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Open Season on Venture Capitalists
A bi-weekly column with timely, relevant and possibly irreverent insight into the BC technology industry.

Something Ventured:
June 13th, 2003

By Brent Holliday
Greenstone Venture Partners


“You may be right,

I may be crazy,

But it just may be a lunatic you're looking for.

Turn out the light,

Don't try to save me,

You may be wrong for all I know,

But you may be right” – Billy Joel, You May Be Right


There is a very busy guy out there taking some time every few weeks to write on subjects for software entrepreneurs, managers and employees.  He has been doing it for a few years and provides a full archive of his work. He is witty and writes fairly well.  Before the Internet, he wouldn’t likely have been published, but he has a small following and some great insight.  Most times he is right on the mark with his theses and suggestions, but on other topics he clearly hasn’t done his homework.  But you forgive him because overall he’s pretty entertaining.  His name is Joel Spolsky and his column is called Joel on Software (a friend of mine, Alan Chiu, put me on to his work). Last week Joel decided to take a hard look at the current state of venture capital and I feel it is my duty to respond.


This might get tedious and I apologize in advance… but you have to read his column before coming back here to read the rest of this column.  This saves time because I don’t have to paraphrase everything he said.  So go here (http://www.joelonsoftware.com/articles/VC.html) and then return.  I’ll be here drumming my fingers on the keyboard until you get back.


Done?  Interesting perspective, eh?


First thing that we need to get on the table here is that he is talking about software application development.  This is a large sub segment of the technology investment universe that a VC has to choose from, depending on the focus of the fund.  But it is not the only type of company out there. He makes some arguments that are relevant only to software application development which are not in the least bit like, say, a drug discovery biotech start-up.


I liked the first part, where he compares the risk profile of a VC to an entrepreneur. It is an accurate description of the divergent risk profiles, but the conclusion that VCs want their companies to do incredibly risky things is the first of a few non sequiturs in his article.  Joel has confused the holistic end view of a portfolio approach to investment with the individual, specific day-to-day interactions of VC and entrepreneur.  What a VC wants to end up with in his fund at the end of 10 years is a guide for decision making along the way, but the decisions made today for the benefit of a portfolio company are actually made in the best interest of a company growing on a stepwise, milestone based development path.  Hmmm, stepwise, milestone based path… sounds like software development.  If the VC simply waved his/her hand and blessed rampant money spending to get to the end faster, then the companies would burn up much as he described in his graphs.  In fact this is exactly what happened in the late 90’s.  It is not happening as much now, if at all.


Most VCs are not the wanton risk takers that he describes.  If you want proof of that, just ask any CEO in Vancouver with VCs on their board.  Present the thesis that the VCs are constantly asking them to spend money and take bigger risks in their business plan.  After the laughter subsides, ask them what is really happening in their board rooms.  I think a majority of the entrepreneurs feel somewhat shackled by the VCs and that the advice is more “stay the course and get to the next milestone on the least amount of money possible”.


Sure, there are big Silicon Valley VCs that play the game closer to what Joel has described, but they represent a vast minority of VC.  Most of us (and virtually all of us in Canada) have a very different risk profile that is more in line with the entrepreneur than Joel understands.  Most of us want all of our investments to succeed (success is anywhere from 2x your invested capital all the way to The Next Netscape) and make original investment decisions based on that theory.  It’s just that we know ahead of time from experience that some of them won’t work out.


The latter part of the article about VCs learning to say “No” and that they wouldn’t know a good opportunity if it bit them in the hiney… well it’s the classic view from the other side of the fence.  It was very entertaining to read, but the VC process is actually pretty good at weeding out opportunities that will never be funded very quickly.  The second major non sequitur is the conclusion that we are too busy saying No to go and get to know a company that is a worthwhile opportunity.  Has Joel seen how long it takes to get a term sheet these days?  It’s not because we are playing golf.  It’s because the number one new commandment of the VC learned in the 1999-2000 bubble is “Thou shalt never be rushed through the diligence process again”.  VCs will say “No” to great opportunities today if it is too tight a timeline for their resources.  There is no rush to get in a deal anymore.  We are doing the dance… and it’s a slow waltz.


Joel started on a very worthwhile point about the deal terms getting too harsh, but then used a poor example with his rant on the “no shop” clause.  The “no shop” clause is usually not a big deal term because the company is exhausted when it gets to a term sheet after vigorous shopping among many VCs.  They don’t care about it because they want to get back to building a company after assembling a reasonable deal.   Anyway, he should have gone into better terms like “participation preferences” and other preferred rights that would have backed his argument about entrepreneurs needing to really evaluate what they are giving up for venture money.  That would have been interesting.


You see, overall, I think Joel was on the right track, but had some weaker arguments along the way. His good advice hidden among some entertaining tangents I think was this:


While venture capital is going through a reckoning right now along with the rest of the industry, you, as an entrepreneur, should be looking at the cost/benefit of going down that path towards creating value for you and your first shareholders.  The cheapest form of capital to expand or grow your business, by far, is from your customer.  That should be your primary focus.  The second cheapest form of capital is government sponsored incentives and grants.  The third cheapest form of capital is your own, followed closely by your friends and family (although we are getting into the realm of risk capital here and they may end up not being your friends or your family if you fail to get them their money back).  Then comes angel money, bank debt, public equity and finally, as the most expensive form of capital, private equity from institutions (i.e. VCs).  What I think Joel is trying to say is, why would you run there first?


Here’s my answer:  You need to get something to sell before you have a customer and to build it requires someone to take a big risk and dole out the capital.  If it is software and you can build version 1.0 and actually sell it to a few unsuspecting folks, you don’t need a lot of money.  If it is the next cure for breast cancer, obviously you need a little help.  VC is not about betting the farm on a software company, ramming $10M down their throats and cutting everyone loose with nothing to show for the effort after it fails to meet expectation, as Joel portrays it.  VC is about entrepreneurs wanting scale and scope and needing to build something that could be large. 


As I have said here many times before, you can grow a business to a decent size and sell it owning 80%.  It will take you a while (10-15 years on average) and a lot of hard work, but you have a nice nut to retire on at the end of the run.  Occasionally, you can make it much bigger, like say Alpha Industries in Vancouver, without ever taking risk capital, but the chances are remote.  Most of the big technology companies of today and the next 100 years will have raised capital along the way and the original founders will own <5% of the company after 6-8 years.  But your chances of getting really big are enhanced and it might not be as long until you get liquidity.


My final response to Joel is that he portrays VCs as omnipotent meddlers and the entrepreneur as the subservient victim in a VC funded company. While it is a popular myth, it simply is not true for the majority of VC funded deals.  I have never met a CEO/founder that is no longer with his/her original company that thinks that they are to blame.  It’s always the damn VCs.  Uh-huh. I am definitely aware of VCs that should have been cast in Dumb and Dumberer, but the entrepreneur can and should find out about their VCs before partnering with them.  And they should be aware that sharing the voting shares in their company makes it a democracy. 


On the whole, I liked Joel’s article and he raises some very good points.  Just remember that there is always another point of view to the story.


What Do You Think? Talk Back To Brent Holliday


Something Ventured
is a bi-weekly column designed to supplement the T-Net British Columbia web site with some timely, relevant and possibly irreverent insight into the industry. I hope to share some of the perspective and trends that I see in my role as a VC. The column is always followed by feedback (if its positive or constructive. I'll keep the flames to myself, thanks).

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