens the in-house expertise. This is one both the general partners’ philosophy and the specific assets of the key reasons that venture capital is one of the few that the fund can leverage. For all VCs, the money they asset classes in which past performance is consistently manage for their limited partners (LPs) is of course their predictive of future results. most important asset. But on top of that, VCs leverage a Finally, we have found that Financiers, Mentors, and wide array of assets to support their portfolio companies: Portfolio Operators also differ in their investment decision process. Because Financiers will have modest inf luence on VC Resources to Increase Portfolio the company after their investment, they are very depen- Company Value dent on the operational competence and industry insight of the management team they initially back. Portfolio • Cash: A significant operational toolkit is expen- Operators, on the other hand, can better accommodate sive. Given the mediocre average returns of the VC weaknesses in the initial management team, for example, industry, and the modest the absence of a strong lead in certain functional areas. of VCs relative to the AUM of a typical private Portfolio Operators know that they can train, modify,

The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. equity fund, many VCs simply cannot afford to and/or expand the team as the company develops. invest meaningful dollars in a large portfolio accel- The following sections describe the three types eration infrastructure. Those who can have a sig- of venture capitalists, their beliefs, characteristics, and It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. nificant advantage. See VC Profile 5 (Andreessen examples of how they operate. Horowitz). • Brand: The fact that a company has been funded by Financiers—“I’m a banker, not an operator.” a well-respected fund/partner alone can increase a company’s odds of success, because that brand The Financiers are the most traditional group of VC makes it easier for the company to attract talented investors; they view venture capitalists as “glorif ied com- employees and follow-on investors. By definition, mercial bankers.” They see their LPs’ financial capital as startups have no brand at launch. See VC Profile their most important asset and their activities focus on 7 (First Round Capital). leveraging that asset in the most effective way. Financiers

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JJPE-TETEN.inddPE-TETEN.indd 9 22/14/13/14/13 4:48:464:48:46 PMPM believe that the most value added by a VC comes from access to investment opportunities by offering a very carefully scrutinizing early-stage companies, generating rapid investment decision (two weeks or less), with a leads, conducting a thorough due-diligence process, and very low hassle process, leveraging their large investment eventually investing the right amount of capital at the in predictive analytics. They have $165 million in assets right valuation and structure. The relationship to their under management. portfolio after making the investments primarily consists Case 1: How VCs can destroy value for their of monitoring. portfolio companies. As stated previously, Financiers Financiers take a more active role when the port- believe that the risks of destroying value in their portfolio folio company is looking for a follow-on round of companies through being closely involved outweigh the investment or when the company plans an exit. Finan- potential benefits. Throughout our research we have come ciers believe that optimizing the number of good deals across many examples in which VC involvement did not have per general partner is the key to success and that deep a positive effect. Two, in particular, illustrate this point: involvement after investing would not only potentially destroy value for the VC and its LPs but could even “One of my portfolio companies had an exit put value at risk for their portfolio companies. Ezra opportunity, but one of the VC board members Roizen, partner at Ackrell Capital, wanted a higher valuation. As a result the negotia- has worked with a wide range of venture-backed com- tions did not succeed and eventually the company panies and observes: was never sold. In his next venture, the same entrepreneur decided to sell too quickly, even Finding good teams and strategies in which to though in hindsight he could have made a bigger invest should be a VC’s top priority—capital is return by waiting a bit longer. Apparently, his their main asset and their two main skills should earlier experience had given him that bias.” be finding and selecting good companies, and “Worst advice I ever gave: I was working forming capital. I believe that is the essence of with an open-source software company and had the VC value proposition. Once you deduct the a pretty strong view on the industry at that time. time it takes to identify great companies, and the As a seed investor, I loved their growth but after time it takes to raise funds, you really have very a few years my partners and I wanted to see rev- little time remaining to actually spend with spe- enue. The entrepreneur clearly opposed this view cific investments. So I believe it’s appropriate for and wanted to grow further first before mon- their focus to be on and capital, with a etizing. I am glad he did not follow our advice, sprinkle of sage advice on macro strategy deci- because in hindsight he was clearly right to sions, follow-on financing, and M&A. approach it in this way.” The company is now the overwhelming leader in its space. As a result, Financiers are more hesitant to invest in a team with clear weaknesses, as they do not have the Mentors—“I try to be the CEO’s consigliere.” infrastructure to address those weaknesses.

