When we meet with entrepreneurs and ask about their competitive advantage or special sauce, one of the common responses is first mover advantage.  ”We’re the first company to do X in an rapidly growing market” or similar.

I’ve always felt being the first mover is a comparatively weak advantage and have been thinking about this more recently.  While our portfolio at NextView is roughly equally weighted to consumer facing and B2B companies, it seems that for consumer companies in particular being first mover confers little benefit and the drawbacks probably outweigh whatever weak advantage might exist.

If you think back to the monster consumer software and internet companies that’ve been built in the last 2-3 decades, it’s actually far more likely they were fast and/or particularly innovative followers rather than first movers.

First Movers

1. Atari (home video game consoles)
2. Twitter (microblogging)
3. Amazon (e-commerce)

Fast/Innovative Followers

1. Microsoft (OS – both text & GUI based, office productivity, game consoles)
2. Apple (today’s Apple of smartphones & tablets… early Apple’s attempts at being first mover largely flopped like Lisa, Newton, etc)
3. Facebook (social networking following in the footsteps of Friendster, MySpace, etc)
4. Dropbox (cloud storage)
5. Netflix (video streaming)
6. Google (search… lots of predecessors)
7. Square (card present payments on smartphones - predecessors like ROAM Data, et al)

The one segment of consumer companies where being first mover seems to have conferred real advantages has been “collaborative consumption” broadly.  The final chapter has yet to be written for most of these companies but being a first mover does seem to have aided the likes of ZipCar, AirBnB, and Uber.  I think this has less to do with network effects which are distinct from first mover (though the two are complementary) and more to do with locking up preferential access to supply.

So why might it be better to be a fast follower?

• Don’t Have to Evangelize - Perhaps the key downside of being first mover with a consumer product is having to evangelize a market and build it from a niche to broad adoption. This usually takes a lot of time, money, and energy. Evangelizing towards a mass market is arguably harder in consumer than B2B given individual consumers adopt based on a broader set of qualitative and quantifiable factors, where as businesses often attempt to quantify ROI more objectively. Google didn’t have to convince people that Internet search was needed… they just had to make it work better (via PageRank and subsequent innovations) and monetize it better (by copying GoTo/Overture with paid search advertising).
• Work Out Early Kinks - Dropbox wasn’t the first consumer cloud storage service.  Companies like xDrive and others let you upload and retrieve files from the web nearly a decade earlier, and there were others like Carbonite that created hybrid local/cloud storage solutions.  But Dropbox realized that one of the kinks of existing cloud storage services was that they were only well suited for alternate or backup storage, not primary storage. For the cloud to work seamlessly for primary storage Dropbox built client side products for an array of platforms, and worked very hard to make this client experience feel super native on every one. By finding a way to work out out this kink they’ve grown larger than all the other consumer cloud storage products out there.
• Wait For Complementary Technologies to Mature - Apple didn’t pioneer the smartphone but obviously the iPhone rightly deserves credit for defining the category and making it a global mass market.  Of course Apple did some truly innovative things with the first gen iPhone launched in 2007 and also harmonized software and hardware better than anyone else. But part of their success was simply due to the vastly improved state of cellular data networks relative to when the first smartphones emerged. The Treo was a revolutionary device, but using one kinda sucked in the early days of digital cell networks.  Similarly RIM had to build their own proprietary data network (after initially launching on Motorola’s ARDIS/DataTAC network) in order to get emails to Blackberries in a reliable and timely manner.

We sometimes think of being a fast follower in pejorative terms. Somehow first mover seems sexier, and to be fair some first mover startups have become category leaders or have successful acquisitions by larger companies. But the reality is that most fast followers are incredibly innovative companies, sometimes even more so than the early pioneers in their category. And at the end of the day most great entrepreneurs are focused on trying to build enduring, category defining companies. Being a fast, innovative follower might be the way to go…

It occurred to me that we usually refer to entrepreneurs associated with a startup as being “behind” the company or phenomenon.  As in Mark Zuckerberg, the Harvard drop-out behind Facebook or so-and-so, the folks behind startup X.  Upon further reflection it seems like this phraseology has things backwards… we ought to be talking about the teams in front of a new or important concept.

I mean this not simply as a paean for entrepreneurs.  While the broader society’s esteem of entrepreneurs waxes and wanes, entrepreneurs have been getting plenty of love in recent years both from within and outside the startup ecosystem.

But the reality is new companies and new products don’t simply come into being themselves.  As we all know too well a lot of time, energy, and creativity goes in first before any new innovation comes to market.  All this work goes in before customers and the broader public ever sees anything.  So to me thinking about founders and early employees being in front of a new product isn’t about stroking peoples’ egos, it simply makes more logical sense.

The other phrase we use is people X invented Y as in “Steve Jobs invented the smartphone”.  But we usually reserve that terms for a select few, and in fact most entrepreneurs put their hard work not in coming up with an idea (most ideas are commodities) but in executing in the face of limited resources and a competitive marketplace.  So most founders don’t really feel like “inventors”.  And so we end up with so-and-so, the folks behind company X.

So I’ve resolved myself to think, speak, and write about teams in front of a product.  Or at least “responsible for company X” rather than being “behind” it.

Yesterday was Apple’s shareholder meeting and as many of you know, there’s obviously been healthy debate about what they should do with the ~$137 billion in cash they’re sitting on.  I had read somewhere that Apple’s cash pile was equivalent to Hungary’s GDP so I tweeted out the suggestion that perhaps an activist shareholder should push an acquisition of Hungary rather than thinking small (e.g. increasing dividends or issuing preferred stock).

