the lower-risk startup: how venture capitalists increase the odds of startup success
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© David Teten 2013. More at ffvc.com and teten.com © David Teten 2013. More at ffvc.com and teten.com
How Venture Capitalists Increase the Odds of Startup Success
The Lower-Risk Startup
David Teten, Koen Bremer, Gyorgy Buslig, and Adham AbdelFattah
ffvc.com // @ffvc teten.com // @dteten
http://www.flickr.com/photos/glynlowe/7087555453/sizes/z/in/photostream/
Intro Financier Mentor Next Steps Resources Operator
© David Teten 2013. More at ffvc.com and teten.com
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Intro Financier Mentor Next Steps Resources Operator
© David Teten 2013. More at ffvc.com and teten.com
• Introduction
• Resources
• VC Type 1: Financier
• VC Type 2: Mentor
• VC Type 3: Operator
• Next Steps
Agenda
Intro Financier Mentor Next Steps Resources Operator
© David Teten 2013. More at ffvc.com and teten.com
Background David Teten, Koen Bremer, Gyorgy Buslig, and Adham AbdelFattah published the first-ever research study on “The Lower-Risk Startup: How Venture Capitalists Increase the Odds of Startup Success” in The Journal of Private Equity (March 2013), as well as in Techcrunch, peHub, and Betabeat. These slides summarize our findings.
This is a sequel to David Teten’s 2010 research study on “Best Practices in Private Equity and Venture Capital Deal Origination”, with Chris Farmer, Venture Partner, General Catalyst, which was published in Harvard Business Review, Institutional Investor, the Journal of Private Equity, etc.
Intro Financier Next Steps Resources
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Mentor Operator
Highlights of our findings • Most of the funds with well-developed developed Portfolio Operator models
have top-quartile returns (above a 20% IRR in the relevant time periods) . (See caveat at end of presentation.)
• Very little systematic research has been executed in this area. • Investors have conflicting opinions about the role of VCs in supporting portfolio
companies; most VCs fall into the “Mentor” category. • Size does matter; VC firms with a larger number of portfolio companies provide
more services. • Few of the VCs we interviewed charge any of their portfolio companies for
services they provide them. • Most common types of support revolve around recruiting, direct customer
introductions, and introduction to vendors, e.g., PR, legal, and other services. • This pattern in VC is in part modeled on the longstanding growth of operating
groups in PE firms; PE firms could benefit greatly by emulating how VC firms are using technology in portfolio operations and firm-wide operations.
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Team
• David Teten (teten.com) is a Partner with ff Venture Capital (ffvc.com) and Founder and Chairman of Harvard Business School Alumni Angels of Greater New York (HBSAlumniAngels.com/NY). He has previous experience (as a consultant) with the portfolio operations groups of Carl Icahn, the Goldman Sachs Special Situations Group, and others.
• Adham AbdelFattah is the Founder & CEO of CircleVibe, a mobile startup in New York; a consultant on leave from McKinsey & Company in the New York office; and a Columbia Business School MBA.
• Koen Bremer is a consultant with the Boston Consulting Group in the Amsterdam office and a Columbia Business School MBA.
• Gyorgy Buslig is a consultant with McKinsey & Co. in the Hungary office and a Columbia Business School MBA.
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ff Venture Capital (ffvc.com)
• Early-stage technology venture capital fund • 160 investments in 60 companies since 1999 • 17 employees by March 2013 • First investments typically $50-$400K at valuations of <$5m pre-money • Follow on in later rounds for best-performing startups • Prominent investments include:
Cornerstone OnDemand (IPO); Quigo Technologies (sold to AOL for reported $340m); Klout; 500px; Voxy; ThinkNear
Intro Financier Mentor Next Steps Resources Operator
© David Teten 2013. More at ffvc.com and teten.com List of companies through June 30, 2012
ff Venture Capital: 160 investments in over 60 companies since 1999 (ffvc.com/companies)
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© David Teten 2013. More at ffvc.com and teten.com
Harvard Business School Angels of Greater New York (HBSAlumniAngels.com/NY) • Members are Harvard affiliates from all industries. • We invest in companies regardless of any Harvard affiliation. • In last twelve months, $1.8m invested in 8 companies. • $84K mean individual check size per company per round. • Third largest angel group in NY tri-state area by number of paying
members (to our knowledge). • Launched Venture Capital Access Program, focused on helping women
and minority investors raise capital from our network.
