Recycling: The challenge and the opportunity for a Seed stage VC

My recent post gave rise to a host of questions around the issue of recycling. What does it mean? How do you do it? And what are the implications for venture investors? I attempted to respond in a Tweetstorm, but recycling is a complicated issue that warrants a more thorough discussion.

When Limited Partners (LPs) invest in a venture fund, they agree to pay an annual Management Fee on committed capital, usually on a declining scale over a 10 year period. In total, these fees amount to around 20% of an investors’ commitment, which implies that LPs only get to put 80% of their investment dollars to work because of management fees. This makes most LPs pretty unhappy - and it should. LPs generally expect to have 100% of their investment working for them, and best practice is to invest up to around 120% of committed capital when possible. Enter the concept of recycling.

Recycling can happen when a fund exits an investment, and rather than distributing the proceeds to LPs, reinvests all or part of the funds in portfolio companies. This sounds pretty easy, but in practice is quite hard, especially for Seed stage venture funds. By definition, Seed stage funds invest very early in a company’s life, meaning that time to exit can be 7-10 years, or more. Further, as a seed fund with higher cash-on-cash return expectations than later stage funds, IA Ventures doesn’t have much time for a company to exit before its other successful investments become too high-priced to warrant later stage capital. This is because a successful seed company often grows into an attractive Series A and perhaps Series B investment from the seed investor perspective, meaning a potential return on a new investment of 5-10x capital invested at each stage. We reserve for this likelihood, and this represents one of the bedrocks of our life-cycle approach to investing. But beyond the Series B, it is often challenging to get comfortable with 5-10x upside from that point, especially for “hot” companies that may be priced in the hundreds of millions of dollars by the Series C round.

So what generally supports recycling in seed stage funds are either companies that: (a) exit early because they get a great offer that is life-changing for founders but so-so for venture investors; or (b) exit early because it is apparent that the “big idea” won’t be realized and the founders and investors want to sell. And if these liquidity events happen early enough in a fund’s life, the proceeds can be deployed into fast-growth, highly attractive companies within the portfolio that still have 5-10x upside potential. These reinvested proceeds count towards recycling, and help to repay the management fees that were burdening the amount of capital available for investment. We had the good fortune of having two exits, ThinkNear’s sale to TeleNav and Simple’s sale to BBVA, early enough in Fund I’s life that we were able to effectively redeploy the proceeds into a set of attractive investments, including The Trade Desk Series B round. We ended up Fund I being around 116% invested, meaning that we invested $58M against $50M of committed capital. This is exactly where we wanted to be.

Hopefully this provides a flavor for how recycling fits into the seed stage venture firm’s portfolio construction and decision logic. A bunch of stuff has to go right in order to achieve a fund’s recycling goals (while remaining true to its return objectives), but we believe it is important to have this mind-set when embarking on a new fund. It is respectful and fair to one’s LPs, and, when used prudently, can amplify the gains available to LPs as well as the GP through carry.

The TTD Investment and the IA Ventures Model

A Little History

IA Ventures began life a little less than seven years ago, just as the world was coming out of the worst economic crisis since the Great Depression. The term “Micro VC” had yet to be coined. “Big Data” was still somewhat mysterious and edgy to those outside Wall Street, Government and Defense. Unicorns were mythical animals that pranced around meadows and were signs of good luck. And there certainly were no discussions of colonizing Mars (!). Upon reflection, 2009 seems almost a generation ago, but I guess that’s what happens when life, fueled by stunning advances in technology, seems to move at warp speed. But with all of these changes, a few basic principles still remain. The greatest venture funds - and firms - in history started small. They started investing very early in a company’s life, owned a lot and continued investing over time. In short, they identified great founders playing in large markets, took significant early risk, continued to lean in when risk/reward appeared attractive and ended up owning a lot for a *little*. This is exactly the model we have followed at IA Ventures since Day 1, and it was never more in evidence than in the seeding, bridging, growth investing and eventual IPO of one of our first investments. The story of this journey and IA’s approach to investing is plainly laid out below.

Jubilation - IA’s first IPO

Last week, we at IA enjoyed perhaps the greatest moment of our (relatively) young life, sharing the opportunity with one of our founders, and his team, to celebrate the occasion of going public. The successful IPO of The Trade Desk has had a salutary impact on perceptions of the best private companies in the adtech sector, as well as on technology IPOs writ large. But perhaps most meaningful to us at IA, it represents a company that we backed when it was a single founder and a PowerPoint (though an awesome co-founder had been identified), through myriad twists and turns, financing struggles and rejected M&A offers, continuing to provide timely financial support, all the way through to a 400+ person global company valued well in excess of $1BN. But rather than talking about what fueled our belief that Jeff Green’s vision, powered by the Company’s amazing colleagues and innovative clients, would ultimately yield a venture-scale outcome (Alex already does a great job with that here), I’d like to talk about how we as a firm put ourselves in the position to win. Because make no mistake, it is anything but easy, and stands in stark opposition to the strategies of many newer venture firms. But it is how we like to work with founders and, ultimately, believe it gives us the best chance to generate superior returns for our LPs.

Getting Started - The Seed Round

Brad and I started IA with a first close of $17M in January 2010. Our initial LPs were, shall we say, non-traditional venture investors, as many if not most were still smarting from the hangover of 2008/09. While we had a vision of closing our first fund at $25M ($25M was on the cover, while $40M was the hard cap), we had the good fortune of being able to close at $50M later in the year. This was nowhere on the radar screen, however, when we first met Jeff in October 2009 or invested in the Company in March 2010. Our initial investments in Fund I were scoped to be up to $750k for 12-15% ownership, with upwards of $2M going into our strongest companies over 2-3 rounds. We intended on doing some limited incubation (see: Vectra Networks, which we incubated as Trace Vector before getting the support of Khosla Ventures, Accel, DAG and other great investors), but were largely going to enter companies at the seed stage. The positioning to investors was “Old style VC,” starting very early (and always pre- product/market fit), building a concentrated portfolio and owning 10%+ of our best investments post-Series C. 20-25 portfolio constituents, of which 5-6 would represent our “best of fund” investments and capture more than half of the investment dollars. With this in mind, our first investment into The Trade Desk was $750k for ownership right in our target range. So far, so good.