Hungary probably wouldn’t sell their sovereignty and entire economy for 1x sales, but Apple has no debt so they could probably lever the deal and borrow money on top of $137 billion in equity.  For some reason the notion of Apple hiking the taxes of Hungary to fund a dividend recap just amuses me…

But in all seriousness, what should Apple do with a massive and growing pile of cash?  The three obvious buckets are of course to invest heavily in new products (the Apple TV or iWatch or whatever), return cash to shareholders (via dividends, buybacks, new class of preferred shares, etc), or acquire stuff.  Besides Hungary, what M&A strategies actually make sense?

FWIW Apple isn’t Cisco or Oracle.  Apple’s an incredible organization because of its long history of internal innovation rather than excellence in acquiring, integrating, and growing other businesses.  Over the long arc of time (by tech standards) Apple has done very few acquisitions >$100M and has never done a billion+ dollar deal.  Buying NeXT provided the foundation of what is now the desktop Mac OS plus brought Steve Jobs back to the Apple fold.  More recently acquiring Quattro Wireless created the iAds mobile ad network and Siri was of course a technology acquired from SRI.  Less auspiciously Apple bought a Swedish mapping technology company (C3) to form the basis of Apple Maps.  Lastly Apple has bought several component companies (chip companies Intrinsity and P.A. Semi, flash memory company Anobit, and security hardware – Authentec) to be integrated in various iStuff.

Apple is fundamentally great at creating innovative new platforms that consumers love because they’re easy to use and rationalize digital fragmentation.  They weren’t the first in PCs, MP3 players, smartphones, or even tablets yet Apple revolutionized each of those categories.  Apple doesn’t really make money by selling software or even digital content, but they seamlessly integrate software and content to support a high margin hardware business.

But Apple’s DNA is about quantum leaps, not incremental ones.  So if they were to become an acquisitive company, I’d argue they have to be as big & bold in buying as they are in product innovation.  The three main vectors Apple might pursue are:

1) Buy Content – Content is strategically important to Apple’s platforms, but in the grand scheme of Apple it’s a pretty meaningless part of their business.  If you add up all the content, software, and services (e.g. iCloud subscriptions) it’s about 6% of Apple’s revenue.  To put that in perspective, all the chargers and other accessory stuff amounts to about 50% of the revenue Apple generates from content + software + services.

Some people think Apple should buy Netflix.  On paper it makes sense… ~$10B market cap, deals with lots of content owners, a nascent library of Netflix developed content, and a happy/loyal consumer base.  But it makes less sense to me… consumers love Netflix because they can get it on all kinds of hardware devices (TVs from many makers, game consoles, tablets, etc) and content owners deal with Netflix because they don’t want iTunes to dominate digital video as it has digital music.  Apple could buy Disney instead (~$98B mkt cap) and own a vast library of content and the “infrastructure” to develop more (ABC/ESPN, movie studios, etc).  They’d probably divest the theme park business but the rest of Disney would give Apple an incredible platform to rethink video @ home in an on demand world.  It would also transform the company by making meaningful profits on content in addition to hardware.  Time Warner (~$50B mkt cap) would be the other logical choice in this vector.

2) Buy Pipes - Many have thought that communications infrastructure would become “dumb pipes” and the content and/or hardware companies would win home “infotainment”.  Pipes companies are still pretty valuable it turns out and on demand video hasn’t really eroded that… you still need cable or fiber to your home to watch Netflix, and it’s not like total revenue to the “cable” companies (Comcast, Time Warner Cable, Verizon Fios, AT&T Uverse) has really declined.  Plus building out a telecom network to the home is pretty hard and costly… there’s a reason Google Fiber is available in precisely 1 of the top 100 US cities.  The satellite TV guys (DirecTV, Dish Network) have good pay TV businesses and nationwide coverage but lack a true broadband internet offering so they wouldn’t be a fit.

Owning pipes and the content deals that go with them could strategically aid Apple in a couple ways.  First the reason the iPhone was such a profitable success for Apple was because they got to double dip… consumers paid Apple and wireless carriers paid Apple (in the form of subsidies) for each device.  No matter how awesome an Apple TV might be, it’s difficult to envision a similar scenario where cable companies subsidized the cost.  By the time the iPhone came out there were 3-4 wireless carriers with national scale so it made sense for AT&T to do an exclusive with Apple, but cable still tends to be a local duopoly or even monopoly so less incentive to try to shift consumer share.

But if Apple owned one of the big cable companies they could essentially boost the profitability of TVs by internally subsidizing with monthly subscription revenue.  They’d also instantly get access to a huge swath of TV and movie content out there.  Plus if they bought Comcast ($106B mkt cap) it’s essentially a twofer of #1 (content production) and #2 (pipes) now that Comcast has fully acquired NBC Universal.

3) Vertically Integrate - Apple could also vertically integrate in more radical ways.  I don’t mean buying Hon Hai (aka Foxconn) to control vast labor and production of Apple’s hardware.  I mean component suppliers like Marvell ($5B mkt cap) or STMicroelectronics ($7B mkt cap) for chips, or Sharp ($3B mkt cap) or Toshiba for LCD displays, etc.  Companies like Samsung and LG also supply Apple with displays, but since they compete in end-user devices trying to buy either of them probably wouldn’t make sense.  The display components are super low margin so Apple is unlikely to do that, but the semi companies conceivably could be a better fit.  But at the end of the day vertically integrating wouldn’t really transform Apple’s business in the way #1 or #2 would.

