The Lower-Risk Startup: How Venture Capitalists Increase the Odds of Startup Success

© David Teten 2013. More at ffvc.com and teten.com© David Teten 2013. More at ffvc.com and teten.comHow Venture Capitalists Increase the Odds of Startup SuccessThe Lower-Risk StartupDavid Teten, Koen Bremer,Gyorgy Buslig, and Adham AbdelFattahffvc.com // @ffvcteten.com // @dtetenhttp://www.flickr.com/photos/glynlowe/7087555453/sizes/z/in/photostream/

Intro Financier Mentor Next StepsResources Operator© David Teten 2013. More at ffvc.com and teten.comDon’t Take Notes!Download these slides,sign up for updates,and get more free resources at:ffvc.com/VC-consulting/andteten.com

Intro Financier Mentor Next StepsResources Operator© David Teten 2013. More at ffvc.com and teten.com•  Introduction•  Resources•  VC Type 1: Financier•  VC Type 2: Mentor•  VC Type 3: Operator•  Next StepsAgenda

Intro Financier Mentor Next StepsResources Operator© David Teten 2013. More at ffvc.com and teten.comBackgroundDavid Teten, Koen Bremer, Gyorgy Buslig, and Adham AbdelFattah published thefirst-ever research study on “The Lower-Risk Startup: How Venture CapitalistsIncrease the Odds of Startup Success” in The Journal of Private Equity (March2013), as well as in Techcrunch, peHub, and Betabeat. These slides summarizeour findings.This is a sequel to David Teten’s 2010 research study on“Best Practices in Private Equity and Venture Capital Deal Origination”, with ChrisFarmer, Venture Partner, General Catalyst, which was published in HarvardBusiness Review, Institutional Investor, the Journal of Private Equity, etc.

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor OperatorHighlights of our findings•  Most of the funds with well-developed developed Portfolio Operator modelshave top-quartile returns (above a 20% IRR in the relevant time periods) .(See caveat at end of presentation.)•  Very little systematic research has been executed in this area.•  Investors have conflicting opinions about the role of VCs in supporting portfoliocompanies; most VCs fall into the “Mentor” category.•  Size does matter; VC firms with a larger number of portfolio companies providemore services.•  Few of the VCs we interviewed charge any of their portfolio companies forservices they provide them.•  Most common types of support revolve around recruiting, direct customerintroductions, and introduction to vendors, e.g., PR, legal, and other services.•  This pattern in VC is in part modeled on the longstanding growth of operatinggroups in PE firms; PE firms could benefit greatly by emulating how VC firms areusing technology in portfolio operations and firm-wide operations.

Intro Financier Mentor Next StepsResources Operator© David Teten 2013. More at ffvc.com and teten.comTeam•  David Teten (teten.com) is a Partner with ff Venture Capital (ffvc.com)and Founder and Chairman of Harvard Business School Alumni Angels ofGreater New York (HBSAlumniAngels.com/NY). He has previousexperience (as a consultant) with the portfolio operations groups of CarlIcahn, the Goldman Sachs Special Situations Group, and others.•  Adham AbdelFattah is the Founder & CEO of CircleVibe, a mobilestartup in New York; a consultant on leave from McKinsey & Company inthe New York office; and a Columbia Business School MBA.•  Koen Bremer is a consultant with the Boston Consulting Group in theAmsterdam office and a Columbia Business School MBA.•  Gyorgy Buslig is a consultant with McKinsey & Co. in the Hungary officeand a Columbia Business School MBA.

Intro Financier Mentor Next StepsResources Operator© David Teten 2013. More at ffvc.com and teten.comff Venture Capital (ffvc.com)•  Early-stage technology venture capital fund•  160 investments in 60 companies since 1999•  17 employees by March 2013•  First investments typically $50-$400K at valuations of <$5m pre-money•  Follow on in later rounds for best-performing startups•  Prominent investments include:Cornerstone OnDemand (IPO); Quigo Technologies (sold to AOL forreported $340m); Klout; 500px; Voxy; ThinkNear

Intro Financier Mentor Next StepsResources Operator© David Teten 2013. More at ffvc.com and teten.com List of companies through June 30, 2012ff Venture Capital: 160 investments in over 60 companiessince 1999 (ffvc.com/companies)

Intro Financier Mentor Next StepsResources Operator© David Teten 2013. More at ffvc.com and teten.comHarvard Business School Angels of Greater New York(HBSAlumniAngels.com/NY)•  Members are Harvard affiliates from all industries.•  We invest in companies regardless of any Harvard affiliation.•  In last twelve months, $1.8m invested in 8 companies.•  $84K mean individual check size per company per round.•  Third largest angel group in NY tri-state area by number of payingmembers (to our knowledge).•  Launched Venture Capital Access Program, focused on helping womenand minority investors raise capital from our network.