Need Mo’ Money - The Bridge Round

Jeff and Dave Pickles (the CTO and co-founder, who joined around the time we and Founder Collective led the Seed round and Eric Paley and I joined the Board) had set a visionary and ambitious plan that involved a tech build that was nothing short of insane. Right in our power alley (!?!). As all great founders do, Jeff stayed close to customers and planted seeds well in advance of the Company’s ability to deliver, laying the foundation for great expectations (and rocking tech and product) and rapid adoption. The only thing that remained was shipping the product. Well, as is the case with pretty much every construction project and startup, stuff takes longer and costs more than expected, and The Trade Desk was no exception. So what did Jeff do? He did great work helping us understand the unfolding of the addressable market (his hypothesis that Programmatic would eat traditional ad buying was not yet clear to many), customer feedback and feature requirements (including query-per-second - QPS - throughput). He and Dave also provided us with revised estimates of release dates corresponding to key technical achievements that would put us in-market. At this point both Founder Collective and IA provided a bridge to this next set of milestones. Why? Because we believed in Jeff’s vision and hypotheses about the reshaping of ad buying, as well as his leadership, recruiting power and industry credibility, together with Dave and the tech team’s ability to ship.

Ugly Industry, Dearth of Believers, still - Bridge #2 + Non-VC Series A

Believe it or not, even after the Company’s successful release, adtech was still so hated and the programmatic opportunity so misunderstood that we had to bridge again, until we finally raised a Series A from non-traditional investors (in this case, successful entrepreneurs from in and around the domain who understood the opportunity first-hand and were happy to invest). At each step of the way IA continued to participate, such that by the time The Trade Desk was generating cash (on a total of $8M raised) we had invested a little over $2.2M across four funding events that resulted in us owning around 18% of the Company. But we had another big decision to make.

Gearing up for Global Expansion - The Series B

As the Company was rapidly expanding its global footprint, we as a Board decided it made sense to put more capital on the balance sheet to both support growth as well as secure a substantially larger credit line for financing receivables and a slice of term debt. Hermes Growth Partners, specifically the force-of-nature Juan Villalonga (ex-McKinsey, former Chairman and CEO of Telefonica) and the whiz-kid Alex Kayyal (now of Salesforce Ventures), stepped in to lead a $20M Series B. Given the Company’s growth and scale, it really had the character of a growth round, and was priced as such (the Series B being a misnomer given how cash efficient Jeff & Co. had been in getting to EBITDA positive).

Recycling Capital - Fueling IA’s Participation in the Series B

At this point in IA Ventures Fund I’s life, we were beyond the initial investment period, so we’d be making no new investments. We have a culture of wanting to recycle capital to between 110-120% of committed capital when possible, which means the intersection of: (a) portfolio liquidity events in a time frame where we can redeploy capital; and (b) later stage opportunities that have, in our opinion, 5-10x cash-on-cash return potential from that point onward. In the case of The Trade Desk, stars and planets aligned due to our earlier sale of Simple to BBVA, which generated significant liquidity, and our deep belief that notwithstanding the nine-figure price of investing in the Hermes-led Series B, it did, in fact, have the return profile referenced above. So IA ended up writing a $3M check into the Series B, bringing our total investment to $5.2M or just over 10% of our Fund I committed capital. On a fully-diluted basis, IA owned just under 17% post-Series B. This is exactly where we wanted to be. Was it seemingly out-of-step for a “Micro VC” to invest at such prices and to have so much of  a fund in a single company? Perhaps. But the way we secured our ownership was by being super early, being close to the arc of the Company’s development and culture, and ultimately having the conviction to lean in hard when opportunities presented themselves (or, in the early days, were necessitated by circumstance: step up or face a premature sale scenario).

The IA Ventures Model

The Trade Desk (Fund I). Vectra Networks (Fund I). Transferwise (Fund II). Digital Ocean (Fund II). Companies where IA was super early, leaned in hard, put ginormous dollars to work (as a % of fund size) and, as a result, owns 14-18% of four high-growth, post-Series C companies, three of which are approaching or beyond $100M revenue run rates and at or beyond EBITDA breakeven. We still believe others in these funds that could achieve these levels as well, but it’s still early, particularly for Fund II investments made in the latter part of its investment period. In each fund we have 24-28 investments, with 6-8 garnering the lion’s share of the capital over multiple rounds. Clearly we’re only seven years in with fewer than 60 data points, so it is too early to claim victory, but I do think that we’ve demonstrated that it is possible to be a successful life-cycle investor at MUCH smaller fund sizes than the traditional Series A and B firms. What it takes is deep conviction and perhaps irrational confidence to successfully invest in pre-product/market fit companies, write larger checks for greater ownership in the face of sparse data, and to amplify ownership and risk when you both want to and can do so. And this isn’t easy, particularly with follow on investors often being very ownership-sensitive and sometimes sharp-elbowed with earlier investors. But this is where the strength of founder relationships comes in, and this is something we at IA invest in very heavily. It is also an outgrowth of being so early and so supportive when there aren’t a ton of believers. As we’re now investing out of our third fund, we’ll have ever more data to validate or invalidate our hypotheses concerning our model. Sitting here today, I feel pretty confident that we’re onto something that fits our companies and our partnership just right.

The Real Heroes

All credit goes to the founders and their colleagues who give us the chance to do what we do. While the highs are often transitory and the lows can feel very, very low, getting to share last week’s IPO with Jeff, Dave, Brian, Rob, Paul and the rest of The Trade Desk team, those people who are helping to transform the advertising and media industries and employ more than 400 well-compensated, mission-driven people worldwide, made plying this particular trade feel very, very worthwhile.

Welcoming John to IA

Brad, Jesse and I are happy to announce that our friend and colleague, John Hadl, is joining IA Ventures as Venture Partner, effective immediately. We have personally gotten to know John over the past four years due to our shared investment in PlaceIQ: IA Ventures led the Seed round and John, on behalf of USVP, led the Series A. John impressed us from the outset with his deep domain experience, tireless work on behalf of the founders and insightful perspectives in Board discussions. Further, his open and transparent style strongly resonated with us as candor and collaboration are two qualities we value highly. From our relationship formed through PlaceIQ our interactions continued to expand. As John has spent time with us it became clear that our networks, experiences and styles, though different, are highly complementary.