4) Buy A Social Platform - Really Facebook ($63B mkt cap) is the only one that makes sense to me from a strategic standpoint.  Twitter doesn’t really give the same depth of strategic synergy and and Apple is a consumer company rather than business-centric so that rules out LinkedIn.  But even though Apple could offer Facebook shareholders a 100% premium over the current stock price, obviously this one is never going to happen given Mark Zuckerberg’s voting control of the company.

My bet is that Apple does none of these things of course.  Maybe Hungary is starting to look more plausible…

I’ve been enjoying my iPad Mini for a couple months month now.  I thought seriously about getting a Nexus 7 (in fact gave one to my sister as a gift recently), but because I’m frequently on the go with intermittent WiFi I got the Mini which is still one of the few LTE-enabled 7 inch tablets currently on the market.

As my partners & I have written about constantly, we think “mobile” is a terribly misleading term for what is a broad megatrend of ubiquitous computing.  More people are computing more of the time with a broader array of personal devices, not simply a substitution of “mobile” computing for “desktop” computing.  And now having lived with my iPad Mini for awhile it’s clear to me that 7 inch or other small tablets are further atomizing the overall world of ubiquitous computing.

Just as usage patterns between smartphones and the original generation of 11″ tablets (led by the iPad of course) are pretty different, and usage between Android and iOS devices varies significantly, I see 7″ tablets being used in different ways and potentially by different people than 11″ tablets or smartphones.  So what are the distinctions?

1. Not A Laptop Replacement – I’m skeptical that tablets will completely replace a primary “computer” (laptop or desktop at home,  workplace, and/or school) for many consumers in the foreseeable future.  But for a meaningful swath of consumers, a large 11″ tablet can be a substitute for a decent chunk of the activities they used to do with a laptop or other primary computer.  In the business world you see some folks that used to bring a laptop to meetings now come with tablets.  In my own family, my wife now basically does all her computing at home using an 11″ tablet rather than her personal laptop.  But a 7″ tablet is marginally harder to use than a large tablet, so you’ll see them used less frequently in these laptop replacement scenarios.
2. Better On The Go Device - For many of the same reasons a large tablet is better as a laptop replacement, a small tablet is better as an on the go device.  It’ll fit in a purse or a jacket pocket whereas an 11″ tablet won’t, making small tablets the kind of thing you use to consume content, do basic communication (e.g. quick emails), etc.  For example, I find my iPad Mini to be a far superior e-reader than a full-sized tablet since the size and weight make it easy to hold with one hand.  Smartphones are nearly ubiquitous (passed 50% US penetration at end of 2012), but many consumers don’t want to use them for more than brief sessions lasting <5 min.  A small tablet on the other hand is convenient and useful for a much longer (e.g. 10-30 min) sessions, so even though you won’t carry it everywhere like a phone people will use small tablets a lot on the go (e.g. the coffee shop, mass transit, quick meeting or waiting period scenarios).  Several people have told me in recent weeks they carry their iPad Mini or Nexus 7 or Galaxy Note similar small tablet wherever they go.
3. Low Cost = Broader Entry Point - We’re >5 years into the smartphone adoption cycle (more than that if you want to count Blackberries and Treos) and barely 2 years into the tablet adoption cycle.  Prices for all tablets will continue to come down over time, but certainly for the next several years 7″ tablets will be several hundred dollars cheaper than large tablets and will therefore be a tablet “entry point” for a broader swath of consumers.  A significant majority of consumers in the US do not have a tablet today, and I believe that by the time we reach >50% penetration of tablets overall, ~7″ tablets could be as much as half the market despite being manufactured and sold for less time than large tablets.

So small tablets are expanding the trend of ubiquitous computing and also will drive higher tablet penetration.  They’re simultaneously atomizing the “mobile” ecosystem.  Developers already have to think about smartphones and tablets distinctly just as they think about platforms (iOS, Android, etc) distinctly.  A bad ecosystem outcome is if small tablets create yet another class of experience that software developers have to consider.  It’s something I’ve been pondering as I think about the broader shifts that are going to happen at an OS and core app level (mobile browser, etc) in the next 0-5 years.

I’ve been using Google’s Chrome browser on my iPad Mini for about a month now.  There are several things I prefer over Apple’s Safari, including the bookmark and search history sync with my other Chrome usage (on laptop) and some small UI touches.  But for now there’s no way to make an OS-level switch to make Chrome my default browser.  So if I click on a URL in another app, say an email reader or Twitter or whatever, iOS me to use Safari.

As we all know the mobile ecosystems have remained mostly walled gardens to date.  Apple has taken the fully integrated OS/hardware approach and while Android is an open source OS adopted by Samsung, HTC, and other device makers Google’s becoming more integrated via it’s Nexus devices (built by partners) and of course the Motorola acquisition.  While there’s a broad ecosystem of third party developers at the app level, even there you’ve seen the platform owners fight hard to bundle their own apps most notably in the maps showdown between Apple and Google.

We’ve seen this before through multiple generations of computing platforms largely driven by antitrust efforts.  The first chapter began more than 40 years ago with IBM being forced to unbundle software and hardware on mainframe platforms.  IBM “won” a Pyrrhic victory in the legal case by the early ’80s against the DOJ but by then they’d already given in to the pressure.  Microsoft famously had to open it’s desktop OS to allow other web browsers to complete against IE.  They further had to open up IE to allow consumer choice of embedded services like search and media players.  And of course the FTC and others have been poking into all sorts of practices at Google in recent years.

