Best Practices of Venture Capital Funds in Finding World-Class Companies Where Are the Great Startups?! http://flickr.com/photos/krikit/2745563123/sizes/o/ David Teten Partner, ff Venture Capital ffvc.com blog: teten.com @dteten New York, NY [email protected]July 12, 2011
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How Venture Capitalists Source Great Startup Investments
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Best Practices of Venture Capital Funds in Finding World-Class Companies
Selected Past Audiences for This Presentation • Association for Corporate Growth (ACG) Intergrowth • Alliance of Merger & Acquisition Advisors • CFA Society of Los Angeles • Columbia Business School Alumni Club of New York • Financial Executives Networking Group • Golden Seeds (US angel group) • Harvard Business School Club of London • Harvard Business School Association of Southern California • Kauffman Fellows program participants • Keiretsu Forum • Wharton Alumni Club of Northern California • Yale Club of Singapore • Singapore Venture Capital and Private Equity Association • CFA Singapore • Women’s Association of Venture & Equity • Leading investment banks, private equity funds, venture capitalist funds, and hedge funds
Background David Teten recently completed the first-ever research project on “Best Practices in Private Equity and Venture Capital Deal Origination”. His coauthor for some of the research is Chris Farmer, cofounder and Managing Partner, Ventures, of Ignition Search Partners, and formerly Vice President, Bessemer Venture Partners.
David and Chris have published their findings in the Journal of Private Equity (December 2010); Harvard Business Review (June 2010); and Institutional Investor (October 2010). These slides provide some of the learnings and underlying data from the research study.
Evalueserve, a global research firm and the acquirer of David’s former company (Circle of Experts), provided supporting research and analytics in the initial phases of this study. We also thank Yujin Chung (Andreessen Horowitz) and Neha Kumar (Wharton 2010), our research associates who provided invaluable support, and interns Corentin Roux dit Buisson, Dan Clark, Nitin Gupta, and Nikhil Iyer .
David Teten Biography (teten.com) • Partner, ff Venture Capital, early-stage technology venture capital fund • Founder and Chairman, Harvard Business School Alumni Angels of Greater New York • Founder and Chairman, Navon Partners, startup focused on sourcing deals for private
equity funds • Managing Director, Evalueserve, through September 2008. 2,500-person finance-focused
research and analytics firm. • Founder and CEO, Circle of Experts (investment research firm), sold to Evalueserve • Founder and CEO, Teten Executive Recruiting, sold to Accolo, #42 on 2007 Inc. 500 • Founder and CEO, GoldNames, domain name investment bank, based in Israel • Technology/Defense Investment Banking, Bear Stearns (#1 group at Bear investment
banking by revenues) • Lead author, The Virtual Handshake: Opening Doors and
Closing Deals Online (TheVirtualHandshake.com) • Harvard MBA 1998, Yale BA, both with honors. • Contact: [email protected]
Partner, ff Venture Capital (ffvc.com) • Early-stage technology venture capital fund with top-decile returns • Founded 1999, with over 100 investments in over 35 companies • Focus on early stage web-based services companies with disruptive models,
including SaaS, video gaming, digital media, social, mobile and VoIP • First investments typically $50-$250K at valuations of <$5m pre-money • 50% of fund reserved for follow-on investments • Prominent angel investments include:
Cornerstone OnDemand (IPO); Quigo Technologies (sold to AOL for reported $340m); Klout; Hashable
• Two partners: John Frankel (21 years Goldman Sachs) and David Teten (serial entrepreneur; Chair, Harvard Business School Angels of New York); one Venture Partner (Michael Yavonditte)
Chairman, Navon Partners (navonpartners.com) We help private equity funds to identify proprietary deals which are predictably attractive long-term investments.
We obtain our data from: • major data vendors; • licensing from niche data vendors; • non-traditional sources, e.g., web scraping from the ‘dark web’; and • our data-based financial extrapolation, e.g., estimating revenues based on
headcount.
Our rigorous, data-driven algorithmic process is modeled on the datasets and process used by quantitative hedge funds.
Minimal outbound origination programs targeted outside of Venture Centers
Firms in venture centers (Boston/NY/Silicon Valley) outperform with investments outside venture centers. Performance gap is larger for late stage (20.7% vs. 15.7%) vs. early stage (15.1% vs. 11.3%)*.
