Information Arbitrage

Building the perfect machine

Mon, 14 May 2012 10:46:56 -0400

If the goal is to do something exceptional, nothing is more important than building a great team. It is very rare that success is a truly individual discipline. Whether one is talking about world-class researchers, top-tier tennis players or sought-after start-up founders, stellar results are the outgrowth of carefully coordinated and chemically-balanced team efforts. I had the benefit of witnessing this first-hand during my Wall Street career and subsequently in my time as an angel and venture investor. The best leaders consistently attract and retain the best teams. But doing this requires a level of self-awareness and humility that is hard to find in nature.

Team-building is hard because it is partly a function of filling in gaps, not only in bandwidth but also in ability and skills. And for super motivated, opinionated, stubborn, high-performing individuals, it isn’t always easy to say “I suck at this: I really need to get someone who is much better than me and from whom I can learn.” But the best find a way to do this. And this isn’t just about Mark and Sheryl or Larry, Sergey and Eric, but about every start-up, every large corporation, and every focused unit where there is a concrete mission and a need for diverse skills and perspectives to achieve the mission. Running a bake sale. A Little League. A product team. It doesn’t matter: the requirements are the same.

My experience in constructing the IA Ventures team is a microcosm of the team-building challenge. When I first conceived of the firm, I recognized that to fulfill my vision of being the go-to seed stage venture partner for all things data I needed several elements, many of which I did not possess:

Deep technical and product knowledge, Ph.D-level depth plus years of practical experience, that could be used to both assess and advise companies on technical issues such as scaling, managing the release cycle and bridging the gap between technology and product. This is a skill set and range of experiences I definitely did not have.

Operational start-up experience, as one who has started a company, built the infrastructure, models and controls, yet has the skill sets of a financial manager that can help advise seed stage companies on modeling, budgeting and tactical decision-making. My experiences touch these areas but don’t represent the ways in which I can personally be most valuable as an investor, adviser, mentor, strategist and partner.

Higher-order financial modeling skills together with a voracious appetite and aptitude for understanding markets, analyzing the competitive landscape and constantly asking questions to keep our firm’s thinking rational and pure. This is an essential part of the connective tissue that keeps everything humming among the firm, the portfolio and the market.

To this end I went out and was able to lasso Brad and Ben, and subsequently Justin and now Jesse. They are all awesome but they are awesome not merely as individuals but because of the separate yet distinct roles they play on the team. Brad sits on a handful of Boards but has helped most if not all of IA Ventures portfolio companies as a sounding board on technical issues, tech recruiting, product roadmap and myriad other topics. Ben also has his complement of Board seats but has certainly helped the majority of IA Ventures’ companies with their budgeting, staffing and financing strategies. And Jesse is a gem of a resource that has literally helped several companies rebuild their financial models, perform very targeted research and stay on top of market developments. And I lead several investments while assisting all companies in our portfolio with financing strategy, business development, recruiting and ensuring that our portfolio company teams know each other and ways in which they might help each other. Rather than feel threatened that I have teammates and partners who are better than me at a bunch of stuff, I am so thankful that our team - the machine - is working well for the benefit of our company partners, our LPs and our firm. It was a very deliberate process and it has been the single most important thing I’ve done since starting IA Ventures. Without all elements of the team we wouldn’t be where we are today.

For the last 25 years I’ve been in pursuit of the perfect machine, that just-right group of people with whom to pursue a shared mission. Sounds a lot like the challenges of our founders, no? It is. Team first. Because with a great team, achieving even big, honking, seemingly insane and audacious goals are comfortably within reach.

Play your game

Fri, 11 May 2012 14:42:16 -0400

I’ve written a lot about the importance of focus among start-up teams. This is a very closely held belief. Develop a hypothesis. Test the hypothesis. If proven, move forward and add gas. If disproven stop, take stock, and determine whether or not to gin up a new hypothesis or go home.

The same is true for investors. All the noise around crowdfunding, party deals and all-angel rounds changing the face of the venture industry doesn’t resonate with me. What it does say is that there is more seed stage capital available from a broader array of sources that will give more chances to more people to start companies. All I have to say is: Bravo!

But to be clear, I don’t perceive this as a threat to early stage venture for many reasons. As a venture investor who is comfortable with the way I and my partners do business, I am confident that teams which see the value in working with us will choose to work with us regardless of the other options out there. Also, more interesting businesses seeded by others provides us with additional data concerning product/market fit, adoption and engagement that can go into our decision-making and relationship-building process. Nothing scary here.

Also, I’ve found that many seed stage start-ups actually want a heavier-weight, more engaged lead investor than a more diffuse group of awesome investors but where no single investor has a deep commitment to the company’s success. I completely acknowledge that lots of start-ups don’t feel they want or need this at the seed stage, and that’s totally ok. But those often aren’t the start-ups that we’re investing in. It’s just not our game.

But the bottom line is that for us it isn’t necessarily about leading or following, small investment or larger check. It is much more about team fit and excitement for the mission. Because when there is great chemistry and trust between ourselves and our founder partners, the relationship tends to work itself out in ways that benefit both parties. We might want to buy up in the company, and the team is psyched to get us more involved and more economically aligned with them. And when this happens it is an incredibly exciting and fulfilling thing.

But the key message is: know what you’re about, forget about what other people are doing and be comfortable in your own skin. Successful venture investing is a long time scale business, and the results of investment decisions will stay with you for years. So be confident. Be comfortable. And by all means do not simply follow the pack because it’s popular. Make no mistake, it’s hard to stay strong against the trend when others seem really successful and are getting all the kudos. But don’t fall prey to this dynamic. Just play your game.

Some thoughts on JPM

Fri, 11 May 2012 10:09:59 -0400

With the web afire with criticism over JP Morgan’s recently announced (and unexpected) $2 billion trading loss, a few “life lessons” came to mind as to how Jamie Dimon - and his PR department - bungled this badly:

Know the facts before taking a stand. When news of a “London Whale” came to light a month ago, and this trader was linked to JP Morgan, Dimon issued a strenuous denial that his was a big deal. According to the Wall Street Journal, and I’d tend to agree with them, Dimon didn’t understand the true extent of his trader’s activities or the risks it posed to the firm. Fast-forward to today: he looks like a terrible leader, one who allowed a trader one of the biggest risk books on the planet without knowing how it was impacting the firm’s financial position. Why on earth would he make a statement about this trader’s activities without truly understanding their impact in depth? His typical bravado backfired in this case. He should have heard the rumblings, did a deep forensic dive into the facts, developed a view and then communicated to the media. He chose not to follow this approach and got absolutely skewered. And deservedly so. He failed Crisis Management 101. Perhaps he should have learned from J&J’s handling of the Tylenol scare. Lives may not be at risk here, but given how far out on a limb he had gone in denying any problem (and now knowledge of the problem) his PR morass is pretty hairy.

Avoid taking self-righteous positions. For all the skill and opportunism with which Dimon navigated JP Morgan through the financial crisis, he has long touted his emphasis on risk management and on prudent risk-taking. He specifically sought to paint his firm as distinctly different than those “cowboys” at Bear Stearns, Lehman and the other investment banks. Better diversification. Greater breadth. Better risk controls. These were the hallmarks of JP Morgan as a world-beater, largely immune to the troubles of its bulge bracket peers. Both the communication breakdown and lack of risk controls giving rise to this massive loss are completely at odds with his characterization of the firm. If you put yourself on the top of Mt. Olympus, you are always prone to a nasty fall if messaging and reality are found to be mis-aligned - as they are in this case.