Smartphone and tablet platforms are likely to be no different in the coming years.  You’ve already seen a small handful of third-party apps achieve meaningful scale in replacing bundled apps – Instagram for camera, Evernote for notes, Sparrow had some modest traction in client email.  Apple and Google haven’t deemed these monopolies worth fighting for, though Google acquired Sparrow, and Apple’s already gotten it’s hand slapped on the iOS platforms for e-book pricing collusion.

In the not too distant future you’re going to see a broader array of apps being used in core categories (browser, email, contacts, calendar, maps / local search).  You’ll also see antitrust pressure to break the OS level shackles that favor the bundled apps, so a consumer can choose a default browser for instance.  A lot of the opportunity will still fall to incumbents with scale… Apple and Google themselves in most categories, Yelp et al in local, Facebook in social, etc.  And the power of the default will remain immense… there’s a reason why IE remains the dominant browser on desktop (esp on Windows machines) Apple Mail dominates client email on iOS / OSX.  But there will be some opportunities for ISVs and even startups in nearly all of these categories.

Smartphones and tablets are ushering in a paradigm of ubiquitous computing, where consumers compute with broader array of devices across a larger portion of their day.  But at the end of the day, the forces of unbundling at the application level that have prevailed on nearly every prior computing platform are likely to persist.

A little more inside baseball from the VC biz… why VC’s rarely make “crossover” investments, with capital from multiple funds the VC firm manages invested in a single startup (see note 1).  I was talking with an entrepreneur recently about this phenomenon.  This person is an experienced CEO and a veteran of several startups, yet appreciating this nuance of how VC’s operate their business was relatively unfamiliar to him.

As most of you probably know, the vast majority of VC firms make investments out of funds structured as limited partnerships with a 10yr life.  VC firms typically raise a new fund every 2-4 years but each of these funds is a discrete pool of capital.  Unlike a startup that might raise equity financing across several rounds all combined in a single balance sheet, VC’s do not simply commingle these funds into a single bucket to be allocated across all the companies in that firm’s portfolio.  If Acme Ventures III, LP invests in Startup X then typically Acme Ventures IV, LP would not.

Why is this?  If Acme Ventures has a new supply of capital with fund IV, wouldn’t they want to reserve some of that for companies in Fund III?  Wouldn’t they want a piece of the winners in the prior fund to be in the new fund?  There’s a couple reasons which basically all relate to potential conflicts of interest from misaligned incentives.

1) LP Bases Change Over Time – Most healthy VC firms tend to have stable relationships with the limited partners investing with them.  In other words, assuming things are going well the majority of LPs that invested in Acme Ventures III usually “re-up” and invest in Acme Ventures IV.  But inevitably there’s some shifts in the LP composition of a VC firm’s funds over time, either due to circumstances with the firm or particular LPs or both.  Of course a VC firm that has stellar performance will often attract new LPs interested in investing, or conversely one that performs poorly will have existing LPs drop out.

But even for healthy VC firms, as a firm grows or shrinks they are typically adding or subtracting LPs in each subsequent fund (still usually a minority of overall committed capital in the fund).  A particular LP might also go through changes in circumstance that dictate they increase or decrease their investment in the VC asset class generally or to a particular set of firms.  Or public policy changes may force GPs or LPs to end longstanding relationships.  About a decade ago Sequoia and some other top firms decided to end relationships with many state university endowments because as public institutions, they became required to publicly release VC performance data which some firms weren’t comfortable with.  More recently the “Volcker Rule” in the Dodd-Frank financial regulation overhaul has meant that most banks can no longer invest in VC or PE funds directly.

As a result, even for healthy firms with most existing LPs returning for new funds, you typically have distinct LP bases in each and every fund a VC firm raises.  Thus VC firms typically have a potential conflict of interest between two “distinct” sets of limited partners who’ve invested in different funds, which makes #2 and #3 more complicated.

2) Differential Cost Basis – Suppose Acme Ventures III invested in the Series A of Startup X and then made follow-on investments in the Series B and C.  Acme raises Fund IV and now Startup X, a breakout winner of Fund III, is raising a Series D.  Why wouldn’t Fund IV invest at this stage?  Well at this juncture Startup X’s valuation is presumably a lot higher than it was at the Series A, maybe even 5-10x+ higher.

Suppose Acme IV invests in the Series D and 6 months later there’s an acquisition offer for Startup X that’s 50% higher than the Series D post-money valuation.  For Acme III’s stakeholders a 10x+ return may look very attractive and Acme III would have a strong incentive to support the acquisition, but Acme IV might feel that the company should “go long” and shoot for a larger acquisition or IPO further down the road since they are seeking a return greater than 1.5x.  As you can imagine, it would put Acme in a tenuous position of being supportive of the transaction with one fund and potentially opposing it with another.

3) Differential Investment Time Horizon – In parallel to cost basis, cross investing creates mismatches in the holding periods of two different funds (see note 2).  If Acme invests at different times in Startup X with two different funds, they will have different willingness for how long they want to remain investors in Startup X before seeking exit.

The rare occasions that you do see crossover investing are typically when a firm makes an initial investment at the same point in time across two funds.  For example Acme III might be willing to invest in a Series B or C stage company in Year 4 of the fund (e.g. late in Acme III’s initial investment period) in parallel with an initial investment from Acme IV in Year 1 of that fund (e.g. beginning of the investment period).  But Acme III is unlikely to invest in a super early stage company at that juncture.  And firms typically reserve in parallel in this rare situations, e.g. if Acme III invests $1 and reserves $2 then Acme IV would do invest and reserve in the same proportion.