In addition to being a strong cultural fit, John has an impressive track record both as an angel investor and as a VC. John was an angel investor in and an advisor to both AdMob (Google) and Quattro Wireless (Apple), as well as an angel in BlueKai (Oracle) and Whisper, among many others. John also served on the Board of JumpTap until its sale to Millennial Media. His investments while at USVP include GoPro (IPO), Quantifind, Swoop and ZEFR. John has a knack for identifying the right founders to execute against a particular mission, and actively supporting them in their quest. His track record and reputation as a true partner to entrepreneurs is tangible evidence of his skill and his value.

We are excited about John’s contributions to the team and all that we can learn from him. Hopefully he extracts the same value and goodness from us. We look forward to welcoming John into the IA Ventures family and are confident he will help us better serve our most important constituency - our founders.

Crowdfunding for start-ups: A durable trend or a bull market phenomenon?

Angel investing is red hot as is the concept of crowdfunding start up investment. Part of this phenomenon has been driven by the emergence of AngelList, the brainchild of Naval Ravikant. What started out as a way for a curated set of angels to invest in startups posting on the AngelList site has expanded to include the notion of Syndicates, investor groups headed by prominent angels who deploy capital pledged by themselves and others in a manner akin to a GP/LP construct. Syndicates have been thought by some to be directly competitive with venture capitalists, initially Micro VCs but then perhaps larger venture firms down the line. While Naval has consistently said that this isn't his intention, it hasn't stopped others from speculating about the end game for Syndicates.

A recent article in Fortune Magazine got me thinking about the compare/contrast between professionally-led angel syndicates (such as those on AngelList) and seed stage venture firms such as IA Ventures.

While we invest in partnership with angels in virtually every seed stage company we work with, we are generally the largest investor and lead the round. We also frequently lead seed-extension rounds to support angel and Friends-and-Family financed companies, which need extra runway to hit key operating metrics and business milestones that will enable them to raise strong Series A rounds. This is the bread-and-butter of how we generally initiate our relationship with founders and their companies. When we invest in a company, we reserve multiples of our initial invested capital for follow on investment. In our experience, these reserve multiples can end up being 3-10x of our initial investment over 3-4 rounds of financing, before the expected cash-on-cash return of the later rounds fail to meet our growth criteria (as we are constantly asking ourselves: "Is the probability-weighted return of this investment greater than or less than investing in a new seed stage company?").

If there is one thing I've learned in my 10+ years as a seed stage investor, it's that plans seldom unfold as expected. This is why: (a) we seek to finance companies adequately from the outset in order to give them a chance to prove or disprove their early hypotheses; and (b) reserve significant additional funds should they be executing well but need more time to hit key Series A metrics and milestones, or the macroeconomic environment becomes hostile and external fundraising is a poor or non-existent option. Having the resources available to support companies during hard times can be the difference between a good company hitting the wall or hunkering down, continuing to build, surviving the downdraft and emerging stronger than ever (and particularly stronger than their less well-financed - and now dead - competitors). It is this dynamic that makes me wonder about the current heat around crowdfunding, and if it can survive a cyclical downturn in venture investment.

If Syndicates exist to push more angel dollars into the early stage ecosystem, that is fine. But it should be done with a cautionary note: unless Syndicates develop the ability to support companies when there isn't an institutional investor standing by if times get bad, they aren't likely to endure. The composition of Syndicates - angels - are generally the first to tamp down risk tolerance because their main source of making money is imperiled and their angel portfolio isn't likely to generate meaningful returns any time soon. So really the behavior of Syndicates aligns closely with the behavior of their constituents, angel investors. This is precisely why I believe Naval is right: Syndicates aren't truly competitive to venture firms in that they lack the reserve mechanism and the ability to extend time horizon. But they do provide access to successful and experienced angel investors, and this is a good thing.

Financial interaction: the next generation

I have spent over 25 years creating, processing and analyzing financial transactions. I like studying them - a lot - whether an outgrowth of my time on Wall Street helping sophisticated entities manage risks, or through IA Ventures’ investments in Simple, TransferWise, and BillGuard. Transactions are fundamentally about people interacting with other people, and are initiated at the speed of real life. But at one time or another they have to touch our byzantine, outmoded, friction-filled financial architecture, and get completed at the speed of banks. Charting the path of a transaction through the bowels of the banks and other intermediaries in our current system would require tons of boxes and arrows and round-trips that would seem absurd to the Internet-savvy crowd. This is where we are today.

Simple was founded in 2010 with the mission to offer the first truly seamless user experience to retail customers, hiding that messy underbelly of the banking world. Transparent. Low-cost. Mobile-optimized. Goal-oriented. First-rate customer service. They did a ton of things right. But in order to get up and running (relatively) quickly and with a modest amount of capital, they had to work with partners and not actually become a bank. This involved a series of known trade-offs that Josh, Shamir and the Board made with an eye towards releasing a basic product, collecting feedback, iterating on the product and creating a delightful experience for Simple users. Obtaining a bank charter was always in the long-term vision, but involves a completely different magnitude of capital, legal and consulting work - and time. Rather than innovating in a vacuum, the Simple team wanted to get a product into the wild and let users help shape the roadmap. They never could have gotten it out so quickly (and without many times more capital invested) if they had pursued the charter route.

Much has been written of Simple’s recent sale to BBVA. Separate from the impact the sale has on my firm, I personally view the acquisition as a rare example of a “win-win.” By mid-2013, Simple had grown to the point where seeking a charter was a very real consideration, but one that would have required a massive capital raise and a fundamental re-shaping of the organization due to a raft of new operational, legal and regulatory requirements. In the process of thinking about a raise, Simple received a bunch of inbound M&A interest, the most exciting of which was from BBVA. Their executive leadership had met Josh and Shamir back in 2010 and they were early believers in the Simple team and mission. By late last year, they were ready to disrupt themselves by injecting Simple’s product-focused, tech-forward DNA into their $820 billion organization. BBVA has a scale US-based banking operation, Compass Bank, which can help support Simple’s infrastructure and capital requirements in the future. Terms were hammered out pretty quickly and a deal was done. I couldn’t be happier for the Simple team that they are joining a group that really gets them, will enable them to preserve their independent and entrepreneurial spirit while providing both capital and an enlarged customer base to change the face of retail banking. However, make no mistake: Simple is optimizing the banking experience. But that experience is necessarily tethered to all that comes with being a bank, for better and for worse.

