Mark Andreessen and Thoughts on the Venture Capital Industry
by Nadav Manham
One of my current projects is to learn about the venture capital industry. Specifically, I want to answer this question: Can venture capital investing be practiced in accordance with value investing principles as I define them?
Marc Andreessen is a very successful entrepreneur who has recently "moved to the dark side" and raised a venture capital fund. In this Tech Tickerinterview he speaks candidly about how the industry actually works. Novice student that I am, I tried to take good notes:
1) On purpose, the fund is designed to invest anywhere between $50,000 and $50 million per deal, meaning it has the flexibility to invest in early stage to late stage companies. Unstated message: most venture funds are too rigid in their mandates.
2) The data say that in any given year there are only about 15 funded companies that will ultimately reach $100mm in annual revenues. These companies end up accounting for something like 97% of venture capital returns (!). Unstated message: If a VC fund can't get into these 15 deals, it has very little chance of delivering strong returns for the above-average risks it takes.
3) The job of the VC investor must be to be able to invest in one or more of those 15 companies. That's the point of having the flexibility to invest across all stages.
4) To call venture capital an "asset class" is a misnomer, because only about 10 to 20 VC firms earn very good returns, and the rest of the 780 or so don't beat the S&P. The dividing line is who is able to identify AND get into the best deals, the magic 15. Andreessen thinks his firm can be one of those firms.
5) Many VC firms will go under--most likely hundreds. But the top 10 or 20 firms will do well and deliver pretty good returns.
6) Ideally the founder of a VC investee goes on to become an effective CEO. That's how you get the big wins.
7) Much less ideally is when the founder doesn't want to be the CEO, because that introduces a gigantic element of risk--hiring a CEO is an extremely dangerous proposition and usually fails.
Here is my question: If you were a "venture capitalist in venture capitalist firms," how would you go about determining which of the 800 VC firms in the country have the ability to be among the top 20 that justify their existences? My sense is that the strongest determinant of the ability to get access to the best deals of tomorrow is the ability to have gotten into the best deals of recent years. There is a "rich get richer" effect in VC that makes the top firms very good businesses. Which begs the next question: Why does this effect exist? I'll save my speculations for another post.
It also begs another question: If incumbent VC firms have such an advantage, why does Andreessen believe his upstart firm has a shot at breaking into the club?
Lots to learn . . .
Addendum: I recently had lunch with a person in the VC industry who made another point that furthered my education. He believes that a necessary element of a good VC fund, an element that is difficult for large institutional investors to stomach, is the ability to tolerate and even encourage great flexibility in the evolution of startup companies. Just as no battle plan survives the first contact with the enemy, no startup business model survives first contact with commercial reality. It's almost a rule rather than an exception that a startup will radically alter its original business model early on in its life, maybe more than once.
Now that I'm involved in a startup project of my own, I think about this stuff often these days . . .
