I caught up with him recently to talk about venture capital from both sides of the equation, investing for the long-term, missed opportunities, and how he gets good ideas.
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Let's start with something basic. What is venture capital, really? What is its ultimate purpose? And what does a venture capital firm do?
At its most basic form, venture capital is a source of funding for companies that are too risky to be ideal candidates for other forms of funding, like a bank loan. It’s meant to support and grow a business until an “exit” in the form of an IPO, a merger or acquisition, or in less than ideal scenarios, a company shutdown. It’s also important to say that while many successful technology companies have been venture-backed--Apple, Amazon, Google and Facebook come to mind-- it’s not solely a funding method for technology companies. Many very successful, non-technology companies have also been products of venture capital, including Home Depot, Starbucks, and Staples.
Traditionally, the role of a venture capital firm was to write a check to a company, and stay up-to-date on its progress at quarterly board meetings. The reality today is that capital is more available than ever and entrepreneurs have become more sophisticated, so founders are looking for more than just cash from their venture backers. They’re looking for guidance on building the company, the ability to tap into a VC’s network, and help with potential business opportunities.
You've seen how venture capital works from both sides--as an entrepreneur and a venture capitalist. How did your perspective change when you changed roles?
One stark difference for me is how you measure success and outcomes. When you’re in a startup, it’s very easy to measure progress in 90 day increments - what milestones does the company need to hit each quarter? If you’re managing the company effectively, you have a clear set of objectives and the ability to determine if you are on or off track from accomplishing those: did we hit our sales numbers, did we ship the product, etc.? Of course, hitting your objectives alone doesn’t guarantee success--you might have set the wrong objectives or the market needs may shift over time--but it’s a reasonable proxy for measuring interim success. And, if you’re a public company, you get daily real-time feedback on at least the perception of your progress, as measured by the stock price.
In contrast, in VC, not only are there very few near-term guideposts to inform how you are doing, but often times doing nothing may in fact be the right thing to do. For example, you may be tempted to think that making investments on a regular basis is a reasonable objective, but there may be 90-day cycles in which the right thing to do is to make no investments. Coming from an operating role in a company, that can feel odd - that doing nothing is in fact accomplishing your objective - so that takes some getting used to. Similarly, our time horizons are so much longer in venture capital that you have to adjust to not getting that near-instant feedback. We’re making investments today that may not ultimately go public or be acquired for 8-10+ years, so you have to think in very long time frames. And while it can often be the case that “lemons ripen early” (meaning that the unsuccessful companies fail early in a fund’s lifecycle), the harvest cycle for the winners in the portfolio can take what sometimes feels like an eternity.
Your new book, Secrets of Sandhill Road, is literally subtitled Venture Capital and How to Get It? Why did you decide to write a manual like this, especially right now?
Having been through the company-building process myself and after a decade in VC working with thousands of companies and negotiating hundreds of term sheets, I wrote this book to help demystify the process. I’ve found consistently over the years that the appetite for learning more about the VC and entrepreneurship worlds far outstrips the available resources. If you live in a major hub of VC - e.g., Bay Area, Boston, NYC, LA - it’s easier to tap into your local resources to help augment your understanding, but there are a lot of smart people with great ideas in other parts of this country and globally for whom access to information is just not as available. We want, and in all honesty we need, more entrepreneurship - if laying out how the business works encourages that, then I think this book has done its job.
More generally, broader and more diverse access to technology, entrepreneurship and capital (whether or not that capital comes from VC alone) is a critically important thing for sustained job and economic growth - not just here in the U.S., but globally. New company formation is the biggest driver of job creation and, particularly in a world where access to those jobs is highly localized to a few select geographies, I believe we can and should do better.
I’ve seen many founders not fully grasp how the venture capital business works and what incentives investors have. Unless you have the whole picture, it’s hard to know what motivates a venture capitalist, and understand what their expectations will be for founders they invest in. Learning everything you can about VC first is important for that reason, but also to ensure it’s the right form of financing for your business. It doesn’t make your business idea a bad one if you conclude that VC isn’t right for you. In fact, it’s quite the opposite - making sure you have the same goals as your financing partner is probably the best thing you can do as an entrepreneur to maximize your chances for success.
I'd love to hear your thoughts on what's happened in the capital markets over the last 20 years--the good and the bad?
Let’s start with the venture side of the equation, where we’ve seen two major shifts. First, the introduction of seed money as an institutional form of capital. Before the mid-2000s, we mostly had individual angels writing small checks from their personal capital, but over the last 10-15 years we’ve seen hundreds of new institutional seed funds formed. And while the total dollars are still small in the context of the overall size of the VC ecosystem - seed is probably 5-6% of total VC dollars - these new firms have significantly increased the number of new startups and the amount of experimentation for new ideas with minimal capital investment - both of which are very positive for the ecosystem.