Stop thinking that VaR has any linkage with reality. While Dimon himself may not have been aware of the magnitude of the Whale’s risk position, certainly his risk managers were. And if they were using VaR, they should be skewered as should Dimon. Have we learned nothing? I was musing about problems with VaR and Sharpe Ratio six years ago, and in between we’ve seen the 2008 crisis and myriad mini-crises in between, and the fact that VaR is still a bedrock of financial disclosure - and financial risk management - is chilling. But hey, we’re still in a world where there are huge arguments over the imposition of true mark-to-market accounting rules, enabling financial firms to present something less than a true picture of how assets and liabilities are valued on a liquidation basis. We should isolate long-term assets and liabilities - those that are truly match-funded on a duration adjusted basis. Then we should look at those short-term assets and liabilities and look at the costs for hedging out the residual risks, understanding the market’s assessment of the true mark-to-market exposure. Why this isn’t current best practice for disclosure is beyond me, but at the very least these tools should be employed within all financial firms, not only the JP Morgan’s of the world (though given their systemic importance they should be mandated by both regulators and the FASB).

Acknowledge that the SEC will forever be playing catch-up. The metaphors that come to mind are Network Security Specialists vs. Black Hat Hackers. Or WADA (the world anti-doping authority) vs. Steroid Using Cheaters. It is a classic good guys vs. bad guys conflict (though I am operating on the assumption that the SEC are the “good guys” - I believe they are trying, just failing). They are out-manned. Out-paid. Out-incentivized. Out of luck. The fact that Mary Schapiro just uttered “I think it’s safe to say that all the regulators are focused on this” is akin to the fire department showing up after the house has burned down. The system is broken. The accounting rules are flawed. Risk analysis and disclosure is flawed. And the regulatory framework is broken as well. Losses of this nature should not come as a surprise. They have and will continue to occur in the absence of common sense disclosure and elimination of all the obfuscation that has been allowed to pervade balance sheets for generations. It’s just that the ante has risen given the magnitude of the risks being borne, the inter-connectedness of the major players in the financial system and the complexity of the tools being used to take risk. It’s not your father’s bond and risk arbitrage portfolios any more: it’s derivatives of all shapes, sizes and liquidity. Until rigorous mark-to-market rules are enacted that facilitate the transparency required to regulate properly, the SEC is fighting a losing battle. All good things stem from transparency. But a broken SEC is good for shareholder-funded speculators. The longer it stays broken, the longer they get to continue making asymmetric bets in their favor (heads I win - tails you lose).

While to many the JP Morgan trading revelations might have been shocking, they should’t have been. The system for deeply understanding financial institutions’ risk is flawed, both inside and outside the house. Until this fundamental weakness is addressed, it doesn’t really matter what the SEC does. Our banks have more than enough latitude to get themselves - and our financial system - in trouble.

Board member vs. mentor dynamics

Tue, 08 May 2012 16:47:22 -0400

As a venture investor, I spend a ton of time trying to as helpful as I can be to my portfolio companies. Most of my regular contact is with the CEO and founder. I actively try to understand what they most need from me and to give it to them. Sometimes it is functional help: thinking through their financial model, hiring plans, financing strategy, etc. Other times it is help “closing the deal” with key accounts or recruits. But there are moments when what they really need is a confidant, someone whom they trust and who can give them truthful, unvarnished feedback and perspective in a safe environment. This is a role that I very much want to fill, but sometimes structural dynamics makes this hard if not impossible. The reason: as a Board member, I play an important role in reviewing and paying the CEO as well as potentially even relieving them of their duties. It is a relationship laden with potential landmines because of the issues such as fiduciary responsibility, money and power.

The role of the Board has been written about both extensively and well. Suffice it to say, a good Board is a very powerful tool for helping a CEO achieve a Company’s full potential. However, as noted above, members of the Board are not a proxy for a trusted advisers or independent mentors. They may act as advisers and mentors, but in a highly bounded manner because of their power to act on the CEOs words. External advisers and mentors have no such power and don’t have split loyalties, whereas the Board member has fiduciary duties to their own Limited Partners in addition to all stockholders of the Company. It is a delicate dance that by definition causes CEOs to avoid full disclosure and share the true depths of concerns weighing on their minds and in their hearts.

This is why it is critical for CEOs to cultivate a rich set of mentors and advisers to whom they can turn for hard questions and candid insights in a private manner. Building and running a company, especially a start-up, is incredibly difficult and stressful, and it is critical that the person bearing the brunt of expectations have a release valve. It’s just that this release valve sometimes can’t be a member of the Board.

As an investor and partner with management I believe deeply in the value of a strong Board of Directors. However, as an investor and partner with management I also feel passionately that CEOs have a portfolio of people outside the Company from whom they can get honest advice without worrying about disclosure. Both roles are essential to the building of a healthy Company (and the maintenance of a healthy and well-adjusted CEO!). I have lots of experience playing both roles, and it is hard to say which one I like better. I think the potentially more interesting question is which role actually conveys the greatest influence - legitimate authority (as a Board member) or expert authority (as a mentor). It would make for an interesting debate.

Entrepreneurship and optionality don't mix

Tue, 01 May 2012 22:44:05 -0400

Laser focus vs. keeping options open. This is an eternal struggle faced by start-up founders and corporate CEOs alike. While focus brings both purpose and increased odds of meeting a particular goal, leaders are plagued by the fear of “What if the goal I’ve achieved is the wrong goal? I’ll have hurt the company, my reputation, my ego and my career in one fell swoop.” This dynamic was outlined in a recent Harvard Business Review article discussing Apple’s success in the wake of Steve Jobs’ return:

But then my Apple lunch companion wondered aloud: “Why don’t more CEOs bring greater clarity to what their companies should not be doing?” It’s a significant question.

***********

In some ways, it makes perfect sense. CEOs often want to keep their options open. If they put all of their energy behind a single idea and it goes wrong, they will feel the full brunt of the blame. Yet, by pursuing too many priorities, these CEOs may actually be risking future success even more.

My friend and co-investor Mark Suster raised a similar point in a post published today:

It’s tempting to take on new projects, new features, new geographies, new speaking opportunities, whatever. Each one incrementally sounds like a good idea, yet collectively they end up punishing undisciplined teams. I like to counsel that the best teams are often defined by what they choose not to do.

This is an area where we spend a tremendous amount of time with our companies. We are passionate about focus, especially at the earliest stages where distractions often mean not shipping software, and not shipping means not being close to customers and getting feedback, which essentially means flying blind. Once a start-up begins living in its head and not in the market working to make customers happy, the chances of actually achieving happy customers and product/market fit fall off a cliff. This frequently happens in nascent markets, where the possibilites to make customers happy seem endless and inexperienced but eager managements want to keep all options open until it is virtually certain what customers want. In real life, however, this is not the way it works.

Success - and failure - is bred of having a hypothesis, aggressively testing that hypothesis, collecting feedback, seeing if the original hypothesis has been proven or disproven and going from there. If the hypothesis has been proven, fantastic. Live close to the customer, identify KPIs, use cohort analysis to inform tweaks to optimize the user experience and scale like crazy. If the hypothesis has not been proven, however, there are a few options:

Pack it in - you are far away from something real people care about and the learnings you’ve derived don’t spark a new and better hypothesis;
Refine the original hypothesis - while you haven’t demonstrated product/market fit and created happy users, you have learned enough such that the original hypothesis can be modified in light of user feedback and a new product can be developed an introduced.

Either of these are perfectly reasonable outcomes, because they involve being in the market, testing with real users and applying the full resources of the company to the challenge of achieving product/market fit with a single product. It is hard to do this in a disciplined manner with even one product much less a diffuse set of products, ideas or hypotheses. In order to really test a hypothesis I believe founding teams need to “burn the boats” - go all-in on a particular hypothesis and see it through. While it might seem smart to keep options open by spreading resources across several initiatives, in reality this only lowers the likelihood of any one initiative actually succeeding. Making customers happy requires maniacal focus, focus that is impossible to achieve when preserving optionality is a primary goal.

Venture capitalists have inherent optionality by virtue of portfolio diversification. Great entrepreneurs have no such luxury. They are all-in on a particular idea or hypothesis. It succeeds or it fails, is proven or disproven. If failure is done well, it can either lead to success in the current venture or spark success in future ventures. Founders who fail well are generally viewed with respect by the angel and venture communities and have the chance to start over. This is where valuable “founder optionality” comes in. But intra-venture founder optionality? I don’t think so.