Prior to the Simple announcement there has been a bunch of stirring around re-shaping the banking experience as we know it in a more fundamental way:

In the same Twitter thread Marc went on to say:

Zac Townsend of Standard Treasury weighed in as well, subsequently sharing a write-up describing a syndicate approach to raising the capital necessary to start a bank that doesn’t run afoul of Bank Holding Company regulations. But Marc and Zac’s ideas, along with concepts proposed by several founders we’ve recently met, all share a common thread: operating within the current banking strictures. A Bank’s involvement as the centerpiece of disrupting banking simply isn’t disruption, it’s derivative. 

I believe disruption will be found by identifying the atomic unit - the financial interaction - and designing a set of user experiences that make these interactions as easy yet robust as possible. This is not limited to retail banking but involves commercial banking and investment management. And with protocols like Bitcoin (see Marc’s post on Why Bitcoin Matters) and others to follow, why remain shackled to the notion of being a bank? As the incumbents become smarter and take more risks (e.g. BBVA) the opportunity within the traditional banking sphere would seem to be muted. There’s a very high price to even play the game (call it $25 million for the charter, legal work and start-up costs, plus another $100 million for regulatory capital) and an interminable period of time that is most assuredly NOT start-up time (two years, minimum, to get all the legalities hammered out and to get up and running. And, oh yes, you need a processor and a bunch of other stuff, too). If you believe that truly disruptive alternative financial protocols such as Bitcoin will be the foundation of our financial world in ten years, then trying to re-create a better bank by connecting with existing ones or building a brand new one seems like a costly and backward-looking play.

However, I can see a place for a small, tightly-knit skunk works team of product and UX people to rapidly iterate on optimizing the UX for a single use case they’re passionate about, be it retail or commercial. They can use an enabling platform such as BancBox (I’m not an investor) to rent the pipes so they can be 100% focused on user experience. They’ll find the ‘wedges’ into peoples’ financial lives that engender trust and make people want to drop their old-line banks. And then when the landscape becomes clearer for which non-bank protocols are winning, this team can simply lay their market-tested interface on top and be a ground-breaker in the next generation of financial interaction. Now this, to me, is disruptive. The bank of the future probably won’t be called a bank. By focusing solely on making the atomic unit - the transaction - fit within users’ lives, we can avoid the interim step of building a brand new bank and skip to the good part, requiring far less expense than buying a ticket to our highly dysfunctional banking show.

If you are such a team that’s excited to figure out what people really want from their financial interactions, and have a heavy emphasis on product design and user experience, then give me a shout. It would be fun, indeed.

IA Ventures: Reflections on 2013

2013 was a very different kind of year for IA Ventures. While the years 2010-12 were characterized by 8-10 new investments per year, in 2013 we invested in only three new companies: Data Robot; Digital Ocean (DO) and Sight Machine (SM). Digital Ocean and Sight Machine were lead-managed investments (though we partnered with OATV and Mark Jacobsen on SM), while Data Robot was done alongside the leadership of Chris Lynch and our friends at Atlas Venture. We are extremely happy with our three new partnerships, and Digital Ocean and Sight Machine represented two of the largest initial investments we've ever made. They were many months (and in the case of DO, years) in the making, and reflected a depth of study, analysis and relationship development that we hadn't undertaken previously. We have been experimenting with different modes of engagement with founders and their companies, and our activity in 2013 emerged from a series of hypotheses we've been testing. We will continue to test and refine these hypotheses in 2014, and we already have our first accepted Term Sheet to partner with a terrific founder and team in 2014 and beyond. While the work that went into studying the company and its space was significant, it happened in a far more compressed time frame than either of our two lead-managed investments in 2013. We are continuing to test, iterate, and evolve.

While we may not have added many new companies in 2013, we deepened existing relationships with several IA Ventures portfolio companies during the year. Our companies either signed or completed eight Series B and Series C rounds in 2013, as several of our largest Fund I investments continued their scalable growth and development. Consistent with the mission we set out in 2009, we are behaving just as one would expect a "conventional" early-stage venture firm to behave: utilizing our significant reserves to support the growth of our most rapidly-growing companies through Series A, Series B and sometimes even Series C rounds. This has been our playbook and now four years after having made our first investment, we are seeing the opportunities to participate in the expansion of our most mature companies multiply. It is certainly gratifying to see founders whom we believed in before there was a business to believe in succeeding at scale, and working towards the ultimate achievement of their missions. Having a front row seat to witness the maturation of founders into full-fledged CEOs managing dozens if not hundreds of people is truly awesome. As my friend Mark Suster correctly points out, the people-side of the venture business is often the most interesting and challenging part of our roles, and when you are as financially and spiritually invested in our companies as we are, there is great joy in watching things just work. 

Where will 2014 take us? Who knows. We, like our companies, will continue to develop hypotheses, test, refine and execute. We work very hard to express and act on independent thought separate from the frenzy that often surrounds us. While part of this is a function of my own contrarian biases, as a firm we have passions and interests that often run counter to prevailing thought. Selling a new approach to quality inspection leveraging inexpensive yet highly performant cameras and sensors into shop floors of manufacturers, wearing steel-toed boots and safety goggles? You bet. Leveraging a growing developer community to supply a less expensive, easier to use infrastructure platform with big-time hardware requirements? Yup. These are neither easy nor inexpensive businesses to build: capex requirements are quite significant. But we believe deeply that both spaces offer tremendous opportunities for well-built and well-run entrants, and that we have chosen great founders and companies in each space to express our views. This is what our LPs pay us for. We are working to identify secular opportunities that will pay off in a wide range of macroeconomic environments. Because let's be real - who really knows what tomorrow holds? We can just think rationally, maintain focus, and stay within our areas of competency. Much more work to do, but we're getting there.

