It’s been a while since our last post on this blog. Year end activities got in the way. We were in the midst of a string of posts on what we look for in our investments when we went radio silent. We’ve addressed issues like the stage we like to invest (early), the amount of traction the company has made, our desired role as lead investor, deal size, and our approach to geography.
We figured we’d come back strong by addressing the most important piece of venture capital investing equation – the people we are considering backing.
Background
There are two kinds of people that we have to consider in this process. There is the person or group of people who came up with the idea and started the company, the founders. And there are the people who are currently operating the business, the managers. They are often the same, but not always. And it’s also true that the founders’ role will change over time as the company grows, and the managers’ role will become more important.
But since we are generally investing within a year of the company’s formation, when there are less than ten employees, it is almost always the case that the founder is the person running the business. But it is also almost always the case that the founder has surrounded themselves with some other people whose talents and temperament will have a meaningful impact on the business. We need to consider how all of these people will work together to drive the business forward. We cannot and do not look at just one person when we make an investment, unless there is just one person involved when we write the check. That has already happened twice so far in the short history of Union Square Ventures. I’ll come back to the situations in which we’ll consider doing that later on in the post.
No business is so good that the wrong people can’t mess it up. And no business is so bad that the right people can’t fix it. If you think about what a business is, it’s a collection of people who have been organized in attempt to profit from offering a product or service to the marketplace. So if you don’t get the people part of the equation right, everything else is really immaterial.
And the people issues always start at the top of the company. Great people attract and retain great people and build a culture where the best people like to work. They value people, compensate them well, motivate them well, and manage them well. On the other hand, there are plenty of people who don’t have what it takes to lead an organization. For some people, that is because they don’t enjoy managing people. For others, that is because they don’t have the empathy or self awareness that is required to manage others. There are many reasons why some people don’t make good managers and leaders.
We believe that management and leadership can be learned and we strive to keep the founders of the companies we back in leadership roles for as long as is possible, often that will be until the company is sold. But we also recognize that some people will not make it as leaders and we must be careful to avoid the damage that can result to a fragile early stage company that results from having the wrong leadership followed by a leadership change.
We also recognize that many leadership changes work out badly. There are so many examples of companies where the founder either stepped aside or was pushed aside in favor of “operating management” and then the hired management was even worse. We work very hard to avoid that circumstance. Our Criteria
So with that backdrop, this is what we look for in founders and managers.
First and foremost, we look for people who we will enjoy working with. We’ve been investing in early stage technology businesses for over 20 years and we’ve backed people we like and we’ve backed people we ended up having great difficulty with. We’ve made the decision that no matter how attractive an investment opportunity may be, we will not get involved if we do not think there is a high likelihood of a very positive working experience. That is partially a recognition that the entrepreneur/VC relationship is critical to the success of the company. But it also a recognition that if we enjoy working with a person or a group of people, it is more likely that others will as well.
We also seek to back entrepreneurs and managers that we’ve worked with successfully before. We realize that this sets up a “club relationship” where it’s hard to break in. And we also realize that some of the best entrepreneurs will be first time entrepreneurs. So we have a process to make sure we back first time entrepreneurs, but the hurdles are simply higher.
When an entrepreneur or even better a founding team that we’ve backed before successfully comes to see us with a new opportunity, we are usually very inclined to support it with our time, energy, and capital. Of course, we have to feel that the business concept has merit and it needs to fit into our investment strategy. And in some cases that doesn’t happen and we don’t invest. But when a team we’ve backed before with success comes to us with a concept that is in our sweet spot, there is a very high likelihood that we will invest. We like to think of these entrepreneurs as “franchise” entrepreneurs.
We are also fans of teams that come back to market with a new opportunity where we were not the investor the previous time. We’ve watched many great entrepreneurs work from afar (or even close up when our companies compete with or work with them). And when they decide to start something new, we are always eager to talk to them. It’s a bit harder for us to be confident that the relationship will work well, but in these situations we do a lot of calling around to learn what it is like to work with these entrepreneurs. We take the time to build a relationship before we invest. We like to think of these entrepreneurs as “serial” entrepreneurs.
But as I mentioned previously, we need to be open to first time entrepreneurs who have no track record with us or others. With this group, we look for traction on the business plan, a service in the market that is being used and getting favorable reaction from the market. We want to spend a lot of time “hanging around the rim” on these deals so we can be certain that our style and the entrepreneur’s style will work well together. We talk a lot about how the entrepreneur plans to develop as a leader or if they don’t, how they plan to develop others to lead the business.
The first time entrepreneur is the riskiest of the three kinds of teams we will back, so when we do it, we want there to be much less risk in other parts of the business. If the service is in the market, gaining traction, with revenues flowing, and the business developing nicely, then there is less likelihood of the kind of conflict over strategy and business direction that creates tension in the entrepreneur/VC relationship.
But even with all of that, we still need to see a personality type or a set of personalities that can create a culture that will attract and retain the best people. We need to see someone or a group of people who understand that a company is a collection of people, nothing more and nothing less. Because we never back just one person, we are backing a group of people who will grow in size and complexity over time and we need to be sure that the people leading it are capable of the challenges that such growth entails.
I promised that I’d address the two times we backed just one person. The first time was Joshua Schachter and Delicious. At the time we backed Joshua, Delicious was already a very successful service in the marketplace, a leader in the category, and a leader in the emerging market we now call web 2.0. Nevertheless, we spent a great deal of time hanging around the rim with Joshua before he and Union Square Ventures decided to become financial partners. We got comfortable that Joshua understood the value of people and that he could attract the right talent to the business. We also introduced Joshua to Albert Wenger who over time became Joshua’s partner in managing the business. Had Delicious remained independent, we were confident that Joshua and Albert would have built a great team and a great company.
The second time is Peter Semmelhack and Bug Labs. Peter is a serial entrepreneur we had watched from afar with great respect. Further, we knew him socially through a number of connections. When Peter came to us with the idea for Bug Labs, it did not take us long to make the decision to back him. Peter has already assembled a wonderful team, a number of whom had worked in his prior companies.
The serial team is something we value greatly. Isaak Karaev has brought many of his best team members from Multex to his new company Instant Information. Dave Morgan brought many of his best team members from Real Media to TACODA. The founding team at FeedBurner has worked together for more than ten years in a number of companies and startups. When you see that at work, you know you are investing in a team of people that know how to work together, where the culture is existent from day one, and where the probability of success is very high.
Statistics
I’ll end this long post (sorry but this is complicated stuff and I’ve barely scratched the surface), with some stats. We have invested in eight companies so far at Union Square Ventures and have term sheets out for three more, none of which are guaranteed to close. The eleven companies break down as follows:
Franchise Entrepreneurs – Two Serial Entrepreneurs – Five First Time Entrepreneurs – Four
So even with our desire to back proven teams, we have found a number of exciting first time entrepreneurs to back as well. I expect that when this portfolio is all said and done and we have eighteen to twenty companies in it, about forty percent will be first time entrepreneurs, forty percent will be serial entrepreneurs, and twenty percent will be franchise entrepreneurs. That feels like a good mix.