Founding is hard and scary yet also emancipating. If you’re going to do it, then do it. Don’t hedge. Go all-in and do it well. Because if you do, succeed or fail, you will have the kind of optionality that really matters - the chance to try again.

Being a builder: balancing conviction and criticism

Mon, 30 Apr 2012 23:05:16 -0400

Building is hard. It just is. Great builders have bold visions, boundless passion and ample energy to achieve the mission. However, great builders also find it necessary to course-correct based upon objective data, subjective input or gut feel that synthesizes both quantitative and qualitative factors. At accelerators the term “mentor whiplash” is bandied about to describe the myriad perspectives received by start-up teams, much of which is conflicting yet delivered by credible people. Who is right? Who do you trust? There are no easy answers.

This is an issue I personally experience every day in the building of IA Ventures. I came into the business with several hypotheses about investment theme, investment selection and portfolio construction. I also had several hypotheses about the way we should engage with teams, participate in financing rounds and take board seats. There are a large number of variables at play with few clear “dos” and “dont’s” marking the path. And to make matters even more confusing, there are people whom I respect greatly that are taking vastly different approaches in how they invest in and advise companies as well as shape their portfolios (think 500 Startups vs. Union Square Ventures). Who is right? Who is wrong? Who knows. Nobody does. It is easy to get caught up in the advice and approaches of others and to lose yourself in the process. Successful builders do not let this happen.

I’d love to say that if only founders followed a particular path they’d be assured that their company would achieve its maximum potential. Reality is quite different. Having deep conviction around solving a specific problem or engaging users in a meaningful way is the essential element for starting a company. From there, however, art and science diverge. As you build the company, shape the product and spend time working with and trying to acquire customers, you will collect a bunch of data. This data will give you a sense of whether or not you are on the right track and if a broader array of users perceive your product’s value in the way you do. You will also likely observe others in the marketplace, both direct competitors and those whom you aspire to be which will influence your thinking. You might also have mentors and advisers with relevant experience and perspective who will weigh in, filling out the information mosaic.

Distilling relevant input and shaping the product without losing the essence of the vision and mission is the delicate balancing act most founders face. Some founders hit product/market fit just right the first time. But the overwhelming majority do not. They have to synthesize massive amounts of structured and unstructured data and make good decisions. This is the magic of great builders.

As I reflect upon my own learnings, I have tremendous empathy for the challenges faced by founders. To have conviction but to avoid being pedantic or foolishly stubborn. To be flexible and adaptive but to maintain the essence of the mission. Being a great builder, whether in start-ups, large corporations or any other place where leadership matters is a matter of balance. And achieving balance requires confidence. NB: Great builders are confident - make no mistake about that.

Should venture capital scale?

Fri, 06 Apr 2012 13:06:48 -0400

My friend Dave McClure’s thoughtful and provocative post on the scaling of venture capital made me think. It definitely rubbed me the wrong way and I think I know why - because I don’t take it as a given that venture firms, by definition, should scale, whereas the premise of his post seems to be that we as an industry are failing by not doing what we are telling (and hopefully helping) our companies to do. I think this grossly simplifies what “venture capital” means and holds it to a false standard that isn’t helpful to building big, disruptive, awesome companies.

Entrepreneurs are the customers of the venture investor. A big difference between the VCs customers and those of, say, Dropbox, is that there is far greater heterogeneity among the VCs customers. While there are myriad use cases for Dropbox, the scope of product that satisfies those use cases is well-bounded. Not so among the VCs customers. The range of variability arising from different personalities, experience levels, competitive landscape, skills sets and team chemistry creates a need for what I’d classify as a “customized” product. It is more akin to a custom-made suit than a pair of athletic socks. It is not a game of portfolio diversification: it is a craft, with each company as its own discrete project warranting that level of attention, guidance and support. This, of course, presupposes that the venture investor actually adds value, versus the view that money is fungible and investors are undifferentiated.

I can’t speak for the entire industry but I can certainly speak to a sizable group of venture investors I know who definitely have a material positive impact upon the performance of their companies, and I certainly hope IA Ventures falls into this bucket as well. Because if money is really all that matters, then why is there a perceived hierarchy in the industry at all? Why should one firm’s historical performance or star partners give them an edge over anyone else? Answer: because it does matter. Great investors make a company more valuable by helping the team think strategically, recruit, react, problem solve, make difficult decisions and handle hard times. And it is this value that can sometimes lead a company to choose a lower offer from one partner they think can make the enterprise much more valuable than another. It actually can be rational to take the lower offer in the short term for a far greater payoff in the long term.

Investors like Dave play a hugely valuable role in the startup ecosystem and help lay the foundation for others who manage smaller, more focused portfolios and are able to invest a lot more capital and to spend a lot more time on a particular company. I do not believe the industry would be best served by all firms looking like 500 Startups. Venture investing is its own “attention economy.” There simply isn’t a way that a great partner’s attention can scale beyond a certain point, and then the question is whether or not providing a lot of attention to a smaller number of companies into whom one has invested larger dollars makes sense. I personally think it does and have built my business around this premise.

I believe firms like IA Ventures play a vital role in the company building process, just a different role than investors like 500 Startups. And I can assure you, we don’t scale well. I actually think scaling in venture capital has rapidly diminishing returns beyond a small number of investing professionals, when the weight of organization begins to place a tax on attention beyond what is spent working with companies and getting valuable input from one’s partners. This is why I respect firms like USV and Foundry who have a commitment to remaining small and working closely with their portfolio companies.

In sum, I applaud Dave and the transformational effect he has had on the seed stage investing scene. I think start-ups could definitely benefit from more firms like 500 Startups. However, I think it is a valuable but insufficient component of a robust venture capital industry. I fundamentally believe concentrated attention can be value accretive, but that this type of engagement doesn’t scale. So what - why does it have to?

When "free" and "no fee" is anything but

Fri, 06 Apr 2012 00:24:55 -0400

A recent tweet from friend Aaron Pressman reminded me of a long-standing deception that needs to be corrected - clarity around the meaning of “free” and “no fee.” In the article Aaron cited, both BNY Mellon and State Street are are being sued by state pension funds over lack of truth in marketing around foreign exchange trades. In essence, trades which were represented as being “free” or “based on market prices” resulted in transactions which in a competitive environment generate small but low-risk profits for executing banks but yielded massive profits for these firms. Why? Because they played fast and loose with the actual exchange rates. Was there a “fee” in executing a foreign exchange trade that didn’t have an explicit charge but resulted in an actual profit that resulted from off-market execution? Is a trade based on “market prices” that takes that market price and increases the execution spread by, say, 10-fold? Well…

The amazing thing is that these techniques form the very foundation of the money transfer business. How often do you walk through airports and see words like “no fee money exchange” and the like over those little booths with the thick glass staffed by young, well-coiffed people sporting big smiles? I do all the time both here and abroad. And you know what? They make a fortune. Why? Because while there isn’t an explicit fee, the bid/offer on the foreign currency transaction is mind-boggling. It is among the most attractive businesses on the planet - at present. It is a shining example of false advertising, as well as lack of transparency around the economics of the relationship. And it’s not just the money changers that follow this practice but large banks as well. Try and wire money cross borders and people are focused on the wire fee, while all the real money is being made on the spot currency transaction. No risk. Almost infinite ROI for the banks.

What we’re now seeing being litigated in the institutional markets has been happening in the retail markets since the beginning of time. It’s sleazy. it’s wrong. And it’s time to fight back. I have no problem paying for value and compensating parties for risk, but I don’t like being ripped off or seeing others getting fleeced, either. While BNY Mellon and State Street are have their practices challenged by deep-pocketed pension funds, what about the small retail customer that needs to send money home or move money across border to pay for educational expenses or rent? Aren’t they due the same square deal?