"If you can't do something willingly and joyfully, then don't do it. If you give up drinking, don't go moaning about it; go back on the bottle. Do. As. Thou. Wilt." 

- The late Peter O'Toole

Venture Capital and "Innovation"

Many have recently been critical of the role of the venture industry in financing "true innovation." The narrative goes something like this: "VCs are like lemmings, flocking to the latest consumer wave (mobile chat, ride-sharing, etc.) in search of explosive short-term hits. This is not how the venture industry is supposed to operate." This story line is further reinforced by the extreme pain felt by high-profile clean-tech investors, causing the burned to rotate away from an area of hard-science believed to be essential for the future of our planet. I mean, if VCs won't fund these companies, then who will? Or perhaps the better question is, who should? And come to think of it, is there really only one kind of innovation, that which results in the development of a new compound or a new technology?

When it comes to breakthroughs in long time-scale, massively capital intensive areas in the hard-sciences, e.g., battery technology and solar technology writ large, I'd posit that the right source of financing for this kind of innovation is either the Government or large corporations. Why (relatively) small, private partnerships are expected to invest in generational ground-breaking science is beyond me. If you are a Limited Partner in such a fund, and the cost of commercializing one of these technologies is several hundred million dollars or more, with the possibility of the result being -0- within the stated time horizon of the fund, how could this rationally be an investment worth making? While large funds, e.g., $1-2 billion funds, have sought to underwrite these risks, even this is a paltry sum when attempting to develop a technology that is nascent and unproven relative to entrenched, well-funded and efficient incumbents. These bets have often ended in tears.

So what about VC investing in "innovation?" I'd argue that VCs have financed tremendous innovation that has either a heavy technology component or a novel business model that disrupts established players, e.g., Dropbox, Box, MongoDB, Square, Airbnb, and many others including Google, Facebook and Twitter. These companies are helping to make the world better, regardless of the fact that none of them involves cracking the atom or developing a new solar cell that changes the cost/benefit dynamics non-carbon based energy.

Does innovation need to equate to hard science? I think not. There are tremendous breakthroughs that can and have been made with a fraction of the funds required to put a man on the Moon, harness nuclear fission, or to develop transformative battery technologies to change how people interact with their devices and modes of transportation. Certain technologies can impact a broad swath of society but require the patient, deep well of capital that is simply beyond the means of private venture partnerships. These are closer to public goods and best financed by either Government agencies or large corporations with generational time horizons. Once the fundamental breakthroughs have been established, the venture community is well-suited to help commercialize and distribute the impact of disruptive technologies. But for the venture industry to be labeled as ineffective or unfairly risk-averse by not backing such initiatives simply isn't fair. Innovation has many forms, and different market participants are better equipped to tackle certain kinds of innovation based upon their bankroll, their timeline and their mission.

Evidence is mounting that people at the bottom are increasingly stuck without skills or pathways to rise. Research from the Federal Reserve Bank of Boston shows that in the 1980s, 21 percent of Americans in the bottom income quintile would rise to the middle quintile or higher over a 10-year period. By 2005, that percentage had fallen by nearly a third, to 15 percent. And a 2007 Pew analysis showed that mobility is more than twice as high in Canada and most of Scandinavia than it is in the United States.

This is a major problem, and advocates of free enterprise have been too slow to recognize it. It is not enough to assume that our system blesses each of us with equal opportunities. We need to fight for the policies and culture that will reverse troubling mobility trends. We need schools that serve children’s civil rights instead of adults’ job security. We need to encourage job creation for the most marginalized and declare war on barriers to entrepreneurship at all levels, from hedge funds to hedge trimming. And we need to revive our moral appreciation for the cultural elements of success.

- From A Formula for Happiness, NYT 12/15/2013

Soft is the new Hard

I live in a world where engineering and technical talent is valued above all others, where the Holy Grail is a "coding ninja" who can crank out oodles of elegant code at a breakneck pace. These people speak a language that is distinct and only understood by those who also speak the language; to everyone else the language is akin to black magic. Myriad programs have sprung up to both preach and teach the gospel of coding, all with an eye towards empowerment. Because as we all know, knowledge is power. It has the ability to lift people up. And this is certainly true. However, I see a risk in all of this that is seldom discussed and will be upon us before we know it: knowledge without empathy.

The medical profession has finally come to this realization, but it continues to be a painful adjustment. Technical brilliance without "bedside manner" - or empathy - is a dangerous profile, as it can lead to both poor customer satisfaction and poor outcomes. Many ailments can be prevented, diagnosed and treated the old fashioned way, through conversation, listening and synthesis. Not everything requires a surgical procedure or a pill. But when it does, it is only after the other means have been exhausted. The "soft skills" of gently questioning, building trust and listening are now complementing the "hard skills" of cutting-edge medical knowledge and expertise in using the latest medications and devices. This will ultimately lead to a greater emphasis on prevention and pre-acute problem solving (once incentives become properly aligned), which is a win for all constituencies.

From an engineer's standpoint, where technical problem-solving is the default mode, it is seductive to throw code at a "problem" without standing in a customer's shoes and really understanding what is needed. These customers can be either internal or external: "Do we need to build this dashboard or is it better to rent someone else's?" "Do customers really need this cool feature on the development road-map or are we doing it because it's cool and because we can build it?" It's great to have a vast array of tools at your disposal, but the real skill comes in determining when to use which tools or, perhaps, when one's tools are not required in addressing a particular need. 

Whether founding a company, leading a team or simply being a team member, communication skills, managerial skills and negotiation skills are essential for long-run success. Simply looking at edge cases such as Mark Zuckerberg or Steve Jobs and modeling oneself along these lines is neither a healthy nor a winning strategy on a risk-adjusted basis. Being a well-rounded person who can interact well with teammates yet has the technical skills to execute complex plans is a much better success mode.

It actually reminds me of my time on Wall Street. Instead of Ruby, Python, R or Java (or any number of others), the mythical and little-understood languages were Derivatives and Quantitative Finance. Bankers quaked in their shoes at the mention of these, certain that the traders were going to rip off their clients (or at the very least recognize the lion's share of a transaction's gain in their book instead of banking's book). It was a land of the knowing and the ignorant, and the we/they cultures of most institutions reflected this reality. But this knowledge gap and lack of a common language eventually helped precipitate a train wreck, one where risk managers and bank senior management were ill-equipped to deal with massive and byzantine risks that traders put on the books. In this case knowledge was indeed power - the power to bring the global financial sector to its knees. 