Origination programs targeted outside of Venture Centers
Leading Late-Stage Tech Investors Portfolio by Geography, 2000-1Q2010
Success rate shown is defined as % of VC portfolio which leads to IPO. Results are similar when success is defined as investment either leading to IPO or acquisition. Only IT & related sectors. Battery & Sequoia data is only late stage/growth equity deals. *“Buy Local? The Geography of Successful and Unsuccessful VC Expansion”, Chen,Gompers,Kovner,Lerner
These funds are typically top-quartile performers; almost all have raised funds equal or larger than their preceding
Ironically, despite increased monitoring of local investments, firms in venture centers outperform with investments outside venture centers (19.0% vs. 17.3%). • Over 50% of the Venture Firms in Pratt’s Guide to Private Equity & Venture Capital are located in
just 3 venture centers: San Francisco/San Jose, Boston, and NYC/NJ/CT. • Over 49% of the US companies that these VC firms have invested in are in the same 3 areas.
• Firms based in venture centers have outperformed funds in other geographies by 4.4%. • This may be driven by superior investment experience, greater connections with corporations &
stronger syndication networks. • Likely driven by lower entry valuations due to lower competition & higher hurdle rates for
investments with higher monitoring costs. • This performance gap between venture centers and non-venture centers is larger for late stage
(20.7% vs. 15.7%) vs. early stage investments (15.1% vs. 11.3%). • This performance applies to both probability of success and expected returns.
• However, performance drops by 2.2% if a firm invests again in the same outside geography. • #1 driver of opening branch office is the percentage of investments in the region in last 5 years. • Counter-intuitively, opening an office in a region has historically lowered the expected returns in
that region. Success rate shown is defined as % of VC portfolio which leads to IPO. Results are similar when success is defined as investment either leading to IPO or acquisition.
“Buy Local? The Geography of Successful and Unsuccessful Venture Capital Expansion” by Chen, Gompers, Kovner & Lerner 6/09
Profiled initially 20,850 2,500 1,394 NA NA 550 Target Selected 1,315 500 261 8,000 10,000 [vi] 190 Met 1,047 NA 20 750 1,000 NA Negotiated with NA NA 14 NA NA 28 Detailed due diligence
577 100 20 NA NA 17
Acquired/ invested
541 20 3 10 to 12 10-20 10
Deals as % targeted companies
33.5% (2.1% of
submissions)
4.0% 1.1% 0.1%-0.2% 0.1%-0.2% 5.3%
[i] Available at http://angelsoft.net/a/venture-valuation , as of twelve months ending March 17, 2010. [ii] Aktihanoglu , Murat. “NYC Entrepreneur Week Events Take-aways.” May 3, 2009. http://centrl.com/blog/?p=53 .
[iii] Rudd, Amber. “A Kind of Magic.” Corporate Financier, October 2006. [iv] Economist, Global Heroes: A Report on Entrepreneurship, March 14, 2009., p. 9. “Targets selected” figure indicates number of business plans received.
[v] Bruner, Robert F., Applied Mergers and Acquisitions. New York: John Wiley & Sons, 2004., p. 183. [vi] Number of business plans received.
Closing one deal requires sourcing 80-100 deals. Investment Search Process (# Companies)
David Teten, Chris Farmer, Evalueserve, Yujin Chung, Neha Kumar Responses for Don’t Know/Cant say is excluded from the analysis. Percentages may not add up to 100 due to rounding off.
% of Funds With At Least One Person Tasked Specifically and Primarily with Deal Origination
Specialist originators are more common in more developed markets.
• Persistence, or "hanging around the hoop" • Personality • Business judgment • Adequate financial sophistication • Seniority and appropriate title • Internal power • Creativity
The best originators are aggressive, indefatigable, and personable.
Lossen, Ulrich, “The Performance of Private Equity Funds: Does Diversification Matter?” Munich School of Management, Institute for Innovation Research, Technology Management and Entrepreneurship. June, 2006. Ernst & Young. "How Do Private Equity Investors Create Value? A Study of 2006 Exits in the US and Western Europe". New York, NY/London. 2006.
• The rate of return of PE funds declines with diversification across financing stages…
• but increases with diversification across industries. • Diversification across countries has no systematic effect on performance. • In an Ernst & Young study of the largest PE deals of 2006, US investors
reported that sector focus was an advantage in 2/3 of their deals, establishing credibility with management and helping to evaluate the growth potential of the target.