Talk about an area ripe for disruption…

Being the preferred investor

Tue, 03 Apr 2012 11:41:00 -0400

I’ve had the words “deal hunting” written on a yellow stickie by my desk as a reminder to write a post on how we compete for investment opportunities. Then Fred’s recent post Coming of Age helped to further clarify my thoughts on the matter. I think this issue is most relevant for younger firms who have yet to create the brand value and track record of a Sequoia, Kleiner, Union Square or Foundry, but is still important for the platinum-branded partnerships lest they get lazy and risk getting lapped by hungrier, newer firms. One need look no further than the impact of Andreessen Horowitz to know that new firms can - and will - disrupt the historical pecking order through innovative approaches to working with entrepreneurs.

As the leader of a young firm, I think I’ve got a pretty good lens on the challenges of newness and competing in a highly competitive marketplace against much larger, more established partnerships. Ultimately IA Ventures’ success will be a function of partnering with great teams in areas ripe for disruption where the opportunities for building big, important businesses are high. But how do we even get the chance to work with these great teams when there are so many other firms from which to choose? And how do we convince these teams that we’re in it for the long-term, and willing and able to support them through the inevitable early bumps and stumbles?

Upon reflection, I think you can break IA Ventures’ strategy for differentiation into three essential elements:

Focus
Engagement
Long-term perspective

Focus

When I started IA Ventures back in 2009, I articulated a vision laser-focused on the creation, management and extraction of value from large, often real-time data sets. Why? Because data and its effective management is going to change the world and be the catalyst of change for a generation. It is a thematic, geography-agnostic approach that cuts across industry verticals. The vision encompasses both core technologies and applications and involves building an investment team with expertise and passion in these areas. Bringing on Brad and Ben were the first steps, followed by Justin, Drew and Jesse. Deep technology, data, infrastructure, hacking and financial expertise. And most importantly a passion for the mission. We put a stake in the ground and worked hard to build awareness across the entrepreneur, data science and business communities that we aren’t messing around in data: we are ALL ABOUT DATA. And it is crystal clear that our investment focus, skills, relationships and interests support this strategy. This has been a boon for our firm and our portfolio companies, as it has created beneficial network effects among our companies. Different companies. Different missions. Data and data-related technologies at their core, with IA Ventures being the connective tissue linking them together.

We have also sought to catalyze an ecosystem around our mission and focus, aided by our relationships across the various communities of which we are a part together with our portfolio companies. We have also worked hard and brought our energies, expertise and networks to awesome programs such as Techstars and HackNY. I don’t think there is much ambiguity at this point about what IA Ventures stands for, or the kind of value we can bring to our portfolio companies. Some companies will want it; others will not. But by being extremely clear about our focus and demonstrating this in myriad ways, we have sought to create an identity and an edge that helps us become the preferred partner for particular teams.

Engagement

Different investors have different styles, and founding teams need to figure out what they really want because the range of engagement differs massively. At IA Ventures, we are unapologetic about our high level of engagement. Hopefully not in the annoying, stereotypical VC way of being micromanaging yet ultimately unhelpful, but by bringing our deep domain-specific knowledge and web of relationships to our partners. And make no mistake: we do not think of our companies as “investments” as one thinks of chess pieces arranged on a board. We work hard to function as partners with our founders, and to establish a level of trust and rapport that makes difficult but honest feedback safe to deliver. Vinod Khosla has been a great mentor in this respect: he hates referring to himself as an “investor,” when he really feels and acts more like a partner or as a co-entrepreneur. We completely buy this perspective and work hard to engage with our companies in this manner.

Part of the reason we run as concentrated a portfolio as we do is to have the time available to be active and productive partners, particularly in ways that can materially impact the outcome for our companies. The entrepreneurial ecosystem is pretty small and companies share notes. There is an efficient information economy in how venture firms interact with their portfolio companies, spanning the range of the good, the bad and the ugly. I believe that the way we engage with our companies has created a positive reputation that has helped us in the marketplace, and solidified our position as a preferred partner for many kind of companies. And while I don’t have any hard data to support this notion, the anecdotal evidence is pretty strong. Regardless, this is the way we roll, and ultimately believe that this is the way we can best help our companies achieve their full potential and to create superior financial returns for our Limited Partners.

Long-term perspective

If there is one thing investors in early-stage companies come to know, it’s that there is seldom a linear path to success. In fact, it is rare that the business which ultimately succeeds is exactly the business that was envisioned at a company’s inception. And coping with these inevitable zigs and zags during a company’s early days requires both a cast-iron stomach and model that supports experimentation, discovery and change. Writing a company off at the first signs of trouble? Not helpful. Being punitive and angry when early targets are missed? Also not helpful. Mentoring and coaching young teams with whom you’ve decided to partner because you believe in them and giving them time to test, collect data, fail, test, collect, adjust, iterate, move into production and mature? Much better. We believe that if you are truly committed to investing in early-stage companies then you have to provide the necessary support and time to discover the right business and model. Sometimes this involves providing additional financial runway. Sometimes it doesn’t. But it certainly means a mind-set of partnership and patience in order to let the team whom you’ve backed to give it a real shot. And if they ultimately do demonstrate product/market fit and traction that warrants additional investment, that you’ve reserved additional capital to support the next phase of their development.

Much as running a concentrated portfolio enables us to be truly engaged partners, it also provides us with the financial capacity to reserve heavily for follow-on rounds, such that we can lead seed, Series A and and even Series B rounds, and to do pro ratas when other great investor/partners join the investment group. We have always taken a life-cycle approach to investing while initiating our investments at the seed or Series A stage, and believe this is another way we’ve created a positive reputation in the marketplace that is valued by both our current and future founder-partners.

At the end of the day the most important thing is to be true to yourself, your mission and your partners. The IA Ventures strategy has been to line this stuff up and to execute our plan. And while we’re still a young firm and have a ton to learn, I think we’ve done a pretty good job creating an identity, reputation and track record that is appealing to many of the companies with whom we want to partner. But we can - and we will - get better.

Thoughts on VC portfolio construction

Sun, 18 Mar 2012 13:15:00 -0400

Issues such as “portfolio construction,” “reserve policy” and “forced rankings” don’t make for sexy reading, but in my opinion are critical elements to building and managing a successful venture investment portfolio. Given that I am trying to build the best venture partnership I can for the long-term, I am seeking to optimize across three dimensions: (1) Generate the highest cash-on-cash returns for our LPs; (2) partner with and assist early-stage companies to build truly transformational businesses; and (3) earn a reputation among entrepreneurs as the “go to” partner in our key practice areas. Seems pretty straight-forward, right? In practice it is not a trivial matter.

Consider the breadth of the venture investment spectrum. On one end there are individual angels writing $25k checks into concepts scribbled on the back of napkins to quasi-private equity pre-IPO investing and everything in between. As a long-time market practitioner, my goal has always been to identify the optimal point along the “efficient frontier.” Most frontiers are not smooth lines but jagged functions where there are certain spots that yield superior returns for a given unit of risk. The question is: where, if any, do these points exist in venture investing?

It is easy to conceptualize the trade-offs at the extremes. Extremely broad angel portfolios are trying to capture the generational outliers (Facebook, Google, etc.), while having small absolute dollars and percentage ownerships in each of their portfolio holdings. More concentrated late-stage funds are calibrated around 2-3x exits with sharply lower risk with time horizons dramatically compressed relative to early-stage investors. But what is less clear are the risk-reward trade-offs among larger seed, early Series A, mature Series A, Series B and Series C rounds. Obviously owning more earlier is better - if you are right. But being right is still a very risky proposition particularly in seed and Series A investing (though some professional LPs view even Series B companies as having experienced limited risk reduction), which begs the question: unless you are going to build a massively diversified seed portfolio, does doing seed investing really make sense at all? And if you’re not going to do a diversified mix of seed, Series A and Series B, does it make sense to play at these stages or rather move towards the Series C/D/E “growth” end of the investment spectrum?