The second shift has occurred in the complete other end of the financing spectrum - the very significant amount of dollars that are coming into the late-stage private market. You have this very interesting dynamic in the market: on the one hand, it’s cheaper and easier than ever, in terms of access to capital, to start a company. But at the same time it’s more expensive than ever to scale a company. The latter is a function of the growing global market size that many of these companies are going after and the investor world has responded by being willing to fund these late-stage dollars. In fact, last year something like two-thirds of all venture capital dollars invested went into rounds of $100 million or more.
What about in the public markets?
We’ve seen an overall decline in the number of IPOs, the virtual disappearance of small cap IPOs (sub-$1b market cap) and a significant increase in the time it takes for startups to go public. It used to be that startups went public about 6-7 years from founding; that number is now 10-12 years. While this may be good for private investors in the short term - since most of the appreciation of these companies accrues to them - I believe it’s a terrible thing for the long-term competitiveness of the U.S. financial markets and economic growth. We’re basically taking investment opportunities that used to be available to the broader retail segment of the market through IPOs and now making those available only to those with the means to invest in private assets. We’ve been active within the regulatory community - as have you of course - to try to address this; I think it’s a critical issue to get right.
As one of the first partners at Andreessen Horowitz, have you seen the role or mission of the firm change in response to changes in the markets? What do you look for now as opposed to then--if it's anything different.
Our objectives haven’t changed - we’ve always aspired to back great entrepreneurs who are applying innovative applications of software to try to build enduring, important and independent companies. As you probably know, we’ve been investing against a consistent theme - Marc Andreesseen’s “software is eating the world” - and always at multiple stages of a company’s growth - from seed to later-stage venture.
But, along the way, as entrepreneurs enter new markets, we continue to leave ourselves open-minded about whether the intersection of software with these new markets makes for interesting investment opportunities. For example, when we started the firm, we didn’t contemplate a dedicated investment effort at the intersection of computer science and life sciences, but beginning in 2013 we organically started to see more talented entrepreneurs building companies in this area, leading us to raise our first dedicated Bio fund in 2015. Similarly, we’ve been investing in crypto-related assets going back to our original Coinbase investment in 2013, but it wasn’t until after the Ethereum launch in 2015 that we started to see a critical mass of entrepreneurs entering the broader crypto startup world. We followed that closely and ultimately made the decision in early 2018 that there was enough of a market opportunity there to raise a dedicated fund to this effort.
The other evolution we’ve seen - and I alluded to it in the previous question - is the nature of funding rounds. We’ve always invested across different stages - in fact, one of our very first investments as a firm in 2009 was in the Skype spin-out from eBay - but until very recently, we’ve always done so out of a single fund structure and with the same teams that are focused on our early-stage investment activities. As we’ve continued to see the growing opportunity for later-stage opportunities as a complement to our early-stage efforts, we just this year decided to raise a dedicated fund to focus on later-stage investments. Along with that, we’re building out a dedicated team of investment professionals with expertise in this area to help us increase our coverage efforts.
Does the market pressure to produce profits immediately affect venture capital's relationship to companies?
This question is one of the reasons why I wrote the book, and I think it’s an often misunderstood area. Venture capitalists seek to invest in companies that can be important, enduring and stand-alone businesses in their respective domains. Nearly every entrepreneur that I’ve met seeks the same - they’re dedicating a significant portion of their lives to doing something that is incredibly difficult because they believe in the long-term potential of the business opportunity.
I think things can go awry is when the objectives are not aligned. For example, an entrepreneur might have a great business idea that just may not be in a market big enough to sustain a large, stand-alone company. There’s nothing wrong with that - in fact, it can still allow an entrepreneur to achieve her professional and financial goals. But, taking on venture capital dollars for it probably doesn’t make sense. This is why it’s so important to have a deep understanding of VC so that you can avoid this misalignment.
Specific to the pressure to produce profits, again I don’t think that often becomes a point of contention between VCs and entrepreneurs. As long as everyone believes in the market opportunity and the ultimate objectives, VCs recognize that their money is intended to enable companies to go after that growth, even if it means producing financial losses in the short term. That’s not a license to spend profligately - the unit economics need to work and the market size needs to be big enough to support the growth - but as long as those elements are there, the incentives between VCs and entrepreneurs are aligned.
Can you think of a memorable pitch that you didn't end up investing in?