4) Fiduciary As a Board Member – On top of the potential conflicts across different funds, GPs also often face the risk of conflict when serving as board directors of portfolio companies.  This is true even if a VC has only invested from a single fund, where as a board director they must serve as a fiduciary for all the shareholders but as a minority preferred equity investor they occasionally have divergent interests.  But certainly crossover investing from multiple funds makes this potential conflict even harder to deal with.

Again, all of these boil down to having a potential conflict of interest for a VC firm given mismatches in cost basis, time horizon, and LP base across different funds.  So at the end of the day VCs rarely crossover invest, which means entrepreneurs just need to understand how the fund that’s invested in their startup is thinking about all of these things (e.g. VC’s reserve strategy, time horizon, etc).

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Note 1: Confusingly, the term “crossover” investing is also used in reference to the practice of some late-stage VC funds where they might invest some capital in a late-stage VC round when a startup is still private and then invest additional capital soon after the company goes public.

Note 2: Evergreen fund structures (where VC’s have a single fund that takes money in & out over time) obviate the issues around differential time horizon.  But given the other challenges associated with establishing and managing an evergreen fund, these are pretty rare in the VC world.

[This also appears as a guest post at PandoDaily]

Over the weekend, I read Sarah Lacy’s PandoDaily article that the VC shakeout is taking too long.  It’s rather thoughtful and definitely worth reading if you haven’t had a chance to yet.

There are some obvious structural reasons why a shakeout in the venture capital industry takes a long time.  We all know that VC funds are typically structured as limited partnerships with a 10 year life, so even if firms are no longer investing and don’t raise a new fund they take a long time to go away.  Sarah also points to the vast global wealth that has to get allocated somewhere as well as a small bump in long term average returns, now that the generally terrible performance of funds from the 2000-2002 time frame (after the tech bubble of the late 90s crashed) no longer factor in to 10 year returns.  It’s been my experience that average returns of the whole VC industry get more attention than they really merit.  Having talked with many active venture LPs over the years I see little marginal impact, in terms of new funds being raised or new LPs investing in VC, based upon an uptick in industry average returns since LPs don’t really approach VC as an index.

So what’s actually happening?  Are there a bunch more shoes to drop?  Or are we “there” yet in terms of a venture shakeout?  Well first it’s worth understanding the distinct phases of exactly how a VC firm dies.

• At Risk – Usually starts with a firm beginning to see challenges in large portions of its portfolio, or in keeping the partnership together, or in the viability of the firm’s core strategy as broader markets start to shift (e.g. there’s a heck of a lot fewer pure-play cleantech VCs today than 5 years ago).
• Purgatory – Next phase is when these internal concerns start to get external validation.  Typically this is when VCs “pre-market” or explicitly try to fundraise a new fund among existing and potential new LPs, only to be rebuffed.  It’s possible for firms to pull back from this brink but somewhat rare.
• Deadpool – VC firm admits to itself (the GPs) and its existing LPs that the firm will not raise a subsequent fund.  The lights are usually still on, both literally and metaphorically, and there are often follow-on investments in existing portfolio companies still being made.  Some of the firm’s partners may move on to new jobs during this phase but at least some are usually still around.
• Defunct - At this point firm is done making even follow-on investments and has largely liquidated the portfolio one way or another.  The lights go off and whoever is still there moves on.

The reality is that it takes many years (5-8) for these phases to play out for a given firm that ultimately dies.  VCs are not like the Neil Young lyrics… they don’t burn out but instead fade away.  Or VC firms are main sequence stars rather than supernovas, for the astrophysics inclined.  It’s not just because of the 10 year fund life either… because VCs make early investments in companies that take a long time to build, and because persistence of performance from one fund to the next is weaker than you might think, it’s not obvious even to the VCs themselves or their LP investors when a particular firm becomes “at risk” or even in “purgatory”.

Ok so now that we understand the distinct phases of VC firms that ultimately die, what other factors are at work in the shakeout underway?

1) The VC Shakeout is 3-4yrs Old, Not 10 – While there was definitely a rough patch for the VC industry in the wake of the early 00′s tech crash, the reality is that much of the last decade was pretty good for the venture biz.  There was a healthy amount of capital ($20-30B annually) invested in VC funds during the 2003-2008 timeframe.  Yes, it was less than the $100B+ that came in ’99-00 but that was bubble driven aberration no matter how you look at it.

In the mid 2000′s VC’s were largely prospering.  The entire US economy was booming (in an unsustainable debt binge, in retrospect) from 2004 through much of 2008, and the tech world was booming along with it.  The IPO market remained closed to IT startups, but there were big acquisitions like Google buying YouTube for $1.65B (Fall 2006) and late stage financing rounds for companies like Facebook (Microsoft round at $15B valuation in Fall 2007). Kevin Rose was on the cover of BusinessWeek.  A huge cleantech boom occurred and battery companies like A123 went public along with biofuels companies like Amyris, Gevo, and others, though in retrospect this was more of a bubble driven by unsustainable government subsidies (A123 is bankrupt and the biofuels companies trade at a fraction of their IPO valuation).  This was also the period when VC started expanding seriously in emerging markets like India and China, and many LPs put new capital into these OUS funds.

