Last week I wrote about some of the common factors that have led great VC firms to stumble or even fade from existence entirely. I wanted to follow-up with some observations of paths to greatness for a select group of firms. Also it’s also worth noting a few clever hacks that some firms have taken which may not assure greatness, but can help avoid the pitfalls that have ensnared past firms.
First and foremost, it’s worth emphasizing that greatness as a VC firm is derived primarily from helping exceptional entrepreneurs build enduring companies. While it’s possible to gain notoriety and even economic rewards for GPs in other ways in the short to intermediate term, the firms we regard as “great” over the long run derive their superiority from investing in and helping businesses grow… that’s where success for all of a VC firm’s constituents (LPs, entrepreneurs, GPs) flows from.
So assuming a VC firm is able to fulfill its core mission with distinction, what are some factors that can make it great?
1) Self-Awareness & Humility – These are of course virtues that transcend venture capital or even professional pursuits broadly. And yes… great firms are self-confident too. But being able to recognize and admit when you’ve slipped and then course correct as needed is often key to a firm’s ascent to or continued greatness. This is true not only in a firm’s dealings with entrepreneurs but also with it’s limited partners and even within the firm among its partners.
A good example of this was Charles River Ventures experience with their 11th fund. Back in the 2000-2001 timeframe, a flood of LP capital was coming into the VC asset class given the strong returns of the mid-late 90s tech boom/bubble. Like many leading firms CRV used this opportunity to raise a huge $1.2 billion fund (CRV XI), though the firm’s roots were modest (Rick Burnes started CRV back in 1970 with a $4M first fund) and until then CRV had mostly stuck to its knitting of early-stage investing with small-mid sized funds. In the midst of the internet & telecom meltdown at the beginning of the 2000s, as a firm CRV realized there were insufficient opportunities to profitably invest $1.2B. Though there might have been short term benefits to continuing to manage this fund, the long-run success of CRV would be hurt by doing so (there’s an HBR case on this). CRV ended up returning the vast majority of CRV XI to it’s limited partners (ended up being a ~$450M fund) which started a trend among some other VC firms and ever since they’ve stuck with early-stage IT investing out of funds in the $250-$375M range (they’re on “Charlie 15” now).
2) Be Willing to to Experiment – I described the risks of strategy drift in Part 1, but often great VCs still display a willingness to experiment in their business model. Even when sticking to your core strategy, there are lots of ways to change up a firm’s model with the goal of delivering better value to entrepreneurs, LPs, and the firm’s GPs.
In recent years firms like First Round Capital and Andreessen Horowitz have experimented with creating a “platform” of services for entrepreneurs that go beyond the traditional investor / board director relationship between VCs and startups. For example FRC launched a founders equity exchange fund and various programmatic forms of knowledge sharing like list serves, CEO summits, conferences, etc. The point isn’t that FRC was necessarily the first firm to do any one of these things, but rather they’ve had a willingness to experiment.
In eras gone by, VC firms experimented with other concepts which seem commonplace today. Entrepreneurs in residence (EIRs) and in-house recruiters were a novel thing for most VC firms back in the 80s and 90s. Even the notion of hatching / incubating a company was once unusual. One of the earliest examples of this turned out pretty well when one of Kleiner Perkins’s young investment professionals (29yr old Bob Swanson) bugged a UCSF professor in the last ’70s about starting a company to develop medicines using recombinant DNA. Genentech of course pioneered what we now know as the biotech industry and KP made >200x on their investment.
A willingness to experiment also means you’re prepared for the risks of failure or looking silly in the ecosystem. Rightly or wrongly, Sequoia has received a lot of flak about their “scout” program recently. But one has to respect their willingness to experiment in this fashion before other firms did the same.
3) Competitive Intensity – At both an individual partner and a firm level, great VCs find a way to retain an intense drive to win. Winning in the sense of finding the most promising startups and earning the right to invest in them. Winning in the sense of helping entrepreneurs they’ve backed build great companies. That being said the venture business is a multi-turn game… good firms will often work with teams of entrepreneurs or certain co-investors multiple times over their history, so a healthy competitive desire is not the same thing as being a jerk just to “win” in a particular situation. And internal competition within a partnership can be a double edged sword.
But when a firm or a meaningful group of a firm’s partners has lost that hunger and drive to win, day in and day out, their days of greatness are usually numbered no matter what their prior successes. Keeping those competitive fires stoked requires a sustained commitment by the firm’s partners and also a fair yet honest reckoning when individual partners find their hunger is dulled whether by age, life changes, or interest in other pursuits. In addition partnerships have to keep pushing their boundaries of risk tolerance since the natural tendency of any organization as it matures is towards risk aversion.
4) Hacking Potential Pitfalls – Another approach is to simply find a way to avoid potential pitfalls like generational succession. Foundry Group is one such firm which has clearly and publicly stated that the four founding partners will continue to invest together for the balance of their VC careers, but after that Foundry essentially will be no more since they never plan to add additional partners. Though they only started in 2006, Foundry’s obviously off to a great start with investments in Zynga and AdMeld and a promising portfolio of others. While their model isn’t necessarily to create a firm that endures after the founders, they have avoided at least one of the biggest reasons why great firms fail.
5) Don’t Be A Victim of Your Own Network’s Success – A byproduct of a VC firm’s success is the creation of a strong ecosystem around it of prior and would-be entrepreneurs and long time co-investors (in fact this can be cultivated intentionally too). This is obviously a good thing since it creates opportunities to back experienced serial entrepreneurs and work with a trusted group of other VC firms as co-investors. The downside is it has the potential to close off a firm from newer entrepreneurs. Also while you might be able to use the same “playbook” for a game or two, in the quickly changing and highly competitive world of technology innovation VC firms risk blindly following a template beyond it’s useful life.
A firm that’s continuously managed to look beyond it’s network has been Sequoia. While they’ve also invested in repeat entrepreneurs they’ve previously backed, Sequoia realized many moons ago that their biggest successes were often by first time entrepreneurs. Think Apple, Cisco, Yahoo!, Google, Dropbox, AirBnB. So the firm assiduously finds ways to form these new connections through and beyond their existing network even relying on that existing network would be an easy thing to do.
Again #1-5 don’t guarantee greatness for a VC firm… only investing in and helping transformative companies does. But in observing great VC firms over the decades, all of the above both support the core mission of backing great entrepreneurs and distinguish great firms from the rest of the pack.