From a pure math perspective, if someone wants the opportunity to secure truly extraordinary exit multiples, ownership needs to be established before the growth capital phase. While institutional LPs are generally happy with 2-3x cash-on-cash returns from this portion of the investment spectrum, it is because mortality is dramatically lower than in earlier stage investing and exit multiples reflect this lower level of risk through higher prices paid. It also follows that the variability of these returns is much lower than in early stage venture. In my discussions with experienced institutional LPs, my sense isn’t that they expect to achieve multiples well in excess of this across their early-stage portfolio, but that there is a meaningful chance that they can, e.g., a return distribution that exhibits positive skewness. In essence, whether they acknowledge it or not, that they are trying to isolate upside volatility while backing a set of managers with sufficient geographic, thematic and stage diversification to avoid extreme downside outcomes. Each LP has their own view of portfolio diversification which differs from that at the fund level. For instance. I can intuit that my partners are not interested in IA Ventures “diversifying” for diversification sake - they are doing that themselves at the portfolio level. They want me to try and identify potentially extreme outcomes and to invest as much capital in those few opportunities as I possibly can. But as a manager running my own business, I am conscious of trying to achieve my own optimal mix of risk and return, LP agendas notwithstanding. Besides trying to help my companies as best I can, this is the issue that gives me many sleepless nights.

Our thinking at IA Ventures has evolved during Fund 1 and into Fund 2. One basic premise under which we operate is that our tight thematic focus and domain expertise helps us filter, and requires a smaller portfolio in order to achieve the diversification benefits of larger, more generalized portfolios. For our $50 million Fund 1, this meant a portfolio of 20-22 investments from which to hopefully identify 4-6 investments that will generate >10x type returns. Further, it is necessary that we own enough of these >10x investments to drive an overall portfolio return of at least 3x (and hopefully higher). Given the ownership requirements in conjunction with our modest fund size, our belief was that we’d need to establish the lion’s share of our positions at the seed stage in order to achieve our initial ownership targets (and subsequent pro rata rights) and execute the plan. And this is exactly what we did in Fund 1 - 21 investments, almost all established at the seed (or pre-seed) stage, with a tightening distribution of who our likely breakout winners are and with reserves flowing to those companies as they scale. The good news is that we’re executing the plan. The challenge is that when you make 21 early-stage investments and hold 14 board seats, this kind of seed stage partnership takes tons of time and scales very poorly. It is a labor of love but make no mistake, the labor is extreme - and necessary.

As we’ve grown our Fund 2 to $105 million, we find ourselves re-thinking our philosophy around entry points, risk/reward and scalability. Let’s assume that our target portfolio in Fund 2 is 24-26 companies with 6-8 that will hopefully generate outsized returns. We could continue with our existing entry philosophy and start almost exclusively at the seed stage, and reserve massively for follow-on rounds. Or we could enter our positions across a range of early stages - seed, early Series A, mature Series A - and trade some skewness for risk reduction and scalability. As of now, we are pursuing the second option. We’ve already done our first “real” Series A as an entry point (Next Big Sound), an “early” Series A (Visual Revenue) and two seed investments (Drawn to Scale and one yet to be disclosed). In the cases of Next Big Sound and Visual Revenue, though still early they have fully-formed products, have achieved clear product/market fit and have built-out leadership teams. This is materially different than almost any investment we initiated in Fund 1, simply because they’ve been at it longer and have gone through the “seed hell” that every start-up naturally endures as they move through the idea-prototype-beta-commercial product life cycle. Did we pay more for these than we would a classic seed investment? Yes. Do we believe it has pushed us to a favorable place on the risk/reward continuum? Yes, we do. So using this model we’d expect to establish ~4-5 positions at the mature Series A stage, 10-12 positions at the early Series A stage and the balance in seed investments and incubations. So while true seed will continue to be a core part of our portfolio construction, it will not dominate as it did in Fund 1.

The more time I spend in early-stage investing the better I understand why so many successful managers have migrated towards the $200-$250 million fund size. They are actively seeking to optimize just as we are, but have a distribution that is more skewed towards mature Series A (and perhaps Series B) entry points versus the average early Series A entry point that we have in Fund 2. They can do this because of the larger size of their bankroll: they can write larger initial checks and pay higher valuations in order to achieve significant ownership in companies with still a lot of room to run. But as the numbers plainly show, even assuming an average 20% ownership position at exit you’re talking $3-$4 billion in gross exit value to achieve a 3x return. This is a high bar, simply too high for us at our stage of evolution. But for seasoned managers who have been through multiple cycles and have a proven edge, I can get why this fund size is a kind of magnet. Lots of flexibility. Lots of reserve for a “rainy day” (or weeks, months or years). Yet not unmanageable.

The sphere of portfolio construction has fascinated me for years, first in the liquid markets now in the least liquid of markets. This will be an ongoing conversation…

From Enterprise to SaaS: the pain and the promise

Sun, 18 Mar 2012 06:53:40 -0400

GigaOm recently published an interesting article on Oracle’s challenges of shifting towards a “metered pricing” model. From my perspective it raises a series of fundamental issues addressing how enterprises buy and consume software:

Is the classic enterprise software licensing model a dying vestige of a prior generation?
Can legacy enterprise software-driven firms make the cultural transition to a more flexible, SaaS-based approach?
Can publicly-traded firms constrained by quarterly earnings targets make the painful financial transition implied by this shift?

Oracle’s circumstance is merely a microcosm of the larger issue. As a business owner, would you rather:

Have multiple parties from which to choose with relatively low switching costs, thereby minimizing lock-in?
Only pay for the stuff you actually need instead of purchasing at all times for peak capacity?
Be able to ramp up and ramp down users and usage on an a la carte basis?

The answers seem fairly clear. The “as a service” (aaS) model is, in general, preferable to enterprise-wide software licensing due to smaller upfront investments, lower switching costs and greater flexibility for managing scale. This also enables centralized software upgrades, the ability to manage either in-house or cloud deployments and yields smoother operating cash flows.

So if more and more customers want software as a service, then why is the transition by the biggest incumbents, such as Oracle, taking so long?

Selling enterprise software is like a drug. Big ticket sizes. Hefty annual maintenance charges. Heavy switching costs. This is why big-time enterprise software sales professionals get paid massive commissions and are often the best-paid people in the company. It is hard treadmill to jump off of, however, because the cash flow dynamics of enterprise software vs. SaaS are very different, and the impact of shifting from one model to the other is dramatic. Enterprise sales are about closing the big license then moving onto the next one (until the periodic upgrade, of course!). The result is large yet choppy cash flows (as annual maintenance is a fraction of upfront license value) unless you can continue to churn out big-ticket sales year in, year out at an increasing rate. Great companies can do it for years by continuing to sell license upgrades and closing new deals in a greenfield market. However, as the market gets saturated this becomes harder and harder, and when compounded by a sea change in the way businesses actually want to buy software the forces of gravity become too strong to withstand.

So what about shifting to SaaS? Well, there is good news and bad news. The good news is that SaaS companies, such as Salesforce, have successfully built huge amounts of something called CMRR - Committed Monthly Recurring Revenue. What this means is that as they sell more seats under 1 and 2-year agreements, they are building an ever-increasing cash flow annuity that is easy to value and kicks off large amounts of free cash flow. Selling costs are far smaller than in enterprise software because the upfront commitment is measured in the hundreds or thousands of dollars, not hundreds of thousands, millions or tens of millions of dollars. Let’s just say that the CIO and CFO aren’t getting involved in the procurement decision for a long, long time. Further, there are often big up-sell opportunities within existing accounts as they often start with small numbers of seats to test out the service and then grow over time, so it is not merely a game of finding a whole new set of companies to generate top-line growth. This is all good stuff.