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Venture Capital Value Creation Research Objectives Discuss the range of philosophies found among major investors in their approach to working with portfolio entrepreneurs
Understand how venture capitalists (VCs) can systematically help startups increase their odds of success beyond simply investing
Define a blueprint for how investors can assess their strengths in order to meaningfully help portfolio companies succeed through operational (non-financial) support
What investment philosophies exist?
What value-creation opportunities exist?
How can we codify the VC value proposition?
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© David Teten 2013. More at ffvc.com and teten.com
Sources • Interviews with over 50 venture capital investors, entrepreneurs, startup
incubators and advisory service providers • Proprietary database and survey of VCs’ value creation practices • Wide scan of academic and practitioner publications focused on the
topics of entrepreneurship and venture investing • Authors’ personal experience working in venture capital, early-stage
technology companies, and strategy consulting
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Mentor Operator
• Introduction
• Value creation: levers & resources
• VC Type 1: Financier
• VC Type 2: Mentor
• VC Type 3: Operator
• Next Steps
Agenda
Intro Financier Next Steps Resources
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Mentor Operator
Five VC resources to increase portfolio company value • Cash • Brand • Industry Network • Funding Network • In-House Expertise
http://www.flickr.com/photos/mariachily/3382799213/sizes/z/in/photostream/
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Mentor Operator
7 levers of value creation (“TOPSCAN”) Team-Building Growing a startup’s human infrastructure Operations Enhancing admin, accounting, legal and
technological capabilities Perspective strategy, competitive positioning, defining the
target market, and scoping the product. Skill-Building Building the right skills and ensuring they
develop with the company’s life cycle Customer Development
Identifying the right customers and gaining access to them
Analysis Helping entrepreneurs measure, understand and report the performance
Network Providing access to the investor’s typically very large network
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Mentor Operator
TOPSCAN: Team-Building
• Identify, • Source, • Recruit, • Close, • Retain, and • Rotate talent
http://www.flickr.com/photos/25802865@N08/3178448986/
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Mentor Operator
TOPSCAN: Operations
• Help startups refine/execute operational systems / processes, particularly: – Admin – Accounting – Legal – Technological
http://www.flickr.com/photos/lac-bac/4679195538/
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Mentor Operator
TOPSCAN: Perspective
• Offer 3rd party strategic advice and market intelligence – Market size and addressability – Competition – Product – Consumers – Research
http://www.flickr.com/photos/soldiersmediacenter/397627724/sizes/z/in/photostream/
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Mentor Operator
TOPSCAN: Skill-building
• Help startups build the right skills
– Management – Sales – Partnerships
http://500px.com/photo/9918021
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Mentor Operator
TOPSCAN: Customer Development
• Evangelize, • Identify, • Source, • Close, • Retain, and • Grow clients
http://www.flickr.com/photos/josefstuefer/9500503/sizes/z/in/photostream/
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Mentor Operator
TOPSCAN: Analysis
• Help entrepreneurs measure, understand and report individual company performance, e.g., benchmark against pertinent startup metrics
http://www.flickr.com/photos/pagedooley/793550071/sizes/m/in/photostream/
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Mentor Operator
TOPSCAN: Network
• The cheapest and sometimes most value-added service that an investor can provide is access to his/her network – Industry network – Funding network – Talent / recruiting network
picasaweb.google.com/lh/photo/FOHUbVdTEYKdftpmi6TkXQ
Intro Financier Next Steps Resources Mentor Operator
© David Teten 2013. More at ffvc.com and teten.com
• Introduction
• Value creation: levers & resources
• VC Type 1: Financier
• VC Type 2: Mentor
• VC Type 3: Operator
• Next Steps
Agenda
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Overview: Financier “I’m a banker, not an operator.” Philosophy • Scrutinize early-stage companies
& conduct a thorough diligence • Invest the right amount of capital
at the right valuation & structure Nature of involvement • More formal interaction,
e.g. board involvement, monthly reporting templates
http://www.flickr.com/photos/jmrosenfeld/2903513401/sizes/m/in/photostream/