The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. Of course, the Financiers are not completely By far the largest group of VCs can be classed as detached from what is going on in their portfolio compa- Mentors. Mentors believe their fund and personal assets nies, but they tend to focus more on formal interaction. can improve the performance of the ventures they invest It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. Examples include: VCs taking board seats, suggesting in. The most important asset they bring to the table structures for board meetings, and providing monthly is their personal and professional network, which they reporting templates. leverage to strengthen portfolio companies. Throughout The most perfect example of a Financier is Cor- our research, we observed many examples of this: intro- relation Ventures, which some have called the “Mon- ductions to potential customers, suppliers, partners, and eyball” of venture capital. Even though the firm’s two executive-level employees. managing partners are both former startup entrepre- What distinguishes the Mentors from the Portfolio neurs, Correlation Ventures never takes board seats and Operators, however, is that they deliberately choose not has only modest operational involvement. They gain to institutionalize the support they give to their port-

10 THE LOWER-RISK STARTUP: HOW VENTURE CAPITALISTS INCREASE THE ODDS OF STARTUP SUCCESS SPRING 2013

JJPE-TETEN.inddPE-TETEN.indd 1100 22/14/13/14/13 4:48:464:48:46 PMPM folio companies. Support is almost always initiated by Case 4: Leveraging a network. In this case, the the entrepreneur and does not involve preset systems or VC’s network saved the company: processes. As one Mentor said, “My entrepreneurs have my cell and email address—and I always answer them.” Almost two years ago we had a portfolio company As a result, Mentors assessing a new investment need that was creating applications. It was to be comfortable that their input will be heard by the doing great—showing fast growth and on its way companies—that the CEO is coachable. to further financing—but also highly dependent In the past few years, there has been a surge of small, on Facebook. One day I got a panic call from solo-GP funds, typically with under $40 million in assets them: Facebook had turned them off and they (e.g., Baseline Ventures, Coastano VC, Cowboy Ventures, were not able to reach anyone at the Facebook Harrison Metal, K9 Ventures, and PivotNorth). Although Policy Team. They estimated that they had a week in many cases these solo GPs have strong operational track before customer turnover would become so big records, they typically have only very limited resources to that they would be done. Luckily, I had worked engage substantively with their portfolio, and so would successfully [in the past] with one of the leaders of normally be classified as Financiers or Mentors. the Facebook team, called his house, and managed Case 2: Convincing a top recruit. A promising to get them back on within two days. investment had been making great progress after raising its seed round and was almost ready to launch its product. VC Profile 1: NextView Ventures, Rob Go. It needed an experienced digital marketing executive on NextView Ventures is a seed-stage VC firm focused on its board prior to launch, and after interviewing several internet-enabled businesses, both consumer facing and people, it had found the ideal candidate. Unfortunately, B2B, based in Boston, Massachusetts. NextView has three the candidate himself was reluctant to make the switch Partners with $21 million in assets under management. from a secure job at a media company to a startup. However, a meeting with one of the VC’s partners—a An example of what we believe is a valuable sup- successful and well-respected entrepreneur in the digital port to our portfolio companies is around the next marketing space—helped to convince him to join the rounds of funding. We are intensely involved in company. this process and actively maintain a database of Case 3: Founder mentoring. Iker Marcaide is individual partners in many VC firms and rel- the founder and CEO of peerTransfer, a service that evant information about them, like personal life, makes it easier and cheaper for international students to character, usual negotiation tactics, deals they are make their educational payments in the U.S. He founded involved in, and so on. As a seed investor we the company in 2009, and has raised a $1.1 million believe that we should not overload our startups seed round and a $7.5 million series A. His leading VC with lots of reporting formats, and so on. investor is Spark Capital, which led both rounds and brought Accel Partners and Mevron on board for the VC Profile 2: Resolute.vc, Mike Hirshland. series A. Iker described his relationship with Spark as, Resolute.vc is a seed-stage venture capital firm managed