HOWEVER, the bad news is that those big upfront sales that the legacy enterprise software model generated? Gone. And the time it would take for high-quality, recurring monthly SaaS sales to begin to approach the lumpy but large enterprise software sales is significant. This is a level of creative destruction that is hard to see being embraced by a large software company, particularly a public company. In fact, I think it would be almost impossible without building a Saas business line along side the legacy business line and eventually selling the legacy business to private equity investors who will see it as a valuable but depleting asset (not unlike an oil well). This way, the old-line company could leverage its long-term relationships during its SaaS transition before casting off its original but antiquated business. Alternatively, Mr. Market might eventually make the decision blindly straightforward. If the service-based software model does become the format of choice for acquiring a particular set of capabilities, then enterprise software multiples will plummet and render these companies takeover targets for private equity investors, anyway. Either disrupt oneself or become forcibly disrupted. This is the feature of fast-moving, innovative and highly competitive markets. Good for customers. Good for growth.

I personally saw this painful transition in one of my angel investments, a company called Global Bay Mobile Technologies. They have a great mobile data collection product that was initially sold into Government agencies. These deals were sold either direct or as a packaged solution through systems integrators. The sales cycles were painfully long. The working capital required to fund the business was significant. But when these licenses were sold, they were very profitable. However, the company saw uses for its technology that extended far beyond Government, into retail for inspections, “line busting,” and other store-based applications. Companies wanted to buy their software in small bites, testing it across a small number of stores before expanding across an entire geography or chain. In short, a SaaS sale. So the company made the tough decision not to sell any more enterprise licenses and to bet its future on SaaS. Revenues initially fell. Cash flow fell, too, as software needed to be re-tooled to function as a SaaS platform. But what resulted was a stream of consistently rising CMRR resulting from a great product, a low-cost initial sale and myriad up-sell opportunities within existing accounts. Eventually, the company caught the eye of VeriFone who purchased Global Bay in Q4 2011. It was a happy ending, but one that took a ton of work, wrecked the financials for 18 months and thankfully happened away from the peering eyes of the public markets.

How enterprise software companies manage this competitive imperative will be fascinating to behold. But rest assured, this transition, be it going private or trying to make this shift in the public arena, will provide fodder for many case studies for years to come.

Data Entrepreneurship

Thu, 01 Mar 2012 18:55:55 -0500

I have been thinking a lot about what a data scientist really is and how we, as academic and business communities, can help more people develop important data-driven skill sets. But every time I use the term “data scientist” to describe what I’m seeking something doesn’t feel right. Probably because “scientist” to me implies something being done in a lab, not in the external world. Perhaps it’s because when I think of data scientists I am thinking about people who pursue Ph.Ds and focus on research, while what I’m really talking about is something entirely different. What then?

The Data Entrepreneur. This is related but different field of study, one that is laser-focused on application versus research. It is a broad-based interdisciplinary program that integrates topics such as software development, data architecture, algorithmic development, database management, machine learning, statistics, optimization, user experience and web design, with classes in entrepreneurship, finance, management and leadership, marketing, data hacking (taught by people from start-ups) and extensive field work. Essentially, taking classic informatics that blend CS/Engineering and Math/Stats and melding it with Entrepreneurship, business foundations and workplace experience. These people will be equipped to both solve hard applied data problems and start companies. By having the knowledge of how to manipulate data and the empathy and experience of leveraging data for the benefit of the enterprise (social or commercial), these are people who will have the skills and perspectives to change the world.

This is a work in progress, but as data sits teetering between opportunity and crisis we need people who can shift the scales and transform data into real assets. And the conclusion I’ve come to is my attempt to re-define the Data Scientist is the wrong approach. I’m talking about a whole new class of people: the Data Entrepreneurs.

The data scientist v2.0

Sun, 26 Feb 2012 18:12:31 -0500

I’ve been thinking deeply about the need for more people facile with extracting meaning from data - or a “data scientist” for lack of a better term. My friend and colleague Drew Conway developed a useful model for thinking about the attributes of a data scientist. He essentially views this individual as sitting at the intersection of three spheres of a Venn diagram - Hacker/coder, Math/stats and Domain Experience. The data scientist, therefore, has the coding tools and analytical rigor that when applied to a specific domain can yield valuable insights.

I love Drew’s framework because it gets to the single biggest issue I’ve seen lacking in many brilliant Ph.D’s who have “data scientist” written all over them yet fail to translate knowledge into production code - applied knowledge. In fact, Drew is a very accomplished data scientist in his own right yet achieved this standing with only an undergraduate degree (and not from Stanford, Caltech or MIT, mind you). My point is this: the ivory tower notion of a data scientist is total bullshit. Can a Ph.D play the game? Sure. But does one need a Ph.D to be a successful data scientist? No way.

I can easily see a cross-disciplinary undergraduate degree in Data Science conferred by the schools of engineering, information sciences or business. It would be a mix of classroom, lab and field work, with fundamentals of coding, CS and user experience, mathematics and statistics and marketing and strategy. For those wishing to delve more deeply into one of these areas, an optional fifth-year Masters degree could be offered. And yes, there will be those for whom a Ph.D is the goal either because of a desire to enter academia or to perform original research. This is perfectly awesome as well. But becoming a skilled data scientist focused on application versus theory does not, in my experience, substantially benefit from a Ph.D. In fact, it may do the opposite.

The data scientist v2.0 will be out in the world applying their skills to real-world problems, not toiling away in a lab, in solitude. The will get better and better by having more of these real-world experiences from which to hone their hypotheses and glean their insights. And yes, collaborating with a larger pool of data scientists about better techniques for achieving these insights will help as well. Perhaps the Academy will not appreciate my perspective on this matter. But I am not of the Academy. I respect and value the Academy but believe there is much to be learned - that must be learned - on the outside. And this will be part of the fiber of our next generation of data scientists: of the people, by the people, for the people.

Thoughts from Ann Arbor

Sun, 26 Feb 2012 17:56:37 -0500

Last week I spent two glorious days deeply engaging with my alma mater, the University of Michigan, and the Ann Arbor tech community. I had the privilege of presenting at the Ann Arbor New Tech Meetup (thanks, Dug!), exchanging ideas with the Wolverine Venture Fund, and spending lots of time with professors and heads of different programs and institutes such as the Zell Lurie Institute, the Center for Enterpreneurship and the School of Information. I also got to see Ann Arbor’s take on the collaborative start-up model, Tech Brewery, which houses some very cool companies. My 48 hours in Ann Arbor were a whirlwind that left me both amazed at the progress the University and the community have made towards fostering entrepreneurship while keenly aware of how much more there is to be done. It also reinforced my already-existant mission of wanting to re-think exactly what a data scientist is and, in its wake, how we help create more of these people towards building a better future.

One thing I noticed at Michigan is how developed and entrepreneurial its Office of Technology Transfer is relative to many of its peers. My sense is that because of Ann Arbor’s physical location (a land-locked jewel of innovation), it has had to be incredibly scrappy and experimental in order to achieve its goals. There simply aren’t the deep network effects that exist in San Francisco/Silicon Valley, New York/Silicon Alley or Boston/Cambridge. And while it is still early in the game, they have done a great job cultivating relationships across the University and working closely with the departments to get technology successfully spun-out from the School (kudos to Wes Huffstutter for greasing the wheels of cross-institutional progress). But the fact that “tech transfer” at Michigan doesn’t conjure up thoughts of the usual hard-to-work-with, inflexible bureaucracy is a tribute to what they’ve accomplished in the past decade. Other schools have much to learn from Michigan’s progress.

I was also impressed with the pockets of entrepreneurship across the schools of Business, Engineering/CS and Information. Yes, these efforts are still way too concentrated within the programs as opposed to truly horizontal across the University, but these efforts give me hope that collaboration-as-necessity will eventually break down these artificial boundaries over time. But the energy an enthusiasm from the program heads, mentors and entrepreneurs themselves is palpable. It is hard not to get caught up in the excitement of what is going on and how much more could be going on, and better, too.