Intro Financier Mentor Next StepsResources Operator© David Teten 2013. More at ffvc.com and teten.comVenture Capital Value Creation Research ObjectivesDiscuss the range of philosophies found amongmajor investors in their approach to working withportfolio entrepreneursUnderstand how venture capitalists (VCs) cansystematically help startups increase their oddsof success beyond simply investingDefine a blueprint for how investors can assesstheir strengths in order to meaningfully helpportfolio companies succeed through operational(non-financial) supportWhat investmentphilosophies exist?What value-creationopportunities exist?How can we codify theVC value proposition?

Intro Financier Mentor Next StepsResources Operator© David Teten 2013. More at ffvc.com and teten.comSources•  Interviews with over 50 venture capital investors, entrepreneurs, startupincubators and advisory service providers•  Proprietary database and survey of VCs’ value creation practices•  Wide scan of academic and practitioner publications focused on thetopics of entrepreneurship and venture investing•  Authors’ personal experience working in venture capital, early-stagetechnology companies, and strategy consulting

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor Operator•  Introduction•  Value creation: levers & resources•  VC Type 1: Financier•  VC Type 2: Mentor•  VC Type 3: Operator•  Next StepsAgenda

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor OperatorFive VC resources to increase portfolio company value•  Cash•  Brand•  Industry Network•  Funding Network•  In-House Expertisehttp://www.flickr.com/photos/mariachily/3382799213/sizes/z/in/photostream/

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor Operator7 levers of value creation (“TOPSCAN”)Team-Building Growing a startup’s human infrastructureOperations Enhancing admin, accounting, legal andtechnological capabilitiesPerspective strategy, competitive positioning, defining thetarget market, and scoping the product.Skill-Building Building the right skills and ensuring theydevelop with the company’s life cycleCustomerDevelopmentIdentifying the right customers and gainingaccess to themAnalysis Helping entrepreneurs measure, understandand report the performanceNetwork Providing access to the investor’s typicallyvery large network

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor OperatorTOPSCAN: Team-Building•  Identify,•  Source,•  Recruit,•  Close,•  Retain, and•  Rotate talenthttp://www.flickr.com/photos/25802865@N08/3178448986/

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor OperatorTOPSCAN: Operations•  Help startups refine/executeoperational systems / processes,particularly:–  Admin–  Accounting–  Legal–  Technologicalhttp://www.flickr.com/photos/lac-bac/4679195538/

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor OperatorTOPSCAN: Perspective•  Offer 3rd party strategic advice andmarket intelligence–  Market size andaddressability–  Competition–  Product–  Consumers–  Researchhttp://www.flickr.com/photos/soldiersmediacenter/397627724/sizes/z/in/photostream/

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor OperatorTOPSCAN: Skill-building•  Help startups buildthe right skills–  Management–  Sales–  Partnershipshttp://500px.com/photo/9918021

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor OperatorTOPSCAN: Customer Development•  Evangelize,•  Identify,•  Source,•  Close,•  Retain, and•  Grow clientshttp://www.flickr.com/photos/josefstuefer/9500503/sizes/z/in/photostream/

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor OperatorTOPSCAN: Analysis•  Help entrepreneursmeasure, understandand report individualcompanyperformance, e.g.,benchmark againstpertinent startupmetricshttp://www.flickr.com/photos/pagedooley/793550071/sizes/m/in/photostream/

Intro Financier Next StepsResources© David Teten 2013. More at ffvc.com and teten.comMentor OperatorTOPSCAN: Network•  The cheapest and sometimes mostvalue-added service that an investorcan provide is access to his/hernetwork–  Industry network–  Funding network–  Talent / recruiting networkpicasaweb.google.com/lh/photo/FOHUbVdTEYKdftpmi6TkXQ