The reality is that it wasn’t until the GEC (Global Economic Crisis, Great Recession, Credit Crunch, call it what you will) of late 2008 and early 2009 that the shakeout really began for venture capital.  This is when LPs started pulling back and VCs who didn’t have emerging winners in their portfolio started to struggle.  So yes it still probably seems slow, but this shakeout is only a couple years old not a decade old.

2) Rebirth of Some Firms - Mobius Venture Capital is now defunct.  For those who aren’t familiar, Mobius was a VC fund with offices in Silicon Valley and Boulder CO and at it’s peak Mobius had $2B+ under management.  But out of Mobius came today’s Foundry Group, a firm that’s prospered in the last five years.  Similarly you’ve seen a handful of firms which once had very large funds ($500M – 1B+) managed by large partnerships which have reinvented themselves as smaller, more focused firms (in terms of stage / geography / sector).  Atlas Venture and Mayfield Fund are both good examples of firms which are being reinvigorated in this way.  So while the shakeout has meant most of the firms that reach the “at risk” or “purgatory” phases will go away, there will also be a small group of reinvented firms or new firms that get created in the process.

3) Sometimes The Promise of Success Turns Into Actual Success – Setting aside very late-stage VC or growth equity type investors, successful VCs always raise new funds on the promise of success rather than actual (realized) returns of the most recent fund.  For some firms that promise seems very sound based on funds well before the most recent one (e.g. the Sequoia’s and Greylock’s of the world) or sometimes its based on the entrepreneurial successes of the founders of new firms (e.g. A16Z today or Founders Fund or General Catalyst a few years ago).

But those VC firms who face struggles in raising subsequent funds based on the promise of success occasionally experience actual success.  This typically occurs well after the typical 2-4 year cycle of raising new funds, but sometimes if a firm sticks together and invests well and/or gets lucky the porfolio will turn out to be a success (see note below).  In these rare cases, and they are rare, a firm might be able to raise a new fund 5-7 years after their prior one because what was once the promise of success has become demonstrable success.

4) VCs Keep Quiet About Fading Away - As described above, VC firms usually die gradually and quietly rather than spectacularly and publicly as is sometimes the case for startups.  This is largely for self-serving reasons… VC firms that may be approaching death usually hold out hope that they will eventually have good exits from their portfolio and perhaps be able to raise new funds (#3 above).  And I think it’s at best bad form (and at worst outright deception) when VCs who have little or no capital to make new investments aren’t clear with entrepreneurs about their situation.

But believe it or not VCs would probably be doing the entrepreneurs they’ve backed and the LPs who’ve entrusted them with capital a disservice by shouting from the rooftops about their own demise.  When VC firms are in the “purgatory” or “deadpool” phases above, the entrepreneurs of the startups the firm has backed are often still relying on them to provide substantial follow-on capital.  And often this capital is provided to these founders alongside capital from still vibrant VCs who take the behavior and status of existing investors very seriously.  Similarly even when a VC firm is on the demise, most LPs (college endowments, pension funds, and the like) are heavily relient on the GPs of that firm to manage the portfolio to the best of their ability.  Your average endowment may be a highly sophisticated investor across many asset classes, but they simply don’t have the human beings on staff to manage and liquidate a portfolio of illiquid startup investments.

Let me be clear… I’m not saying the VC industry is populated by a bunch of Mother Theresa’s.  Most dying VC are out to save their own skins by keeping their firm’s demise on the DL, and IMO even then they should be totally transparent with their stakeholders (LPs and entrepreneurs).  But it is also typically in the interests of those same stakeholders for the VC firm’s challenges not to be broadcast widely.

So I appreciate that for most, both inside and outside the VC industry, this shakeout is taking a long time.  As a VC myself I’m not looking for sympathy for industry brethren that may face struggles.  But I think it’s worth illuminating for all why the shakeout is playing out over years not months.  We’re in the middle innings, but by the same token there’s no way the clock will be turned back on this one.

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Note: While “venture” returns for a single investment would be making 10x+ multiple on your investment, this is of course balanced by other investments in a given VC fund that lose money or only generate a modest return.  So at a fund level (e.g. a VC fund’s entire portfolio in aggregate, net of management fees and carried interest) a good return from an LP’s perspective would be 2.5-3.0x typically, which in most cases would  to >20% IRR.

The VC industry (both the GP part and the LP part) pays attention to the sector’s returns, but the broader tech ecosystem only occasionally tunes in.  Typically it’s when Cambridge Associates releases their benchmark data on the VC asset class (here’s a 2010 example article from TechCrunch) or an organization like the Kauffman Foundation publishes a white paper (a 2012 example article from Business Insider here).  And to be fair, the sector overall has done poorly in terms of returns in the last 10-12 years despite the fact that some funds (both established and new) have done very well.

But the reality is that average VC industry returns don’t really matter to many people.  This is true for both LPs and GPs for several reasons:

1) No Tradable Index – VC funds are private investment vehicles, making investments in private companies.  LPs investing in venture hold a subset of all the funds in the VC universe by design (see #4 & 5).  And even if they wanted the index return, there is essentially no way to buy (or sell) a broad-based basket of VC funds in the way you can trade the S&P 500 or Russell 2000 or other public equity index.