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Case study: Financier Correlation Ventures • Referred to by some as the “Moneyball” of venture capital • Partners never take board seats and maintain only modest operational
involvement despite background as startup entrepreneurs • Offer rapid investment decisions with little hassle • Leverage large investment in predictive analytics • $165 million AUM
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Other Financiers
i2X
Intro Financier Operator Next Steps Resources Mentor
© David Teten 2013. More at ffvc.com and teten.com
• Introduction
• Resources
• VC Type 1: Financier
• VC Type 2: Mentor
• VC Type 3: Operator
• Next Steps
Agenda
Intro Financier Operator Next Steps Resources Mentor
© David Teten 2013. More at ffvc.com and teten.com
Overview: Mentor “I try to be the CEO’s consigliere.” Philosophy • Fund and personal assets can
improve the performance of portfolio
• The most important VC asset is its network
Nature of involvement • Assets are leveraged to add value
on an ad-hoc basis • No structured, formalized
processes
http://www.flickr.com/photos/duncan_mcneil/863770985/
Intro Financier Operator Next Steps Resources Mentor
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Case study: Mentor West Coast Early-Stage Fund • Monthly mentoring conversations with the companies’ founders to
discuss ways to leverage the VC’s network • When requested by entrepreneur, VC partners leverage their network to
support portfolio companies with specific challenges
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Case study: Mentor Small solo-GP Funds • There has been a surge in such funds over the past few years • Examples: Baseline Ventures, Coastano VC, Cowboy Ventures,
Harrison Metal, K9 Ventures, and PivotNorth • Many would be classified as financiers or mentors, because they
typically have very limited resources to engage substantively with their respective portfolios
Intro Financier Operator Next Steps Resources Mentor
© David Teten 2013. More at ffvc.com and teten.com
• Introduction
• Resources
• VC Type 1: Financier
• VC Type 2: Mentor
• VC Type 3: Operator
• Next Steps
Agenda
Intro Financier Operator Next Steps Resources Mentor
© David Teten 2013. More at ffvc.com and teten.com
Overview: Operator “We have a structured, standard process for adding value.” Philosophy • VC can add value by leveraging
assets in a structured way Nature of involvement • Accelerative systems and
processes are offered to portfolio companies
• Wide range of implementations • The most prevailing service is
with recruiting assistance
http://www.sxc.hu/photo/1109610
Intro Financier Operator Next Steps Resources Mentor
© David Teten 2013. More at ffvc.com and teten.com
A New VC Structure? • As HBS Prof. Noam Wasserman writes, VCs have long been structured
as “upside-down pyramids” in which GPs outnumber more junior employees • This highly atypical organization likely arose due to the need for
GPs to exchange rich information in the course of pre-investment activities
• Many operators are switching to pyramidal models because they are the most efficient means of systematizing and delivering operational support due to the benefits of leverage, delegation, and specialization. • Decreasing startup costs and increasing growth rates make the
application of these resources all the more valuable Noam Wasserman (2005), Upside-down Venture Capitalists and the Transition Toward Pyramidal Firms: Inevitable Progression, or Failed Experiment?, in Lisa A. Keister (ed.) Entrepreneurship (Research in the Sociology of Work, Volume 15), Emerald Group Publishing Limited, pp.151-208
• The pyramidal model ultimately won out in other, more mature knowledge-intensive-industries, such as law and investment banking
Intro Financier Operator Next Steps Resources Mentor
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Case study: Operator Andreessen Horowitz • Possibly most prominent Operator VC, having raised $2.7B and investing in
Airbnb, Facebook, Skype, Twitter, Zynga, and others • Give portfolio companies structured support through one of four operational
support teams, focused on executive recruiting, marketing/PR, technology, and business development
• 40+ operational staff assist in preparing negotiations, making client introductions, and providing preferred suppliers
Intro Financier Operator Next Steps Resources Mentor
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Case study: Operator First Round Capital • Has wide range of initiatives to support portfolio companies
• Organize yearly CEO, CFO, and CTO summits • Offer portfolio free access to a ‘venture concierge’
• $400+ million AUM and 22 full-time employees
Intro Financier Operator Next Steps Resources Mentor
