Mark Andreessen and Thoughts on the Venture Capital Industry

One of my current projects is to learn about the venture capital industry. Specifically, I want to answer this question: Can venture capital investing be practiced in accordance with value investing principles as I define them?

Marc Andreessen is a very successful entrepreneur who has recently "moved to the dark side" and raised a venture capital fund. In this Tech Ticker interview he speaks candidly about how the industry actually works. Novice student that I am, I tried to take good notes:

1) On purpose, the fund is designed to invest anywhere between $50,000 and $50 million per deal, meaning it has the flexibility to invest in early stage to late stage companies. Unstated message: most venture funds are too rigid in their mandates.

2) The data say that in any given year there are only about 15 funded companies that will ultimately reach $100mm in annual revenues. These companies end up accounting for something like 97% of venture capital returns (!). Unstated message: If a VC fund can't get into these 15 deals, it has very little chance of delivering strong returns for the above-average risks it takes.

3) The job of the VC investor must be to be able to invest in one or more of those 15 companies. That's the point of having the flexibility to invest across all stages.

4) To call venture capital an "asset class" is a misnomer, because only about 10 to 20 VC firms earn very good returns, and the rest of the 780 or so don't beat the S&P. The dividing line is who is able to identify AND get into the best deals, the magic 15. Andreessen thinks his firm can be one of those firms.

5) Many VC firms will go under--most likely hundreds. But the top 10 or 20 firms will do well and deliver pretty good returns.

6) Ideally the founder of a VC investee goes on to become an effective CEO. That's how you get the big wins.

7) Much less ideally is when the founder doesn't want to be the CEO, because that introduces a gigantic element of risk--hiring a CEO is an extremely dangerous proposition and usually fails.

Here is my question: If you were a "venture capitalist in venture capitalist firms," how would you go about determining which of the 800 VC firms in the country have the ability to be among the top 20 that justify their existences? My sense is that the strongest determinant of the ability to get access to the best deals of tomorrow is the ability to have gotten into the best deals of recent years. There is a "rich get richer" effect in VC that makes the top firms very good businesses. Which begs the next question: Why does this effect exist? I'll save my speculations for another post.

It also begs another question: If incumbent VC firms have such an advantage, why does Andreessen believe his upstart firm has a shot at breaking into the club?

Lots to learn . . .

Addendum: I recently had lunch with a person in the VC industry who made another point that furthered my education. He believes that a necessary element of a good VC fund, an element that is difficult for large institutional investors to stomach, is the ability to tolerate and even encourage great flexibility in the evolution of startup companies. Just as no battle plan survives the first contact with the enemy, no startup business model survives first contact with commercial reality. It's almost a rule rather than an exception that a startup will radically alter its original business model early on in its life, maybe more than once.

Now that I'm involved in a startup project of my own, I think about this stuff often these days . . .

Comments

[Crocodilian:]

The venture capital industry has been spectacularly unsuccessful. Once you get beyond the very top of the heap (Sequoia) the returns have been lousy, and the liquidity nil. You need look no further than Andreeson's own startup (Loudcloud) to see why: smart people with a great track record plus a lot of venture money = not much.

Google skews everyone's view, but remember there were _many_ search companies, and by and large most haven't made any money at all. In a winner-takes-all business, if you don't have a share of the winner, you have nothing. What's more, you could have waited for Google to go public as a profitable company to invest in it. Investors who bought the Google IPO will end up doing far better than venture investors as a class.

The venture capital "business" has a considerable burden of proof in establishing that they have a business purpose -- and not mere vanity-- for their existence.

Jul 11 09:36 PM

[Elliott Dahan:]

The VC stage of Risk Investing provides money for growth.

The Seed stage of Risk Investing creates and innovates.

The VC stage and the Seed stage are systemically, operationally and attitudinally different. They have different metrics for acceptance and success; funding, oversight, sourcing, profitability and, most importantly, infrastructure.

The VC stage requires various levels of traction.

The Seed level requires a belief in the technology and people who are trying to implement the product/service.

The VC stage of the Risk Investing industry is bloated and, yes, many, many VC firms will disappear.

I have personally been involved in situations where a Seed company was not ready for VC level funding and the entire process was both a waste of time and, at times, offensive.

I have been involved in situations where a Seed company has high profile Validation and VCs were tripping over themselves to invest.

The "heavy lifting" of Seed stage investing is the sourcing, screening and oversight of the Entrepreneur.

What is needed is a strengthening of the Seed stage. All Seed companies need two things: Money and Validation. What is needed is a system to build stronger Seed stage companies that can then approach the VC stage with credibility and validity.

What is needed is a Public-Private For Profit dedicated effort to work with, support and compensate the Seed Infrastructure (Incubators, Economic Development Agencies, Tech Transfers). This infrastructure already exists and provides the efficient sourcing, screening and post-investment oversight needed to develop Series A worthy companies. What is needed is a dedicated effort that is not geographically constrained. What is needed is a thorough Virtual Incubation system that brings both Community and Collaboration to all elements of the total Investing community.

Thanks,

Elliott Dahan
Managing Partner
The Growth Group
www.thegrowthgroup.com

Jul 14 11:15 AM