The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. by founder Mike Hirshland. It operates in the San ... basically a mentoring relationship with one of Francisco, New York, and Boston markets. their general partners. We talk often and I go to It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. him whenever I have questions. What is most First of all: do no harm and let the entrepreneur important for me is that I trust him. I am a first- run the company. There are a lot of VCs out time founder and I profit from the experience and there that feel a need to demonstrate value and expertise they bring to the table. They help me get involved in the day-to-day business of their finding the right service providers (accountants, portfolio companies. I have the blessing of never lawyers, etc.) and leverage their network when I having been an operator, so I’m not trying to grab am recruiting people for sales or business develop- the wheel and drive. I once invested in a company ment positions, which is their field of expertise. where every VC brought its own advisors and experts (in recruiting, marketing, technology,

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JJPE-TETEN.inddPE-TETEN.indd 1111 22/14/13/14/13 4:48:464:48:46 PMPM and so on) to the table. A great idea in theory, We find that Portfolio Operator VCs are building but when all give different advice it becomes a teams of employees that are unusually large for the VC very confusing situation for the founder. industry and include many people with strong opera- tional backgrounds. These larger teams tend to be VC Profile 3: West Coast early-stage fund. accompanied by a transition toward pyramidal orga- This early-stage venture capital firm manages funds of $70 nization, which is increasingly becoming the norm in million and is an example of a Mentor. The firm supports Portfolio Operator funds. As Harvard Business School its 60+ portfolio companies on an ad-hoc basis. In monthly professor Noam Wasserman discusses,2 VCs have long mentoring conversations with the companies’ founders, been structured as “upside-down pyramids” in which the managing partner and associate (who have operational/ GPs outnumber more junior employees. This phenom- entrepreneurial backgrounds) discuss opportunities and enon is attributable to the fact that VCs are “knowledge- potential ways for them to leverage their networks. intensive firms in which esoteric expertise predominates Whenever requested by the entrepreneur, the partners over standard knowledge.” The need to exchange rich leverage their network of advisors to support portfolio information in the course of pre-investment activities companies with specific challenges, which mainly revolve (e.g., due diligence) serves as a disincentive to expand around marketing and go-to-market strategies. the firm beyond a certain size or adopt formal, pyra- midal structures (which are, to a certain extent, an emer- Portfolio Operators—“We have a structured, gent property of large and/or complex organizations, in standard process for adding value.” which workers become specialized and need to structure their interactions more). Although late-stage VCs have Portfolio Operators agree with Mentors that the luxury of concrete quantitative data, early-stage VCs their unique personal and fund assets can be used to rely on more tentative information for which analysis develop their portfolio companies, but unlike the Men- cannot be easily delegated. tors, they do this in an institutionalized and structured Post-investment activities, such as operational sup- way. Whereas Mentors tend to be reactive in their sup- port for portfolio companies, however, can be delegated port, Portfolio Operators proactively look for ways to and benefit from economies of scale. Pyramidal struc- improve the performance of their investments through tures are the most efficient means of systematizing and systems and processes. We know of numerous instances delivering this support due to the benefits of leverage, in which companies took lower valuations to win Port- delegation, and specialization. folio Operator VCs as investors versus other categories of We think that three trends are accelerating the tran- VCs, because the entrepreneurs so valued the resources sition to pyramidal models and operational focus. First, a Portfolio Operator could bring to bear. In other cases, the cost of starting a company has come down dramati- entrepreneurs have offered board options or other sweet- cally and, as a result, young entrepreneurs with modest eners to highly attractive Portfolio Operator VCs. capital and only angel/Series-A investors can find them- The most common service Portfolio Operators offer selves leading significant businesses beyond their man- their portfolio companies is recruiting assistance. Most agement capacity. Second, the rate at which startups can