It is incumbent upon schools, start-ups and larger companies to train today's technical talent for tomorrow's world, one which will invariably require the melding of engineering/coding/data science expertise with communication skills, business sense and empathy. The soft skills complement the hard: creating a squadron of coders without context does a disservice to their development and their ability to create a better world.

Why should VCs hire Associates?

The question: Why do venture capital funds hire associates to source if most good deals come directly through partners?

This was a question posed on Quora and it resulted in an outpouring of thoughts that were made more lucid by putting them in writing. 

The answer:

a. They teach me stuff and expand my thinking; b. They add another smart perspective around investment discussions; c. They allow me to leverage my skills and let me do more of what I'm best at; and d. They might be my future partner. I came to venture investing with a very particular set of skills, few of which one would call "conventional" in the venture sense. I didn't grow up in VC. I am not a serial entrepreneur. I was a fairly well-known angel investor, and that certainly exposed me to many kinds of businesses and enough data to develop a view on the elements of founder success. But I have gaping holes in my knowledge and experience that my partner Brad - and our associates Jesse and Amy - help to fill. And I am thankful for all I learn from them every day. They make me better, without question. So while they are learning and growing at their tender ages, I am doing so as well, albeit at an age somewhat less tender than theirs :-).  I also find that my younger colleagues have a level of empathy for founders that is both refreshing and helpful, particularly because many of our founders are much closer in age to them than to me. They also dive deep into the guts of our founders' businesses and those in which we are considering investing, giving them a level of clinical knowledge and "vibe" of companies that is hugely valuable when either deliberating over whether or not to make an investment or to make a specific recommendation to one of our companies. By giving them voice and armed with data and insights from their deep investigations, Jesse and Amy have had and will continue to have a marked impact on the decision-making at IA Ventures, and our Limited Partners should be very thankful for that. By performing much of the detailed financial modeling and forensic deep-dive into both current and potential portfolio companies, Jesse and Amy allow me to focus on the stuff I do best: coaching founders; helping with C and VP-level recruiting; assisting with strategic business development; working to shape an optimal Board; troubleshooting when required; and helping drive fund raising. While some people are great at everything, I am not. But with Brad's deep technical skills, mentoring of tech-driven founders and helping build their organizations and Jesse and Amy's vast array of vertical-specific knowledge and quantitative know-how, we've got the bases covered. This is what team is really all about.   Finally, I am not from the "two years and out" school of thought. I treat junior hires as partners from the perspective of their having a voice and an opportunity to interact directly with founders and senior management of our companies (not to mention receiving carry in the funds). I don't do this because I'm awesome but because it is just good business. We are painstaking about recruiting precisely because we take the long view, that an analyst hire could, in fact, grow into being a full Partner and take the Firm forward after I leave (and even after Brad leaves someday). Conventional thinking is that junior staff should go out and get operating experience, go to Business school, grow a bunch and have a range of life experiences before returning to venture investing. While I understand this logic, I've worked with enough unicorns in my life to know that one-size-does-not-fit-all and that some people don't need to run the usual gauntlet to add unique value to a founder or a company. And if the associate wants to leave and start their own company, they would find a friend, a supporter and very likely a backer in me. And if they are enjoying the world of venture investing and continuing learning, growing and becoming valued and sought-after by the entrepreneurial community in their own right, then all I can say is: Welcome home.

Greener pastures

Today is a day of big change in the IA Ventures family. After nearly five years working together my partner Ben has decided to return to being an operator. While I’ll miss Ben, I’m proud of his decision to follow his heart and take the long-term perspective on his career. With his experiences as a banker, as an operator and as an investor, he has built a set of skills and experiences that will serve him well in his next company.

Ben and I started working together well before IA Ventures. Ben joined me at IA Capital (my angel investment vehicle) straight out of Columbia Business School, and improved the organization and accessibility of my portfolio data. He later became an operations lead at a few of my portfolio companies, most notably the very successful search retargeting firm Magnetic. He was a boon to technical founders who needed help on the business and operations end of things, and was key for helping Magnetic (then called Domdex) between its Seed and Series A rounds. I saw his passion for working closely with founders as well as his love of business operations. And he was very good at it.

Ben's operating career was derailed by IA Ventures. We raised two funds, built a portfolio I’m proud of, and developed the IA Ventures brand as well. It has been a very good period for the firm, our portfolio companies and our growth and development as investors. However, after deep introspection Ben decided that this was the right time in his career to return to the operating side, something he has always deeply valued, as evidenced by the in-depth way he'd connect with founders and their teams. Now it's time for him to fully immerse himself in that world, not as an agent but as a principal. I know he'll do great.

Regardless, Ben will always be part of the IA Ventures family and his contributions during our earliest days will not be forgotten. Thanks for everything, Ben, and all the best as you tackle new and exciting challenges.

What I've learned from Little League

As my friends know all too well, mine is a life immersed in baseball. Yes, there's that venture investment stuff, but in between board meetings, team meetings, meeting new companies, staying in touch with my networks and breaking down the barriers to data entrepreneurship at Michigan and Columbia there is baseball. Both my kids are intense baseball players. My wife is a Little League executive (and holds a Ph.D in psychology, which helps) and division coordinator. And I am a long-time manager and coach of teams with kids ranging from ages 7-17, from Junior Minors all the way to Seniors. It has almost become a third career of mine (Wall Street, venture capital, baseball coach). Along the way I have learned a ton about strategy, human psychology - and life.

Newly-minted baseball teams and start-ups have a tremendous amount in common. Every Spring there is a Little League draft and the managers sit around and pick their teams, not dissimilar from kicking off a new start-up. Those of us who have been around Little League a long time know most of the kids, their playing histories, their personalities and their families. But this anecdotal knowledge is augmented with objective data that are generated in a common League-wide tryout the morning of Super Bowl Sunday. Players are scored on their batting, fielding, pitching and catching (if they pitch and catch), and there are various sub-categories in each of these areas. Think of these scores as their resumes and conversations with prior coaches as being reference checks. Drafting players, like hiring team members, is an inexact science but the goal is to get as much quantitative and qualitative data as possible to make the most informed decision you can. Assuming all the mangers work reasonably hard in the data collection process, there is a somewhat common view of how players rank by position based upon skill. But somehow, people's draft boards look very different post facto. The reason: managers draft for different things.