What Ann Arbor currently lacks is a bunch of successful exits where the entrepreneurs re-invest back into the Michigan ecosystem. Firms like Google, Facebook, Twitter and IBM descend upon Ann Arbor to hire the best and brightest, and several tech firms are establishing local presences. However, for the flywheel of entrepreneurship to take hold companies need to be be invented and built in Ann Arbor, with founders coming back and seeding businesses locally after they’ve had an exit. They also need to start new companies as experienced entrepreneurs in order to deepen the management talent that is sorely lacking. A local start-up will get funded but then relocate to Silicon Valley or New York, and this has to be ok. But it is important for people to remember where they came from and got their break. Ann Arbor needs this kind of memory to keep the Michigan diaspora engaged and invested in the University and Ann Arbor ecosystems.

Also, my sense is also that there is not yet a robust software-knowledgable base of angels around town. Life sciences has historically been very strong as well as businesses related to the auto industry, but pure software does not have the same shape as these legacy businesses. Start-ups in general, and software start-ups in particular, can look really ugly. A few coders in a little crappy office or shared work space is what a software start-up almost always looks like. Yes, they might be building a profound product but it doesn’t look like a “real” company to inexperienced eyes. More experienced angel eyes are needed in A2 to help nascent companies move beyond Friends & Family and get to a real seed round.

While I’ll deal with my view of the next generation of data scientists in a subsequent post, I am incredibly interested in helping to build a dedicated program towards this end at Michigan. All the pieces are there. It just requires some cross-departmental cooperation in order to bring it to life. This is one of my missions for my alma mater: help to pull together a data science program that empowers student/practitioners to solve tomorrow’s problems today. It can be done. It must be done. It will be done.

"When everyone seems to want to unload the same risks at once, it is a good idea to ask yourself..."

Sat, 25 Feb 2012 07:54:23 -0500

“When everyone seems to want to unload the same risks at once, it is a good idea to ask yourself whether joining them might be the biggest risk of all.”

- Wall Street Journal 2/25/2012, Is “Derisking” Even Riskier?

IA Ventures - the next phase

Wed, 08 Feb 2012 13:02:40 -0500

The facts are straight-forward. We just closed IAVS Fund II. This new fund, at just over $105 million, allows us to pursue the same investment strategy we followed in Fund I – investing in companies that create competitive advantage through data. Just like Fund I, we will continue to invest in strong founders at the Seed, Series A, and even sometimes Series B stage. As part of this fund we will reserve even more heavily for follow-on investments, continuing to view our initial investment decision as the beginning of a long and rewarding relationship.

While the facts may be straight-forward, the path to building a venture firm like IA Ventures is far more complicated and nuanced.

Over two years ago we launched IA Venture Strategies I with $17 million in initial commitments, hell-bent on executing a thematic strategy focused on Big Data. In those early days, we had the good fortune of investing in a number of fantastic companies. Building on our initial success we raised additional capital, eventually closing at $50 million in Q4 of 2010. This provided us with the resources to implement the early-stage life-cycle strategy of which we had originally conceived.

Fast forward to late Q3 2011. We had a portfolio of 21 investments with significant reserves held for future rounds. We had led seed rounds, Series A rounds and even a Series B round. We had exercised follow-on discipline and invested as much time and capital as possible in truly disruptive companies as well as those which already had demonstrated traction. But when looking at our reserves, our portfolio companies needs, and our interest in supporting their continued growth, we concluded that we really didn’t want to make any new investments out of Fund I. We had established our hand. We liked our hand. And we simply wanted to play it. It was at this time that we decided to discuss our second fund. But how large? How many investments? What kind of investment period? What types of LPs? There were a lot of questions to answer before entering the fund-raising process.

So as a team made up of a former derivatives professional, a Ph.D in EE and Machine Learning and a data geek, what did we do? We developed a hypothesis, modeled it, tested it, subjected it to brutal peer review, iterated on it and finally arrived at an approach that felt good to each of us.

There was much we liked about our strategy in Fund I including the number of portfolio companies and commitment to a life-cycle investment strategy. As part of Fund II we wanted to reserve more heavily for individual companies and address some of our “vintage concentration risk” concerns lurking in the back of our minds. While a two-year initial investment period for our first fund felt ok, it did not feel optimal. It felt fast. And while we believe we were fortunate in that we established positions at fair prices at a good time in the economic cycle, this is not a risk we’re happy to wear again.

Once we went through this exercise and received feedback from our Partners and mentors, we decided that $100 million was a size that achieved our objectives for this next phase of IA Ventures. We took a bit more than this because there were several amazing individuals whom we were honored to have as our partners and who can add immense value to our investment activities. It was an opportunity that we simply could not pass up. We have a fantastic group of deeply experienced Limited Partners who measure relationships in generations, not years. It feels like family. Exactly how we wanted it to be. We have quarterly advisory board calls, and I reach out to my LP mentors in between these calls all the time. I can’t stress enough how great Partners can be assets well beyond their money, just as we strive to be perceived and treated in the same way by our portfolio companies. This kind of active management takes work by the GP. But from my perspective, my time has been incredibly well-spent.

I am so excited for what the future holds and so thankful for my IA Ventures partners and colleagues, our LPs and our portfolio companies. The responsibility of running a firm like IA Ventures is awesome, but joy of the pursuit of delivering on our promise is even greater.

In startups, Always be...

Mon, 06 Feb 2012 21:20:20 -0500

recruiting.
selling.
raising money.
thinking about risk.
worrying about running out of money.
focused on firm culture.
selling.
recruiting.
having fun.
aware of your utility function.
honest with partners, employees and investors.
evaluating yourself against objectives.
humble.
identifying and leveraging mentors who can help you grow and achieve your objectives.
“paying it forward” by helping others grow and achieve their objectives.
worrying about not running out of money.
cognizant and honest about stress and digging the start-up gig all the same.
selling.
recruiting.
trying to change the world.

This is my Top 20. You need to come up with yours. Ours are unlikely to be identical, but the key elements of selling, recruiting and protecting the firm’s finances should be hallmarks of every Top 20 list. Because without customers, the best people and the liquidity to hire the best people and deliver a great product, the whole effort is destined for failure. So do whatever you can to increase the chances of success - including self-preservation…

What startups can learn from the NY Giants

Mon, 06 Feb 2012 11:02:57 -0500

Last night’s Giants/Patriots game was another epic contest, displaying the greatness and intertwined fortunes of two of the best teams of the era. However, what underpinned the contest were the widely divergent paths of the teams who had reached the pinnacle of the sport: a 13-3 Patriots team with arguably the best quarterback (Tom Brady) and coaching mastermind (Bill Belichick) of our generation, and a much-maligned 9-7 Giants team with an oft-chastised quarterback (Manning) and an old, out-of-touch coach (Coughlin). It wasn’t that long ago that the Giants, 7-7, hobbled by injuries and with calls for the coach’s head, appeared irretrievably lost and done for the season. Yet somehow the team was able to turn it around, not only to finish the regular season 9-7 and to make the playoffs but to steamroll their way through a brutal postseason schedule and to defeat the mighty Patriots looking to cement their “dynasty” label. But let’s be clear, this wasn’t a Patriots team that was coasting along with little to prove: they had everything to prove. And they weren’t going to make it easy on the Giants. No matter: the Giants were able to get it done in the face of their own adversity and the determination of their worthy opponent.

So just how did the Giants do it, and what lessons might we extract for those facing a similar set of circumstances - namely, just about every start-up on the planet?

Don’t panic. How many times have we seen release schedules slip? An unexpected new market entrant? A hostile fund-raising environment? Regardless of the challenges, staying calm and clear-headed is absolutely essential for overcoming them. Just because things don’t go according to plan doesn’t mean it’s time to freak out. Quite the contrary: hard times require cool, rational thinking unburdened by fear-mongering and hysteria. Many in the Giants diaspora panicked: neither they nor their ownership did. They were confident that they had a strong leader and solid players (with several on the mend as the season wore on), and let them do what they were meant to do: lead and play.