The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. of the VCs in this category not only provide personal scale has increased dramatically, so the judicious appli- references to interesting candidates, but also use their cation of VC resources can have an exponential impact. own websites as job boards for portfolio companies. First Third and finally, we have moved to a more transparent It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. Round Capital takes this a step further by running a pro- world in which both VCs and entrepreneurs are easier to gram in which it recruits MBAs for internships and full- examine with due diligence. This puts pressure on VCs time positions with its portfolio companies. This illustrates to differentiate themselves substantively. The pyramidal a common approach to the Portfolio Operators category: model ultimately won out in other, more mature knowl- assessing the VC’s most valuable assets and designing a edge-intensive industries, such as law and investment structure to leverage those assets. First Round can leverage banking, and the same may occur in venture capital. its brand and 155+ company network to provide MBA VC Profile 4: Partners, Chris students with an attractive double offer: work at a vetted Farmer. General Catalyst Partners is a venture capital startup and gain exposure to a prominent VC. firm based in Cambridge, Massachusetts, that focuses

12 THE LOWER-RISK STARTUP: HOW VENTURE CAPITALISTS INCREASE THE ODDS OF STARTUP SUCCESS SPRING 2013

JJPE-TETEN.inddPE-TETEN.indd 1122 22/14/13/14/13 4:48:464:48:46 PMPM on early-stage and growth equity investments. General VC Profile 6: Extreme Venture Partners, Catalyst has 11 partners with approximately $2.2 billion Ray Sharma. Extreme Venture Partners (EVP) is a in assets under management. It currently has 33 full- Toronto-based early-stage VC comprising f ive partners. time employees (including partners, EIRs, and venture From its website: partners) and invests out of its sixth fund of $500 million. Chris Farmer is a venture partner at General Catalyst and • We recognize that sometimes all that is needed to co-founder of Ignition Talent, a talent acquisition and propel a good idea into greatness is a small amount advisory firm. His views underline many of the beliefs of funding and support from a seasoned team of Portfolio Operators hold: “We have systematically built technology and business alumnus. ‘ecosystems’ for our portfolio companies to add value to • Whether you are pre-revenue or expanding, we them, e.g., our Corporate Partner Days, CIO Forums, want to be involved as early as we can so we can related non-profits and service support, e.g., recruiting, provide the most support and impact possible. events, real estate, analytics, and so on.” Most—if not all—of General Catalyst’s invest- The general partners of EVP are also the cofounders ment partners come from strong operating backgrounds. of Xtreme Labs, one of the leading mobile platform For example, one partner took four companies public developers in Canada, employing almost 150 full-time before joining General Catalyst. Furthermore, it has a mobile and tablet application developers. EVP portfolio very active entrepreneur-in-residence program. Over companies get preferred access to Xtreme Labs at a dis- 35 companies have started in its offices, for example, counted rate. These related companies now employ more Kayak, Demandware, and Brightcove. than 1,000 people, mostly focused on mobile app devel- Farmer adds, “The entrepreneurs seek us out (or we opment. Ray Sharma (chairman Xtreme Labs, founding convince them to join us) because of our deep experience partner EVP, CEO of XMG Studio Inc.) takes pride in building businesses and because of the leverage that the the amount of jobs the group has created even more than platform offers them. But the entrepreneurs deserve the in the successful exits. credit, and we simply hope to systematically multiply VC Profile 7: First Round Capital, Howard their energy and break down walls for them.” Morgan. First Round Capital is a VC based in New VC Profile 5: Andreessen Horowitz. Perhaps York, , and , investing from the most prominent example of a Portfolio Operator VC is its fourth fund of $135 million. Current high-profile Andreessen Horowitz (“A16Z”), a Menlo Park–based fund investments include Square, Mint.com, and Fab.com. that has raised $2.7 billion since it was founded in 2009 FRC has seven partners with more than $400 million and has made investments in , Facebook, Skype, in assets under management and 22 full-time employees. , , and many other highly successful FRC has a wide range of initiatives to support portfolio startups. It gives its portfolio companies structured support companies. For example, it organizes yearly CEO, CFO, through one of its four operational support teams, focused and CTO summits in which executives of all portfolio on executive recruiting, marketing/PR, technology, and companies in certain roles come together, as well as business development. The fund has six Partners and a related online community. Because of the internal,