Intro Financier Next StepsResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.com•  Introduction•  Value creation: levers & resources•  VC Type 1: Financier•  VC Type 2: Mentor•  VC Type 3: Operator•  Next StepsAgenda

Intro Financier Next StepsResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comOverview: Financier“I’m a banker, not an operator.”Philosophy•  Scrutinize early-stage companies& conduct a thorough diligence•  Invest the right amount of capitalat the right valuation & structureNature of involvement•  More formal interaction,e.g. board involvement,monthly reporting templateshttp://www.flickr.com/photos/jmrosenfeld/2903513401/sizes/m/in/photostream/

Intro Financier Next StepsResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comCase study: FinancierCorrelation Ventures•  Referred to by some as the “Moneyball” of venture capital•  Partners never take board seats and maintain only modest operationalinvolvement despite background as startup entrepreneurs•  Offer rapid investment decisions with little hassle•  Leverage large investment in predictive analytics•  $165 million AUM

Intro Financier Next StepsResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comOther Financiersi2X

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.com•  Introduction•  Resources•  VC Type 1: Financier•  VC Type 2: Mentor•  VC Type 3: Operator•  Next StepsAgenda

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.comOverview: Mentor“I try to be the CEO’s consigliere.”Philosophy•  Fund and personal assets canimprove the performance ofportfolio•  The most important VC asset is itsnetworkNature of involvement•  Assets are leveraged to add valueon an ad-hoc basis•  No structured, formalizedprocesseshttp://www.flickr.com/photos/duncan_mcneil/863770985/

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.comCase study: MentorWest Coast Early-Stage Fund•  Monthly mentoring conversations with the companies’ founders todiscuss ways to leverage the VC’s network•  When requested by entrepreneur, VC partners leverage their network tosupport portfolio companies with specific challenges

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.comCase study: MentorSmall solo-GP Funds•  There has been a surge in such funds over the past few years•  Examples: Baseline Ventures, Coastano VC, Cowboy Ventures,Harrison Metal, K9 Ventures, and PivotNorth•  Many would be classified as financiers or mentors, because theytypically have very limited resources to engage substantively with theirrespective portfolios

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.com•  Introduction•  Resources•  VC Type 1: Financier•  VC Type 2: Mentor•  VC Type 3: Operator•  Next StepsAgenda

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.comOverview: Operator“We have a structured, standardprocess for adding value.”Philosophy•  VC can add value by leveragingassets in a structured wayNature of involvement•  Accelerative systems andprocesses are offered to portfoliocompanies•  Wide range of implementations•  The most prevailing service iswith recruiting assistancehttp://www.sxc.hu/photo/1109610

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.comA New VC Structure?•  As HBS Prof. Noam Wasserman writes, VCs have long been structuredas “upside-down pyramids” in which GPs outnumber more junioremployees•  This highly atypical organization likely arose due to the need forGPs to exchange rich information in the course of pre-investmentactivities•  Many operators are switching to pyramidal models because they are themost efficient means of systematizing and delivering operational supportdue to the benefits of leverage, delegation, and specialization.•  Decreasing startup costs and increasing growth rates make theapplication of these resources all the more valuableNoam Wasserman (2005), Upside-down Venture Capitalists and theTransition Toward Pyramidal Firms:Inevitable Progression, or FailedExperiment?, in Lisa A. Keister(ed.) Entrepreneurship (Research inthe Sociology of Work, Volume 15),Emerald Group Publishing Limited, pp.151-208•  The pyramidal model ultimately won out in other, moremature knowledge-intensive-industries, such as law andinvestment banking

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.comCase study: OperatorAndreessen Horowitz•  Possibly most prominent Operator VC, having raised $2.7B and investing inAirbnb, Facebook, Skype, Twitter, Zynga, and others•  Give portfolio companies structured support through one of four operationalsupport teams, focused on executive recruiting, marketing/PR, technology,and business development•  40+ operational staff assist in preparing negotiations, making clientintroductions, and providing preferred suppliers