Year after year, in my experience newer managers tend to underperform more experienced managers. Why is this? My hypothesis is that the newer managers tend to draft based on the theory of "best athlete available that meets my position requirements," while the old timers tend to draft with a particular team construction in mind. This means taking into account factors such as "Is the kid a team player? Does the player show up for practice on time? Are they humble and do they work hard? Are their parents over-involved and stressing out the kid (and the coaches and other team members in the process)? Is the player a potential leader? Has the player previously been on teams with other kids where they've been successful?" In short, the objective function is building the best team, not assembling the most talented group of individual players. And in Little League, as in life, teams win when they function as a single unit and not as an amalgam of autonomous parts. So I have consistently passed up more skilled players in order to draft players who are good, but even more importantly, are good kids and fit within the team concept.

This is a movie I've seen many times before in start-ups I've backed. There is the seduction of hiring the "rock star, 10x performer, force of nature" contributor, even if they are a prima donna and most assuredly not a team player. I've witnessed this from the perspective of whether or not to hire these people as well as whether or not to fire these people who are already in the company. It is a very painful decision to make, but in my experience these people almost never work out in a start-up environment, where every person is so crucial to getting the business off the ground. Positive team chemistry and culture is critical at all times, but especially when a team needs to be working in perfect synchrony, backing each other up and focused as a single unit on the task at hand. Selfish but talented people mess up this dynamic, even if they can write beautiful code but piss off their team members or treat them in a disrespectful way. Fortunately there are talented people who aren't destructive to a firm's culture, and these are the people start-ups need to find. Optimizing for team, not simply talent, is the message. 

When building a high-performance team the question you should be asking yourself is: what is the goal and what are the resources I need to get there? Because the goal invariably requires multiple skill sets spread across several individuals, ensuring that you build the connective tissue among these people who are receptive to this "team first" notion is Job #1. It's not about finding the brightest stars in the sky, it's about finding those stars that make the constellation you want to call your own.

Breaking through

I spend a bunch of time speaking at events, guest lecturing at friends' classes and mentoring young people. It is something I feel passionately about and enjoy a great deal. I always try to be blunt, honest and unambiguous with my input, hoping that at least some of the take-aways will be employed by those hearing my words. But I continue to be surprised by the number of common mistakes made by start-up founders, and wanted to provide a short list of some of my hot buttons.

Post-presentation behavior: When I (or someone like me, be they an investor, a well-know start-up founder, etc.) speak at a conference, it is commonplace for a group of people to line up to say hi and chat for a minute. All good. Except what often happens is that a (most often young) founder will try to pitch me their idea. I hate this and it generally leaves a bad taste in my mouth. There are too many people and too little time for this to be successful. You do not have my undivided attention. However, the goal should be to be brief, on point and to either say something smart or ask a good question that relates to discussion. This way, you can send me an email at roger@iaventures.com and you might have seeded a dialogue. But if you force a pitch on me at this moment, forget it.

Getting in touch with a VC: The number of blind emails we get with a pitch and a meeting request is extreme. This exercise is a complete waste of time as far as I'm concerned. The signal/noise ratio is simply too high to do all the calls and take all the meetings people want. But there is one way people short-circuit a meaningful part of the deal funnel - getting referred into us by a trusted person. This person can be another investor with whom we're close and done business. It can be one of our founders. The common thread is someone whom we trust and whose judgement we value. While we don't take every meeting requested from referrals, the likelihood of getting a close look is infinitely higher than sending in your stuff and hoping that a meeting will take place. So use that entrepreneurial intensity, passion and ingenuity to network to someone who knows me or one of my colleagues and impress them sufficiently such that they're comfortable making the introduction.

Networking: Even with all that has been written about the importance of networking, I see way too many aspiring entrepreneurs looking for a silver bullet for how to meet domain relevant people for collaboration, recruitment and support. Have you checked out relevant Meetup groups? General Assembly? Do you have specific experience where you might mentor other founders at TechStars or another accelerator program? Have you spent time doing research around events taking place at local colleges and universities? How about starting your own community around your particular area of interest? With even a little effort it is impossible not to find abundant opportunities to network, learn and grow. You've just got to do it. I have no simple answer. It just takes time and hard work. Kinda of like what it takes to be a startup founder.

Building your brand: If you are in the start-up world, either as an employee, founder, investor or aspiring to do any of the three, it is important to thoughtfully build your online and offline identity. The beauty is that these efforts are valuable for anything you might want to do, and, in fact, is great practice for what you'll do when you land your dream role. Develop a thesis and take a stand. How can you add value to the community discussion? Start writing, but with a purpose. It forces clarity of thought, opens up your mind and lets people get to know you better. Create opportunities for speaking in public and sharing your ideas with others. This will help bridge the online/offline gap and build a more personal identity, as well as providing a forum for feedback and debate instead of living inside your head. And of course actively maintain a Twitter account and an up-to-date LinkedIn profile. These are table stakes for people wanting to get a quick snapshot of who you are and what you're about.

Be passionate, be strong but be deliberate. The fact is that no matter how smart or hungry you are, it just takes time to network, acquire knowledge and experience and to feel comfortable in your own skin as a member of the start-up community. And this is a good thing. Life is a marathon, not a sprint, so be purposeful and focused without feeling like you're behind where you should be. The worst thing you can do is be unfocused and reactive, letting the environment dictate your roadmap instead of the converse. This doesn't mean be insular and block out external influences; it means remaining true to your mission. It's just like my idol W. Edwards Deming used to say (paraphrasing): It's about understanding the process. If you develop the best processes, positive results will follow. 

It's all there within your grasp. Just be thoughtful. Listen a lot. And by all means, follow your passions.