The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. employs more than 40 operational staff, helping portfolio closed nature of the platform, it has become a trusted companies with preparing negotiations, making client source for advice (e.g., “Our finances are out of control introductions, and providing preferred suppliers. and we need a CFO yesterday; what should we do?”). It It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. A16Z partners have been very public about their offers the portfolio free access to a “venture concierge,” strategy to model the firm after Hollywood’s Creative a lightweight consulting and research service that helps Artist Agency (CAA). A16Z tracks the elite engineers in its entrepreneurs save time on research-related tasks. Silicon Valley (and to a lesser extent elsewhere), identifying VC Profile 8: Ventures. Google Ventures who is looking to build a company and who is looking for has over 115 portfolio companies, makes 60–80 investments a new role. Just as CAA offered a full suite of services to a year, and is investing north of $100 million per year. its actors, A16Z wants to make it as easy as possible for its It leverages both Google’s vast resources and a dedicated entrepreneurs to focus on their core job of building great 54-person team, including 10 partners. One partner, Joe companies.

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JJPE-TETEN.inddPE-TETEN.indd 1133 22/14/13/14/13 4:48:464:48:46 PMPM Kraus, observed, “We believe helping companies plays . Grinda has founded several companies more of a role than most people give it credit for.”3 prior to Olx, and his investments span the U.S., Europe VC Prof ile 9 : f f Venture Capita l, John Frankel. Brazil, Russia, and Turkey. He has backed more than 100 ff Venture Capital (ff VC) is a New York–based seed- startups so far (predominantly early-stage investments). stage VC. Founded in 1999, ff VC has made more Grinda emphasized that outside the U.S., he typically than 160 investments in over 60 companies, including looks for CEOs who are already seasoned managers, 500px, Cornerstone OnDemand, Klout, Quigo, and more so than in the average U.S. startup: “We invest in Voxy. As of October 2011, the firm had $38 million in more experienced teams in emerging markets because assets under management and 12 employees (including these are markets that require a lot of workarounds and three partners), which is probably the highest ratio of where the ecosystem is not as developed. We often back employees to assets under management of any asset former consultants and B-school grads.” management firm in the U.S. Omar Koudsi is the founder of Jeeran.com, a Jorda- In an interview, John Frankel, Partner, highlighted nian VC–backed startup. Koudsi highlights the need for the firm’s institutionalized services and processes: more-involved VCs in regions like the one his company operates in. He f irmly believes that seasoned VCs can add We are strong believers in continuous process a lot not just in building the ecosystem, but also in devel- improvement. We have invested extensive effort oping the entrepreneurs themselves and guiding them on in identifying best practices for the disciplines strategic matters: “Most investors in the region are in the necessary to grow a startup, e.g., product devel- high net worth individual mode and not yet in profes- opment, sales, marketing, and fundraising. For sional VC mode. The market is slowly changing, and I each function, we share as needed template plans, believe professional VCs will add tremendous value to an sample spreadsheets, and sanitized best practices up and coming region in the tech world like ours.” across the portfolio. We have also partnered with over 50 (and growing) service providers special- GUIDE TO CHOOSING YOUR VC STRATEGY izing in the startup community, who provide discounted services to our portfolio. How can VCs decide which role of the three (Finan- ff VC has a dedicated finance and accoun- cier, Mentor, or Portfolio Operator) they should choose? ting team which provides outsourced CFO, A company should determine its strategy based on both accoun ting, and related services to over a dozen the assets it has and those it can acquire. Some VCs have portfolio companies at cost. We particularly focus a culture and team that only fits one of the models we on helping our portfolio companies in raising later have discussed. However, when evaluating intangible rounds, preferably from Portfolio Operator VCs aspects of one’s competitive strengths, it is easy to over- like us, whom we know will add value. estimate one’s abilities. Therefore, VCs would benefit We work hard to build a vibrant entrepre- from a methodology to assess and evaluate rigorously the neur community through regular events and an assets they can leverage, as well as the most efficient way online community. This includes close relation- for them to build on those assets.