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.comCase study: OperatorFirst Round Capital•  Has wide range of initiatives to support portfolio companies•  Organize yearly CEO, CFO, and CTO summits•  Offer portfolio free access to a ‘venture concierge’•  $400+ million AUM and 22 full-time employees

Intro Financier Operator Next StepsResources Mentor© David Teten 2013. More at ffvc.com and teten.comCase study: Operatorff Venture Capital•  $38 million AUM and 12 full-time employees, probably the highest ratio ofemployees to assets under management of any asset management•  Institutionalized systems and processes offered to portfolio include:-  Finance acceleration-  Recruiting assistance-  Mentor and entrepreneur networks-  Process improvement-  Discounted services-  Access to leading universities-  Office Space-  Recruiting

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.com•  Introduction•  Resources•  VC Type 1: Financier•  VC Type 2: Mentor•  VC Type 3: Builder•  Next StepsAgenda

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comVC Resource: Cash•  Most VCs are (relatively) poor•  If you have high cash levels:-  Select the support services to createthe most value for companies-  Foster technology-enabled knowledgesharing•  Low cash levels:-  Make targeted introductionshttp://www.flickr.com/photos/jaselabs/3252664493/

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comVC Resource: Brand•  If you have a strong brand:-  Maintain reputation; leveragebrand equity in marketing/access to talenthttp://500px.com/photo/1298772•  Weak brand:-  Build brand image, e.g. byinvesting alongside top VCs andin successful companies

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comVC Resource: Industry & funding networkhttp://www.flickr.com/photos/jurvetson/3346659199/•  If you have a strong network:-  Understand what types of introsportfolio companies seek-  Invest in a CRM system•  Weak network:-  Rely on external partners andservice providers

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comVC Resource: Expertise•  If you have strong in-house expertiseand an internal consulting bench:-  Monitor that you are using yourresources judiciously-  Publicize your open door policyto the portfolio•  Weak in-house operating expertise:-  Establish relationships withoutside consultants/serviceprovidershttp://www.sxc.hu/photo/1101337

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comAny questions ?Slides at ffvc.com/VC-consultingSign up for updatesat ffvc.com and teten.com@ffvc @dteten

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comCaveat: On analyzing returns of VC fundsFor our study, we wanted to analyze if the Portfolio Operator strategy led tohigher returns. Sadly, this is virtually impossible to do rigorously, for severalreasons:•  This strategy is relatively new, so insufficient data is available for thesmall number of funds pursuing this strategy.•  Returns data for VCs are difficult to obtain and difficult to compare withone another across inconsistent fund sizes, check sizes, and strategies.•  VCs with higher returns naturally have more cash and feel more self-confident, and therefore are more likely to invest the money needed forthe expensive Portfolio Operator strategy.We can only say with confidence that most of the funds with well-developedPortfolio Operator strategies tend to have returns in the top quartile (over a20% IRR) for the time periods during which they have used that strategy.

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comff Venture Capital does not endorse or encourage use ofany of the sites or resources discussed herein, and is notresponsible for any damages caused by their use. You areencouraged to do your own due diligence and make yourown independent decisions as to the appropriateness ofthese sites and services.Disclaimer

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comDavid Teten (teten.com)•  Partner, ff Venture Capital, early-stage technology venture capital fund•  Founder and Chairman, Harvard Business School Alumni Angels of Greater New York .Co-founded Venture Capital Access Program, introducing women and minorityentrepreneurs to Harvard-affiliated angels•  Lead author, The Virtual Handshake: Opening Doors andClosing Deals Online (TheVirtualHandshake.com)•  Lead author of first-ever research study on best practices in private equity/venture capitaldeal origination•  Lead author of first-ever research study on best practices ofventure capitalists in increasing portfolio company value•  Board Member (now Observer), Ionic Security*•  Harvard MBA 1998, Yale BA•  @dteten* ff VC portfolio company

Next StepsIntro FinancierResources Mentor Operator© David Teten 2013. More at ffvc.com and teten.comVenture Capital Access Program•  Program to help minority and women entrepreneurs meet members ofthe Harvard Business School Alumni Angels of Greater New York•  Partnership with the Marathon Foundation, a subsidiary of the NationalAssociation of Investment Companies.Introduction

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The Lower-Risk Startup: How Venture Capitalists Increase the Odds of Startup Success

by David Teten

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