• In Europe, investors reported that sector focus was an advantage in 25% of deals.
• In both regions, these sector-focused deals performed above average.
Web 2.0 Signals Network Next Steps Warm – Lukewarm – Ice
Partners Intellectual property Intellectual Ventures Spinning out processes from within Fortune 500 companies and setting them up as independent ventures
Exigen Capital
Deep focus from early to late stage in narrow vertical Andreessen Horowitz, Healthpoint Capital Minority-owned businesses AP Capital, ICV Capital Partners
Women-owned businesses Hypatia Capital
Family-owned businesses Heritage Partners Film financing Relativity Media Buying Western companies and outsourcing operations to China Crimson Ventures Distressed Searchlight Capital
Web 2.0 Signals Network Next Steps Warm – Lukewarm – Ice
• Have a clear point of view and area of expertise
• Develop and publicize quotable white papers and other thought leadership pieces
The best reason for deals to come to you is reputation. However, the bad news is: of 109 journalists surveyed, zero rated private equity firms “excellent” in communication.
Haynes, Bill. “Making Media Count”. PrivateEquityOnline, April 7, 2009.
Recommendations: Journalists’ Evaluation of PE Funds’ Communication Skills
Web 2.0 Signals Network Next Steps Warm – Lukewarm – Ice
VCs should focus on co-investing with the best investors in your target vertical. • VCs that are better networked at the time a fund is raised subsequently enjoy significantly better fund performance, as measured by rate of successful portfolio exits over 10 years.
• Network “centrality” may be a better predictor of future performance than experience or exits. • 1 standard deviation improvement in network centrality improves probability of successful follow-on round or exit by 5.8% and performance by ~2.5%.*
• The benefits of a heterogeneous syndicate are well known: complementary industry expertise and network; local or geographic expertise and network; validation of investment; and future reciprocity. However, VCs demonstrate a clear preference for syndicate homogeneity: investing with firms of similar “social status”, high geographic proximity and prior co-investments.**
• We recommend you market yourself as the go-to co-investor for target sectors by developing proprietary insights and a deep network of key partners and talent.
• Sell value-add to entrepreneurs and key “peer” firms and actively drive syndicate creation.
* “Whom You Know Matters: VC Networks & Investment Performance”, Yael Hochberg, Alexander Ljungquist & Yang Lu, Aug 2005. Network Centrality – (1) # of VC ties; (2) frequency of co-investment invites; (3) access to the best connected VC’s; (4) ability to syndicate its own deals (5) ability to make new co-investor connections. Performance data correlation – exit rates & follow-on rounds.
** “Birds of a Feather or Celebrating Differences? The Formation and Impact of Venture Capital Syndication”, Qianqian Du, Mar 2009.
Web 2.0 Signals Network Next Steps Warm – Lukewarm – Ice
Entrepreneurs-in-Residence are a powerful and underused VC model. • An EIR is typically a serial entrepreneur or top-flight executive that a venture
capital firm would like to fund in his or her next venture. • According to many industry insiders, venture firms often get better returns from
companies created by EIRs than they get by buying equity in existing startups. In the early years after Benchmark’s founding in the mid-1990s, approximately half the companies the firm funded were led by EIRs. Even without the firm’s breakout investment in eBay, its early funds would rank among the all-time best in the venture industry. Other firms with active EIR programs: Benchmark Capital, General Catalyst, Accel Partners, Bessemer Venture Partners, etc.
• The EIR typically joins the fund for 6-18 months and reviews business plans alongside the venture capitalists at the fund.
• The benefit of the program is that the entrepreneur gets an excellent window into the marketplace, access to the firm’s resources and network, and realtime feedback from the investment partners.
• The venture capital fund gains the sector expertise of the EIR and has a front row seat to invest in the entrepreneur’s next venture.
Web 2.0 Signals Network Next Steps Warm – Lukewarm – Ice
Private equity funds use expert networks to originate deals in three main ways:
Based on interview with Michael Duran, Gerson Lehrman Group, and other sources
• Facilitate top-down, “rainmaker” sourcing strategies. Connect to senior industry executives.
• Support bottom-up, “boil the ocean” sourcing strategies. An investment team can exhaustively call experts to identify all the companies in a target sector or geography.
• Enable thematic sourcing strategies. Identify experts and consultants to help develop investment themes, map target markets, and engage market-leading firms.