The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. ships with leading universities, which the com- We start by defining a method of objective mea- panies can tap for future employees and research. surement for a VC’s assets and evaluating the VC’s var- We also help the companies tap our proprietary ious resources: It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. database of talent in transition: high quality people who have told us they’re looking for great • Evaluating cash resources opportunities with pre-vetted startups. • Evaluating brand resources • Evaluating network resources International startups. Startups in places where • Evaluating in-house resources the entrepreneurship ecosystem is not as developed as the U.S. require more attention from investors. Fabrice These are detailed in Exhibits 1–4. Grinda is the founder and CEO of Olx.com and a serial

14 THE LOWER-RISK STARTUP: HOW VENTURE CAPITALISTS INCREASE THE ODDS OF STARTUP SUCCESS SPRING 2013

JJPE-TETEN.inddPE-TETEN.indd 1144 22/14/13/14/13 4:48:464:48:46 PMPM E XHIBIT 1 Evaluating Cash Resources

FURTHER AREAS FOR POTENTIAL tion between the assets a VC firm possesses, the role the INVESTIGATION GPs assume, and the performance of the fund the firm manages. Our initial findings, based on a limited set of A logical follow-up to our research would be a rig- survey responses, seem to indicate that there is a measur- orous, quantitative, statistical analysis about the connec- able positive relationship among the three factors. While

E XHIBIT 2 Evaluating Brand Resources The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission.

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JJPE-TETEN.inddPE-TETEN.indd 1155 22/14/13/14/13 4:48:464:48:46 PMPM E XHIBIT 3 Evaluating Network Resources

E XHIBIT 4 Evaluating In-House Resources The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission.