What about fund of funds (FoF), you ask?  Aren’t they a form of bundled investment into the VC asset class?  It’s true that FoFs provide LPs a way to purchase VC funds in a basket, but by design these are comparatively narrow actively-managed investment funds rather than broad-based passive vehicles.  FoFs have a range of strategies of course, but broadly speaking LPs that invest in FoFs pay them a management fee and carried interest (on top of the fee & carry of underlying VC funds they invest in) for access, diversification, active management or a combination of all three.  Access in the sense that some FoFs have relationships with top-performing funds that aren’t open to new would-be investors.  Diversification in that a small investor (by large institutional standards), say a foundation with $25M in assets that wants to commit $1M (4%) of their assets to VC, can get exposure to 10+ individual VC funds through a FoF but might only be able to inveset in 1-2 if they tried to do it directly.  And active management in the sense that many institutional investors feel that they are better served with having a specialist manager overseeing their allocation to VC rather than trying to do it with their in house staff.  But no matter how you slice it, FoFs don’t really represent a broad-based way to invest in VC.

2) No Synthetic Alternative – If an LP can’t “buy” VC as an index, could they replicate the returns of an index some other way?  For example, if there were no S&P 500 ETFs or index mutual funds an investor could easily buy a “synthetic” equivalent by buying shares of all the S&P 500 stocks in proportion to each company’s weighting in the index.  The same is not true for venture capital of course, since the underlying startups VCs invest in aren’t publicly selling their equity.  Yes accredited investors can theoretically buy shares in a small number of very late stage startups through secondary exchanges, but these are a tiny slice of the VC-backed startup ecosystem and of course the largest returns accrue to the earliest investors in these companies not the latest ones.

3) GP’s Care About Absolute, Not Relative, Returns - Of course most GPs pay attention to the broader returns of the market, but at the end of the day absolute returns are what matter.  They matter in the sense that GPs only earn carried interest if they generate absolute gains on their portfolio, regardless of how their fund does relative to other VC funds or even other asset classes.  Even if you’re top decile for your vintage year (e.g. in comparison to all other VC funds raised in a given year) or you blow away the S&P index over the same time period, a 1.0x fund or marginally profitable fund doesn’t generate any carry for the GPs that are investing it.

4) Venture Is Driven By Exceptional, Not Average Outcomes - The entire VC business is based upon outlier outcomes, not the average.  This is acutely true at the underlying startup investment level… across a broad range of vintage years and fund sizes, the bulk of VC fund returns are driven by a small minority of the portfolio companies that produce 10x+ returns for their investors.  By definition, the “average” investment in a VC fund that produces a “good” return (2.5-3.0x+ cash on cash) is profitable.  But the median investment is almost certainly a middling return if not a modest loss.  Startup outcomes are a power law distribution rather than a standard distribution.

This impact of exceptional returns is diluted some at the fund level due to portfolio effect, so the distribution between the best and worst funds is far narrower than the distribution of startup outcomes.  The best startup investments are routinely 50-100x+ returns whereas a grand slam fund return is something more like 5-10x.  So LPs aren’t necessarily trying to pick the one or two VC firms that will have the standout return of a given vintage year.  But most typically are trying to assemble a roster of VC managers and select those groups that they believe have a disproportionate advantage for sourcing, selecting, and winning the underlying startup investments that are exceptional “head end” outcomes.

5) Long Term Alpha-Seeking LPs - A good majority of LPs actively investing in venture take a long-term view of the asset class.  Yes, some investors come and go (tending to sell low and buy high) and over the decades some new categories of LPs may enter the investment category.  Within a large institution, the VC asset class may be “competing” for allocation with a very broad range of investment types.  And even long-term LPs committed to investing in venture will periodically rebalance their VC portfolio, swapping out underperforming managers for better ones or shifting allocations between different segments of the VC sector (different industries, stage focus, geography, etc).  But these long-term LPs are by definition using active managers in search of alpha (i.e. better than the market average), rather than trying to achieve an index return within the VC asset class.

So the average returns of the venture industry don’t have a meaningful impact on either GPs or LPs, and in reality they probably have little direct impact on entrepreneurs.  In the very long term (5-15+ years), sustained increases in average VC industry returns may attract more capital in aggregate into the system just as bad returns may decrease the total capital committed to the asset class.  But even though it’s episodic, the ecosystem seems to pay more attention to average VC industry returns than is probably warranted.

I had the pleasure of giving a talk on entrepreneurship at UPenn last week, which happens to be my alma mater.  I’m always thrilled to speak with undergraduates who are interested in startups.  One of the most common questions I get is “What’s the best career path to becoming a founder someday?”

The very short answer is that most people who are ultimately founders (or usually co-founders) of a company “tack” towards that goal in a series of career steps.  For those less familiar with sailboats, tacking (and conceptually similar jibing) is the process sailors employ as they zig-zag towards their ultimate destination.  While it’s theoretically possible to sail straight towards your destination if the winds are just right (downwind generally), most of the time sailors have to change direction repeatedly to get where they want to go.  But while the winds may be capricious, tacking is a highly intentional and continuous process to get to a specific goal.

To me the process of becoming a founder is very similar to sailing and tacking, and so I try to relate this concept to folks who are about to set out on their careers.  A small minority of folks who will ultimately become founders of a business do so right off the bat… while they’re in college or just after college.  These are the stories we all know and celebrate like Bill Gates, Steve Jobs, Sergey Brin & Larry Page, Elon Musk, and Mark Zuckerberg.

But most people aren’t ready to start a business of their own at the age of 21 or 22.  It’s not usually a lack of intellectual horsepower, inherent willingness to take risk, or exceptional work ethic … folks who don’t possess these traits at a young age rarely acquire them later in life.  Rather it’s usually an underdeveloped sense of a market opportunity worth pursuing or a desire to gain more experience before trying to launch a company.  There are a great many examples of successful founders who started companies some years after college like Larry Ellison, Jeff Bezos, Andy Grove & Gordon Moore, and even my own mentor Reid Hoffman.