Web 2.0 Signals Network Next Steps Warm – Lukewarm – Ice
• Focus on geographies/sectors that are undercovered by peer firms. • Maintain clear criteria and metrics to ensure that the relationships being
developed have a reasonable likelihood of yielding investments, and stick with them.
• Institute a formal CRM system, tied to a formal deal tracking program. • Directly tie compensation to developing and maintaining the database;
volume of flow; and quality of flow. • Require regular follow-up with priority companies. • Organize scheduled reviews with partners and sector teams. • Maintain consistent dialogue with key prospects and sources. • Use multiple outreach methods: phone, email, fax, overnight mail, etc., in
order to get the attention of the person you’re targeting.
Key Steps for a Successful Cold Calling Program
Web 2.0 Signals Network Next Steps Warm – Lukewarm – Ice
Sample Market Mapping Approach Market mapping is a powerful way to identify competitive white space.
# Stage Example 1 Choose industries and geographies of initial interest Global growth equity fund with focus on North American and
Japan. 2 Define your proprietary point of view. Thesis: Population in developed countries is aging rapidly. 3 Translate into investment theme for specific industries
and/or geographies of interest. We expect growth of financial services providers with low-risk investing products.
4 List major players in target industries/geographies, and how each will be impacted by investment themes.
Asset managers with expertise in annuities and fixed income products will likely benefit.
5 Iteratively improve market map based on feedback from industry
Publish elements of the market map to key sector players through industry forums and mass media.
6 Determine which activities along the value chain offer the highest return (typically the proprietary ones).
Develop deep ties in the brokerage community that distribute low risk financial products.
7 Identify areas of future growth. Fund researches bolt-on acquisitions while diligencing its primary target.
8 Assess fit with Fund’s strategy. Local geographic leader that would benefit from Fund’s global reach.
9 Regularly update the market map based on market feedback and lessons from investment prospects.
Maintain internal wiki or database regularly updated with key market data and insights.
Effective use of social media and other research tools allows you to filter for companies who are flashing signals that they are interested in your capital.
David Teten and Scott Allen, The Virtual Handshake: Opening Doors and Closing Deals Online (www.TheVirtualHandshake.com)
Ch = Character Co = Your Firm’s Competence R = Relevance of the contact S = Strength of your relationship I = Information N = Number of people D = Diversity
= D * ∑ (Chn*Con *Rn* Sn*In) N
n=1
Corporate Network Valuation Formula
Web 2.0 Signals Network Next Steps Character – Competence – Relevance – Strength – Information – Number – Diversity
Best Practices in VC Blogging (written humorously, but still good advice)
Hi, I’m a tech VC on Twitter. I’m @xyzvc My icon is cool. It’s a painting/cartoon/wacky photo. Shows that I’m hip and approachable. But when I meet with you, I’ll
still crush your dreams. I tweet about technology, but occasionally post personal stuff. Important to show I have a sensitive side and care about
more than just making tons of dough. I use # tags, sometimes as a funny form of emphasis. Kind of like a wink and a smile ;) #donttakethisposttooseriously I love Twitter because I can broadcast my blog posts. Otherwise, no one would read them! I blog at xyzvc.com! I tweet blog posts with advice on fundraising, customer acquisition, and company building. Usually, someone really
smart has said it before and said it better. But I haven’t been in Hacker News for a while, so I figured there is no harm reinventing the wheel.
Retweeting is fun. It’s like a virtual high-five. I retweet the posts of my partners, coinvestors, and entrepreneurs I’ve backed. Oh, I also retweet posts from guys whose butts I’m currently kissing so that they will like me. I really hope @fredwilson retweets this… I’d get so many new followers!
My portfolio companies are the best. I will share so much of their good news with you it will make you want to unfollow me (unless you are a co-investor, in which case you will probably RT and add a #)
If a portfolio company is doing bad, no Twitter love. It’s like going to Disneyworld and trying to find Hercules or Mulan. It’s like they never existed.
I also tweet about the cool places I’ve been (via Foursquare and Gowalla), things I buy (via Swipely and Blippy), and the cool places I’m going to go (via Plancast).
Wow, that’s a lot of tweeting! That’s why I also tweet about how busy I’ve been and how little I’ve slept. It’s a tough life. Full disclosure, I’ve been a tech VC and I’ve done most of these things.
Hi, I’m a tech VC on Twitter (by Rob Go, NextView Ventures)