16 THE LOWER-RISK STARTUP: HOW VENTURE CAPITALISTS INCREASE THE ODDS OF STARTUP SUCCESS SPRING 2013

JJPE-TETEN.inddPE-TETEN.indd 1166 22/14/13/14/13 4:48:474:48:47 PMPM these initial results confirm our findings quantitatively, 11. How many investments have you made from the Most a more extensive dataset would be needed to achieve Recent Fund Near Liquidity and what has happened statistical significance. We designed a questionnaire (see to these investments? Appendices A and B) to measure the connections among • Investments made from this fund the three factors. • Exits with a money multiple of 3.0+ • Exits with a money multiple between 1.0 and 3.0 CONCLUSION • Exits with a multiple below 1.0 12. For your Most Recent Fund Near Liquidity, on how The venture capital industry fulfills a crucial role in many companies does one of your employees have a our financial system. VCs could have even more impact if board seat? they could improve their success rate. The crucial factor ______in achieving higher eff iciency is to understand your assets and choose a strategy that leverages your strengths and In this block we try to understand your and your f irm’s approach to supporting portfolio companies beyond simply mitigates your weaknesses. Those VCs who are honest providing capital. in their introspection and act accordingly are far more likely to be effective stewards of investor capital. 13. What is your portfolio management philosophy? 14. On a scale of 1–6, an investor should... A PPENDIX A 1: Focus only on picking the best teams and should not SURVEY OF VCs interfere with any operational issue at all 6: Provide hands-on support to the portfolio companies 1. In what year was your firm established? in a very structured and institutionalized way 2. In what year did you raise your last fund? 3. How much is your firm’s total assets under man- In this question, we would like to understand what you agement (AUM)—defined as the amount of capital believe the order of importance is for various shared services invested, but not liquid, plus capital raised but not yet an investor could provide to his or her portfolio companies. invested? (in million $) 4. How much money has your firm raised overall during 15. Please indicate how important it is for a VC to provide its lifetime? (in million $) the various types of support to the portfolio compa- 5. How many general partners (GPs) are at your firm? nies on a scale of 1–6: 6. How many portfolio companies does your firm have • Administrative help i.e., secretarial support (to port- currently? folio companies) 7. What is your typical investment size? (please indicate • Accounting support your answer in $) • Recruiting support In the following questions we try to understand the • HR support (excluding recruiting) performance of your f irm. In our study, we will link this data • Marketing/PR related support to aspects about operational support and thus will try to draw • Design support (graphic, UX, UI) The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. insights about the relationship between the two factors. • Management Coaching Services For standardization purposes, we’d like to focus our • Investment banking services (formally running analysis on one fund in your portfolio, the “Most Recent a capital-raising and/or M&A process, not just It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. Fund Near Liquidity.”We define this as the most recent fund ad-hoc introductions) that was raised prior to 2005. • Referral to preferred services providers • Exclusive events for portfolio companies 8. What is the of your most recent fund • Online community for portfolio company executives raised prior to 2005? • Other ______9. What is the overall IRR of your f irm for Most Recent Fund Near Liquidity? (in %) 16. What do you believe are the capabilities/assets your 10. What is the current money multiple of your Most fund possesses that your portfolio companies could Recent Fund Near Liquidity? (a number, not a range) most benefit from? (please rank)

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JJPE-TETEN.inddPE-TETEN.indd 1177 22/14/13/14/13 4:48:484:48:48 PMPM 1. ______• Design support (graphic, UI, UX) 2. ______• Management coaching services 3. ______• Investment banking services (formally running a Comments ______capital-raising and/or M&A process, not just ad-hoc introductions) In this question, we would like to understand the mix • Referral to preferred service providers of services that your firm provides “beyond the money.” • Exclusive events for portfolio companies Please indicate the level of service your firm provides • Online community for portfolio company executives to the portfolio companies in each category. • Other ______0: No help at all, entrepreneur should handle it 17. What question did we miss in this survey that we 1–3: GPs leverage their network, but no structured should have asked? ______processes exist 18. What advice do you have for other VCs who would 4–6: GPs use tools to measure the need for and the like to increase the value of their portfolio companies? effect of their help and provide it accordingly Please tell us if we can quote you by name for your 7–9: There is a team of free lancer professionals at the response to this specific question. ______disposal of portfolio companies 10: There is a full-time in-house team at the disposal Thank you for dedicating the time and effort to filling of the portfolio companies out our survey! We strongly believe that the insights drawn from this study will benefit not only the venture community, • Administrative help i.e., secretarial support (to portfolio but the U.S. economy as a whole. companies) We will handle your data with the highest degree of • Accounting support privacy. All results will be anonymized, and the majority of • Recruiting support the analysis results will be based on aggregated measures. • HR support (excluding recruiting) What is the name of your fund? (Optional—results will be • Marketing / PR support anonymized and aggregated) ______• Design support (graphic, UI, UX) • Management coaching services • Investment banking services (formally running a A PPENDIX B capital-raising and/or M&A process, not just ad-hoc introductions) SURVEY OF ENTREPRENEURS • Referral to preferred service providers 1. In what year did your startup become live? What year • Exclusive events for portfolio companies did your CEO/Founders start working full time? • Online community for portfolio company executives 2. In what year did you receive your first round of non- • Other founder capital i.e., the first round of capital raised from outside investors (could be VCs, Angels, F&F)? In this question, we try to understand the magnitude of 3. What was the post-money total company valuation of this your firm’s commitment in the various support types. first round? (please indicate your answer in million $) How many dedicated professionals does your firm 4. How many employees did you have upon raising this employ in the various support functions, and in what year