We were fortunate enough to see the pitch for the Series A round of Square; unfortunately we decided not to invest. Square’s then-CEO and co-founder, Jim McKelvey, had a great organic origin story. The Square dongle was derived from a personal experience of hardship - Jim was a professional glassblower and was frustrated with his inability to use credit cards as a method to sell his wares at local fairs . And while this was a positive signal for us, we unfortunately didn’t have enough time to get to know Jim and evaluate his skills as a CEO. Jack Dorsey at the time was serving as Chairman, but hadn’t committed to playing a full-time executive role in the company. So we passed on the A round.
In this situation, we failed to appreciate two things. The first was that Jack would realize that the best way to maximize the success of the business was for him to become the CEO, which he eventually did - just a few months after that financing round closed. The second was that the Jack’s star power could provide the company with an unfair advantage in the marketplace. For example, Jack told us in the pitch that - just as Ev Williams had done with Twitter - he might be able to use his network of relationships to go on The Oprah Winfrey Show and use that as a way to tell the company story to a massive, broad audience, for no marketing spend. He also had great relationships with financial services luminaries such as Jamie Dimon that might enable him to pitch a partnership to bundle the Square dongle with the J.P. Morgan credit card business to acquire tons of Square customers at a very low cost. These things of course wouldn’t guarantee success for the business, but they were unique potential avenues of distribution that might be available only to someone of Jack’s professional stature - in a startup, every potential advantage can indeed matter.
What's a startup you wish someone would try to build (and we'll leave whether or not you'd invest in it out of the equation!)?
I’m pretty sure this is not a fundable idea, but here goes!
I’ve long been interested in health and, in particular, the role of food choices in determining health. I also believe that if people understood what was in fact healthy - not an easy task given the difficulty in producing scientifically rigorous studies on nutrition - and if they had the luxury of time to prepare healthy meals, they would in fact do so. We’ve certainly made progress over the last twenty or so years in addressing some of these challenges - there are more restaurants that do more to cater to the health-informed and of course we have the plethora of ingredient and meal home delivery services.
But what I think is missing is the perfect substitute for a home cooked meal that caters precisely to the ingredients/nutritional needs of the individual. I’d love to be able to order a meal that incorporates the precise ingredients I want and is made from the precise recipe I provide - just as I would do if I had the time (and patience) to do it on my own. This of course is probably why this will never work as a business - I’m not sure mass customization works economically. But, I am fascinated by the new “cloud kitchens” type models that are being formed and am hopeful that maybe they will crack the code on this.
Have you seen companies that you thought would make it burn out because they didn't have enough time or funding to get their business model right? No need to name names.
Sure - as you know, probably 40-50% of what we invest in at the early stage never makes it to a successful outcome. That is the nature of this business - starting a company is incredibly hard. You have to be able to “willfully suspend disbelief” and be an eternal optimist to take on the task of being an entrepreneur.
Specific to your question, though, I would have guessed coming into this business ten years ago that most failure would be a function of bad product/market fit or, as you mentioned, time and money. But my experience has been that organizational/scaling challenges tend to be more relevant to success or failure. We’ve had examples of where we thought something was a good idea that turned out not to be, or the market just didn’t develop in the way we expected-- those are just part of the risks of being in this business. But the more challenging and disappointing ones are where the product is there and the market is there, but the team just doesn’t coalesce in the way you would hope to really take advantage of the opportunity in front of you. Getting a hire wrong is certainly painful, but waiting too long to get the right person in the seat can be equally damaging. On the positive side, we’ve also seen great cases where executing perfectly on the team buildout and scaling make a huge different in the success of the business.
So, I would turn your question around a little bit in that often not having enough time or money is systematic of something not firing on all cylinders in the business. It’s often more an effect than a cause. Granted there are times where the market opportunity just develops more slowly despite your best efforts and in those cases access to capital alone can indeed be determinative. But, other than a big macro shock that causes all financing to dry up, I think those situations are in the minority.
And last, a question about how you manage all of the above. Do you have a go-to stress relief method?
I have been a runner for as long as I can remember and have always believed in the physical and mental health benefits of running. I love the solitude of it, and I love the fact that it’s the one place I can go where nobody can call or email me for at least a 45 minutes (on a good day). I don’t run to solve business problems, but I do often find that I come up with new ideas or ways to address some existing challenge when I’ve got nothing else to focus on during a run. By the way, airplanes in the pre-WiFi days used to provide similar solace; I’m not sure that I’d wish to not be connected on flights now, but it sure was a mixed bag for me when that technology was deployed!