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Case study: Operator ff Venture Capital • $38 million AUM and 12 full-time employees, probably the highest ratio of
employees to assets under management of any asset management • Institutionalized systems and processes offered to portfolio include:
- Finance acceleration - Recruiting assistance - Mentor and entrepreneur networks - Process improvement - Discounted services - Access to leading universities - Office Space - Recruiting
Next Steps Intro Financier Resources Mentor Operator
© David Teten 2013. More at ffvc.com and teten.com
• Introduction
• Resources
• VC Type 1: Financier
• VC Type 2: Mentor
• VC Type 3: Builder
• Next Steps
Agenda
Next Steps Intro Financier Resources Mentor Operator
© David Teten 2013. More at ffvc.com and teten.com
VC Resource: Cash • Most VCs are (relatively) poor • If you have high cash levels:
- Select the support services to create the most value for companies
- Foster technology-enabled knowledge sharing
• Low cash levels: - Make targeted introductions
http://www.flickr.com/photos/jaselabs/3252664493/
Next Steps Intro Financier Resources Mentor Operator
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VC Resource: Brand • If you have a strong brand:
- Maintain reputation; leverage brand equity in marketing/access to talent
http://500px.com/photo/1298772
• Weak brand: - Build brand image, e.g. by
investing alongside top VCs and in successful companies
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VC Resource: Industry & funding network
http://www.flickr.com/photos/jurvetson/3346659199/
• If you have a strong network: - Understand what types of intros
portfolio companies seek - Invest in a CRM system
• Weak network: - Rely on external partners and
service providers
Next Steps Intro Financier Resources Mentor Operator
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VC Resource: Expertise • If you have strong in-house expertise
and an internal consulting bench: - Monitor that you are using your
resources judiciously - Publicize your open door policy
to the portfolio • Weak in-house operating expertise:
- Establish relationships with outside consultants/service providers
http://www.sxc.hu/photo/1101337
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Any questions ?
Slides at ffvc.com/VC-consulting
Sign up for updates at ffvc.com and teten.com
@ffvc @dteten
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Caveat: On analyzing returns of VC funds For our study, we wanted to analyze if the Portfolio Operator strategy led to higher returns. Sadly, this is virtually impossible to do rigorously, for several reasons: • This strategy is relatively new, so insufficient data is available for the
small number of funds pursuing this strategy. • Returns data for VCs are difficult to obtain and difficult to compare with
one another across inconsistent fund sizes, check sizes, and strategies. • VCs with higher returns naturally have more cash and feel more self-
confident, and therefore are more likely to invest the money needed for the expensive Portfolio Operator strategy.
We can only say with confidence that most of the funds with well-developed Portfolio Operator strategies tend to have returns in the top quartile (over a 20% IRR) for the time periods during which they have used that strategy.
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ff Venture Capital does not endorse or encourage use of any of the sites or resources discussed herein, and is not responsible for any damages caused by their use. You are encouraged to do your own due diligence and make your own independent decisions as to the appropriateness of these sites and services.
Disclaimer
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Appendices
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David Teten (teten.com)
• Partner, ff Venture Capital, early-stage technology venture capital fund • Founder and Chairman, Harvard Business School Alumni Angels of Greater New York .
Co-founded Venture Capital Access Program, introducing women and minority entrepreneurs to Harvard-affiliated angels
• Lead author, The Virtual Handshake: Opening Doors and Closing Deals Online (TheVirtualHandshake.com)
• Lead author of first-ever research study on best practices in private equity/venture capital deal origination
• Lead author of first-ever research study on best practices of venture capitalists in increasing portfolio company value
• Board Member (now Observer), Ionic Security* • Harvard MBA 1998, Yale BA • @dteten
* ff VC portfolio company
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Venture Capital Access Program
• Program to help minority and women entrepreneurs meet members of the Harvard Business School Alumni Angels of Greater New York
• Partnership with the Marathon Foundation, a subsidiary of the National Association of Investment Companies.
Introduction