The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. first round of funding? have you established the given support groups? 5. How much of your (company leadership) is spent on Please provide your response in FTE (full time employee) non-customer and non-product activities? Includes equivalent. If someone works part time, count him or her as It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission. legal, office admin, accounting, other vendor/supplier a fraction of 1. search, setting up office IT, and payroll/HR issues (ex. recruiting) • Administrative help, i.e., secretarial support (to port- folio companies) • _ Very Little (<10%) • Accounting support • _ Significant time (10% − 30%) • Recruiting support • _ A lot of time (30% − 50%) • HR support (excluding recruiting) • _ It is killing me (>50%) • Marketing / PR support

18 THE LOWER-RISK STARTUP: HOW VENTURE CAPITALISTS INCREASE THE ODDS OF STARTUP SUCCESS SPRING 2013

JJPE-TETEN.inddPE-TETEN.indd 1188 22/14/13/14/13 4:48:484:48:48 PMPM 6. Please tell us how your investors (VCs or Angels) have 9. What is your current number of employees? given you support on the following dimensions—check 10. What question did we miss in this survey that we all that apply of the following: 1) structured & con- should have asked? sistent support through dedicated personnel, 2) list of Thank you for dedicating the time and effort to fill out preferred vendors who provided me with support, 3) our survey! We strongly believe that the insights drawn from ad-hoc advice (upon need), 4) none this study will benefit not only the venture community but • Recruiting the US economy as a whole. • Admin We will handle your data with the highest degree of • Legal privacy. All results will be anonymized and the majority of • Operations the analysis results will be based on aggregated measures. • Marketing / Customer Development What is the name of your company? (Optional - results • Procurement will be anonymized and aggregated) • Accounting In case you wish you wish to receive the aggregated results • Other ______from this survey, please leave your email address below ______7. Please tell us how helpful it would be to you to have advice and structured support from experienced VCs in ENDNOTES the areas below—check one of the following: 1 1) Extremely important (They have access to resources Our research originated as an MBA student research I could not readily access myself), study by Adham AbdelFattah, Koen Bremer, and Gyorgy 2) Important (Their involvement will save me a lot of Buslig, closely advised by David Teten, and sponsored and time), supported by Professor Morten Sorensen, Columbia Business 3) Neutral (I can do it but it’s nice to have), School Daniel W. Stanton Associate Professor of Finance and 4) Unimportant (Don’t really need it) Economics. 2N. Wasserman. “Upside-Down Venture Capitalists and • Recruiting the Transition toward Pyramidal Firms: Inevitable Progres- • Admin sion, or Failed Experiment?” In Entrepreneurship (Research in • Legal the Sociology of Work, edited by L.A. Keister, Vol. 15. Emerald • Operations Group Publishing, 2005. • Marketing/Customer Development 3See http://venturebeat.com/2012/08/13/google- • Procurement ventures-startup-lab/view-all/. • Accounting • Other ______To order reprints of this article, please contact Dewey Palmieri 8. What was the latest post-money valuation on your at [email protected] or 212-224-3675. company? (please indicate your answer in million $) The Journal of Private Equity 2013.16.2:7-19. Downloaded from www.iijournals.com by Jeanne Miller on 04/03/13. It is illegal to make unauthorized copies of this article, forward an user or post electronically without Publisher permission.

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