Embrace uncertainty. If there is one thing that’s certain, it’s that the world is uncertain. Every - not many or most, but every - start-up faces a host of “known unknowns” and “unknown unknowns,” and simply has to roll with them as they become known. This requires a flexibility of mind and spirit that is crucial for achieving long-run success, otherwise a team will get emotionally ground down by constantly reacting to uncertainty. It shouldn’t be surprising. It should be programmed into one’s psyche. Every football team knows that bad things will happen during a season - injuries, suspensions, fines, new tactics by other teams, historically bad years by team members, etc. - and they simply accept it as a part of life and dynamically adjust. The Giants did a masterful job of his throughout 2011, and it paid off when it mattered most.

Focus on the mission. It is perilously easy to get distracted by both internal and external influences. Finger-pointing due to shipping “misses.” Not enough customer feedback to inform development. Poorly-received PR strategies. External criticism that threatens firm morale. All of this is garbage. There is a mission - lots of happy customers. Everything else is noise. Executing the plan and adjusting the plan, when necessary, to get there is the bottom line. There will be the natural non-linear path of getting there, but the mission has to always be the beacon illuminating the destination. The Giants never forgot their simple mission - win the Super Bowl. Now, they used the tactics above to achieve the mission, but it was always crystal clear what they were pursuing to everyone involved, both on- and off-the-field.

Remember there is no “I” in “team.” Successful start-ups are made up of super-talented and motivated people, many of whom will often rate as “stars.” However, when pursing the mission it is critical that the entire team, both stars and the mere talented, work together as a single unit in its pursuit. If engineering misses a deadline, everyone misses. If sales is having a hard time closing accounts, everyone has a hand in it. Shared losses and shared wins. Individual performance isn’t really the point if you are confident that you have the right players. The Giants could easily have gotten down on any number of individuals for less-than-stellar performance. The players could have created a bad locker room dynamic that poisoned Coach Coughlin’s chances of leading a turn-around of the season. None of this went down. They stuck together and shared their painful losses and their decisive victory - as a team.

Always remember where you came from. If a start-up becomes successful and really begins to scale, there are many who had a hand in its success. It was invariably a function of all the learnings above plus a healthy dose of luck, and even in success it is important to remain humble because fortunes can, and often do, change. Being classy in victory is as important as being classy in defeat, and Tom Coughlin’s words in victory are words of humility, thanks and shared success. Coach C has had more than his share of ups and downs in his career, and to have finally reached such a high level of credibility, achievement and respect is not lost on him. And he wears it well.

As a Giants fan, it was an exciting and satisfying end to a crazy roller-coaster season. But the metaphor of the Giants season and the start-up life cycle was particularly resonant having been immersed in both. Upon reflection, these are not just start-up lessons but life lessons…

Founders: Be The Honey Badger

Sun, 29 Jan 2012 22:56:50 -0500

I was recently watching a funny YouTube video with my kids titled The Crazy Nastyass Honey Badger and having a few chuckles when it hit me: that Honey Badger actually has many of the essential characteristics of a start-up founder:

Determined. The Honey Badger goes after what it wants - hard. It has the same kind of laser focus and persistence as every great founder I’ve ever known. Hungry? Chase down and eat the snake. Tired? Dig a hole in record time and chill. Just get it done. Period.

Thick-skinned. The Honey Badger has loose, thick skin, which enables it both maximum freedom to maneuver and incredible protection. The start-up founder is likely to hear of a chorus of “You’re crazy” and “That can’t work” along the way, and need to adjust plans and pivot as the market opportunity becomes clearer. These barbs and arrows just bounce off the Honey Badger. No problem. You can’t stop me.

Ability to withstand pain. The Honey Badger can withstand snake bites, bee stings and countless other assaults from targets seeking to defend themselves against attack. The bottom line is that the Honey Badger can take it all and move forward undeterred. The start-up founder? Exactly the same make-up. Cash crunch? Disappointing customer interaction? Lose that great engineer to Facebook? No matter. Just press on. The Honey Badger just shrugs it off. So does the successful entrepreneur.

Just doesn’t give a s*&t what others think. The Honey Badger is a beast. No manners. No decorum. In short, a heat-seeking missile. See prey. Pursue prey. Conquer prey. Messy? For sure. Successful? Without question. Sometimes the start-up founder can seem insanely intense, brusque, and paranoid, all because they want nothing to keep them from achieving their objective - building an awesome company and doing everything in their power to make it happen. Sometimes manners and niceties get checked at the door. Just ask those on the receiving end of the Honey Badger’s attentions.

Adaptive. The Honey Badger can dig prey out of holes. Chase them down on the plains. Even grab them out of trees. Prey simply has no place to hide from the Honey Badger. The start-up founder is able to just get s&*t done. Build product. Recruit. Evangelize. Sell. In coding sessions, Meetups or boardrooms, the great founder just figures it out. The do what’s necessary given the context. The Honey Badger does it for survival: so does the start-up founder.

There are obviously other skills that come into play when founding a company that ultimately becomes successful (I’m not sure that the Honey Badger really has “vision” beyond its biological imperative), but those characteristics demonstrated by the Honey Badger are certainly essential elements to achieving success. I find metaphors in business to often be both helpful and entertaining, especially when the going gets tough. So when the s*&t is hitting the fan and you need to tap into that single-minded focus, passion and energy deep inside you, just remember this: be the Honey Badger.

Loyalty

Mon, 23 Jan 2012 23:29:54 -0500

One of the hardest dynamics I’ve had to manage throughout my career is loyalty. I, like most of my friends and people whom I respect, have feelings of faithfulness and devotion to those with whom we interact - partners, employees, investors, vendors, etc. However, there is a point beyond which loyalty can become costly - too costly, in fact - for historical relationships to remain as they are because of the negative impact on business. And when the problems spread into areas which can effect either individual or firm reputation, loyalty necessarily needs to take a back seat to pragmatism and protecting one’s (and one’s colleagues) own interests. This is, without question, an area fraught with ambiguity and confusion, where the pain of dealing with issues head-on can lead to procrastination with potentially expensive outcomes. And while procrastination is never ok, the question remains: when is it appropriate to sever ties with a person (or a firm) to whom you feel loyal?

A useful rubric will necessarily take into account the impact of one’s actions on the relationship. For instance, an employee who has done good work for a long enough period of time to foster loyalty but then runs into a patch of diminished productivity. Do you cut them loose as soon as performance drops? Generally not. I think tools such as GE’s performance matrix as useful in this regard.

On one axis is Performance and the other axis Attitude. High performance with great attitude? A star. Low performance with lousy attitude? Fire immediately. High performance with lousy attitude? Coach the employee and give them the chance to remediate, but if they remain solo stars without regard for the team or its norms they have to go. And low performance with great attitude? Provide concrete feedback and coaching to help the under-performer raise their productivity, but if they are unable to turn things around then they have to go as well. So in the case of someone to whom you feel loyal (so, by definition, has performed well in the past and with an attitude that supports the team) but whose performance isn’t what it used to be, give them a chance to fix things and lend support. This demonstrates loyalty. However, letting them go if they continue to perform poorly is not disloyal - it’s protecting the team and the firm. And both you and the company can help ease the transition in many ways.

But think about a situation where the impact of a mistake, a lapse of judgment or simply bad behavior is so bad that it fundamentally affects the trust people have in the individual or firm? It is hard to see how the rubric above can apply. For example, what if an employee does something to damage the reputation of the firm that materially impacts its brand and position in the market? This would seem to trump any notion of loyalty completely. And what if a service provider, such as counsel, made an error that ended up putting the company in badly compromised position due to shoddy work? It is hard to imagine retaining that firm again any time soon even if there had been a successful pre-existing relationship. The essential element where historical feelings of loyalty rapidly become marginalized is when basic trust has been breached. Without trust, loyalty cannot be reciprocal.

Except in the case of bad actors, severing relationships is almost always difficult, especially among those who pride themselves on being loyal. But sometimes circumstance overrides loyalty: it just does. And at these times, it is critical to address the situation quickly and honestly, for the good of the person being let go and the company which has to move on. That’s just life.