Rabbi David Adelson, East End Temple, April 16th, 2013

The response to the terror in Boston: Channeling for good

Yesterday's horrific and senseless tragedy in Boston stirred up many of the same feelings I had on a beautiful September morning almost 12 years ago. Sadness. Anger. Rage. Confusion. And simply Why? Why did this happen? How could it happen at a time of celebration, peace and personal and community achievement? Words simply don't do the feelings justice. I went to Twitter to get more facts about what had happened, and then looked for the Tweets of my many Boston-based friends to see that they and their families were ok. Finally, my feelings washed towards empathy, understanding how such a tragic event can both shock and ultimately cause a city, a community to come together in ways previously unimaginable.

As I've watched the many responses to the event pop up on blogs, Facebook, Tumblr and Twitter I've been both amazed and blown away by the stark message sent by all: We will not stop. We will not be scared. We will get busy helping, contributing - and running. I wouldn't be surprised to see 2x the applications to the 2014 Boston Marathon given the vibe I've seen across the social nets. Many of my running friends across the start-up and investment communities have already stated their intention to run next year's Boston Marathon, to simply say no to fear and to move forward in a constructive way. Props to all.

But perhaps the most surprising aspect of the responses I've seen is that rather than focusing on anger and thoughts of revenge, they've largely centered on feelings of sadness followed by calls to action. Donating blood, money and time. Running in next year's race. Positive stuff. I don't know if we as a society are getting better at reacting to crises or if violating something as pure and sacred as the Boston Marathon caused a specific outpouring of emotion, but I'm truly blown away by the tone of the messaging. To me it is a life lesson in how to handle crises being demonstrated on a mass scale. 

#respect

Reflections on IA Ventures, 3.5 years in

I periodically write about my learnings as the leader of IA Ventures, principally to unlock what is in my head and in my heart. As an operating partner with people who are giving their lives to building their businesses and a financial partner with those who have entrusted us with their capital, this is a very serious undertaking. Sometimes I find it necessary to call a "time out" in order to reflect, assess and share. That time is now. 

As I've written before, our most valuable resource is time, not money. Given this realization, we've continued to emphasize lead-managed investments or relationships where we are co-lead with a partner and firm whom we like and respect a lot. This necessarily means writing somewhat larger checks and working to own more of companies driven by compelling teams possessing great chemistry, rich skill sets and bold visions. The result of this strategy is to take somewhat longer to close an investment, but to have established an even deeper relationship with our founders, their customers and other key players in their ecosystem. I can't tell you how many times I've referenced my friend and co-investor Mark Suster's memorable post Invest in Lines, Not Dots. His advice cuts both ways - not only is it important for we as investors to get to know our potential founders well, but for founders to get to know us as people and potential partners, too.

This also works to cement one of my absolute bottom lines as an investor: our founders need to want to work with us as much as we want to work with them, and if there is a "fire drill" to consider an investment or a sense that founders are optimizing for round price and not for who-is-the-best-partner-to-build-the-best-business, we'll simply agree to disagree and bow out. No hard feelings, but these are simply not the situations that comport with our notion of deep partnership. I've also been amazed and impressed at the due diligence our potential founder/partners are doing on us, and value and appreciate the thoughtfulness and the time they take to make sure we're the right fit for them. 

It is important to note that the above in no way has impacted the stage at which we invest in companies, which continues to be seed stage/first money in (or first institutional money in) or early Series A. Our fundamental philosophy is that we are best-suited to help build companies from Seed through Series B stages, and this is closely tied to our belief that we are building a portfolio that sits at the optimal point of the risk-reward continuum. We've always believed that "small is beautiful," and continue to cultivate deep relationships with larger firms to partner with us at later stages of a company's development. It is very hard to be good at everything, and we've deliberately chosen to focus on the early stages of a start-up's life.

This approach also has also worked to shape our reserve policy. While we have always created significant reserves for follow-ons, we are now firmly settled into a "life cycle" approach: we are positioned to lead Seed and Series A rounds, with sufficient reserves to do our full pro rata in Series B rounds. We have done and will do select Series C participations, but only where we expect the marginal return on our capital to be in the 7-10x range or higher. But as companies experience rapid growth and begin to scale beyond our early-stage competency and capital base, we allow ourselves to get diluted down from the early high ownership levels to still significant but lesser levels as fresh capital is better deployed against new opportunities. This is a natural and comfortable hand-off that takes place from early stage to growth stage, and we are not in the growth stage business. And that is fine with us.

Likely the hardest thing about building a business for the next 50 years is team construction and company culture. While I work hard to create a particular culture that I hope is retained well beyond my leadership of IA Ventures, team construction is a delicate balance that needs to evolve as the business grows and develops. Venture capital is a people-powered business and one which doesn't scale particularly well (at least in the way we interact with our partner companies). Therefore growth requires more people, each new person adds to and changes the culture to a certain degree. Core principles are retained but style and chemistry dynamically adjust to new people who have entered the system.

So as culture and vibe are shifting and incorporating new inputs, the nature of communication necessarily changes in response to more specialized roles and responsibilities. New analyst? That changes things. New principals and partners? I can only imagine the shock to the system. It's not that shocks, jolts and new dynamics aren't good; in fact, they're mostly great! But getting the balance of skills and styles right that all fit within the culture is not an easy task. This is why we've been super deliberate when bringing on new team members, and our approach has worked thus far. But the stakes continue to grow as the firm grows, and as we are all so busy traveling and spending time with our companies it is challenging remaining centered, strong, focused, synchronized. Mindfulness is one thing: successful execution is something else entirely.

In the time I've spent building the IA Ventures business, it has become abundantly clear that I am facing exactly the same issues as those founders whom we back every day. Articulating and selling the mission and the vision of the firm. Clearly communicating the value and benefits of our product. Closing business. Staying close to and getting feedback from customers. Recruiting. Understanding the competitive landscape. Proactive strategy development and planning. Marketing and PR. To say that I have empathy for the startup founder is the understatement of the century. I get it. Believe me, I get it. Few things are as exciting or rewarding as building a business, but it is also among the hardest things I've ever done. But 3.5 years in, there is nothing I'd rather be doing. Thanks to Brad, Ben, Jesse, Julie, Joey, Adrian, Drew, and all of our founders. You've pushed me hard, yo! The best is yet to come...