If you’re ready to be a founder at a young age go for it… I’ll be the last person to try to stop you.  But my recommendation to people who aspire to be a founder but aren’t quite ready for it is to think about entrepreneurship as a career path and tack towards being a founder someday.  People often ask me “If I want to be a founder in 3-5 years [or 5-10 or whatever], should I pursue job X now or job Y?”  My advice is usually the following:

1. IMO the best first job you can get on the path towards being a founder is to join a startup.  Even if that startup is ultimately unsuccessful or you’re joining a fairly large, later stage startup, getting the experience of being in a high growth company surrounded by other entrepreneurially minded people is the single best way to prepare for being a founder.  It’s also far and away the most fertile ground for meeting future co-founders.
2. The next best thing would be to join a recently public (e.g. <3 years) company that began as a startup.  Joining Microsoft in 1987 or Yahoo in 1997 or Google in 2005 or Facebook today still gives someone new to the professional world a lot of the exposure to the “startup” world.  Yes these are all big companies with hundreds or thousands of employees at this point, but often many of the senior execs and junior to mid level people were involved in the company when it was still a startup.  These companies are often organized and run more like startups than mature businesses, and tend to still be far more innovative and rapidly growing than a mature business.
3. After #2 the next best thing you can do is join a large, mature publicly traded company in the field you’re interested in starting a business.  So for software based businesses it’s obviously Oracle, Microsoft, and others but if you want to start a biotech company someday it’d be Genzyme, Biogen, Genentech, and others.
4. Join a mature, non-technical operating company.  Working at P&G or Ford isn’t going to feel like a startup and isn’t likely to help you build an entrepreneurially-minded network.  But you may be able to gain either industry expertise that’s relevant to being a founder and/or functional expertise in marketing, sales, operations, etc.
5. Professional services (accounting, mgmt consulting, investment banking, etc) can be a fine career path for many.  And there are certainly plenty of examples of great entrepreneurs who started their careers in these types of jobs.  But overall, professional services is a less good place to start your career if you want to be a founder some day.  These careers are one or more steps removed from the day to day decision making and execution involved in an operating company.  Also the professional network you build in these fields tends to be less relevant to entrepreneurship relative to #1-3.
6. Non-profits and public policy (e.g. politics, policy think tanks, etc) are also a great career path in general, but often not well suited to helping a young person ultimately become a founder.  One advantage of the policy/politics world is that exceptional people can often get a lot of responsibility at a very young age, similar to working in a startup.  But again the day-to-day tasks are farther removed from operating a business, and it’s rare to be able to develop domain expertise that’s relevant in the longer term.

So all things being equal, it’s better to start at #1 or #2 than at #5 or #6.  But regardless where a recent college grad starts their career, if you truly have the ambition of being a founder someday the best thing you can do is keep tacking towards your intended course.  If you start in professional services, try to shift to an operating role in a big company or a startup before too long.  If you start in a big company, keep an eye out for potential collaborators (e.g. future co-founders) and think about jumping out to start something when the time is right.  And overall don’t worry if you’re not a founder the day after you graduate… most people who are ultimately founders aren’t, but nearly all of them worked purposefully to tack towards their goal.

There’s a lot of good suggestions out there for how early stage startups can approach (or improve) board meetings.  Some of my favorites are from Brad Feld (also this one from him), Andy Payne, and Steve Blank.  All three have perspective as both entrepreneurs and as investors / advisors in the startup board room.

There’s a range of different approaches from the somewhat traditional to the more radical (e.g. single slide board mtgs).  I personally think there’s no single template that’s “right” for all startups.  Each startup CEO has their own style and each board has its own quirks in terms of composition and DNA (size, investors vs founders vs independents, etc).

As an entrepreneur I only participated in a single board, presenting as a member of LinkedIn’s management team in the early days when we still had a pretty small board.  As an investor I’ve been a director or observer of many more boards, both highly effective and some less so.  Regardless of what template or style you choose, the common facets I’ve seen from productive and efficient board meetings are as follows:

1. Materials in Advance – this one is pretty obvious, but it makes #2 a lot easier.  There’s also a happy medium between nothing and a package with 50+ pages across multiple documents.  Assuming they’re sent out 12+ hours in advance, it’s entirely reasonable to expect board members to have digested these prior to convening.
2. Majority of Meeting Discussing Top Priority – a minority of the session should be spent on general business update and reviewing the materials.  The best board meetings always focus on a substantive issue where an engaged discussion among a small group of smart folks with common motivation can accomplish something.  The topics of course vary – maybe it’s a discussion of pricing, or figuring out right org structure for the next 1-2 years, the merits of competing product strategies, or the approach to an impending fundraising process.  All of these are temporal in nature, but can benefit from a serious discussion with concrete to-dos for both the company and outside BOD members.
3. CEO’s Should Have A Point Of View - in addition to having more time for discussion and lest for general reporting & updating, I think it’s imperative that CEOs come to these discussions of top priorities with a point of view.  I don’t mean they should dictate the conversation or that they can’t lay out several hypothesis or potential plans.  Discussions should by definition be collaborative.  But as the leader of the company, as an investor board member I genuinely want to hear startup CEOs have a specific point of view.  Hopefully they synthesize the input they may receive and admit when they’re wrong, but at the end of the day being intentional and having conviction are huge parts of leadership.

Again there’s no single template or agenda that makes sense for every company and every board.  But all of the best boards I’ve been involved with have included #1-3 above.