2. Introduction
The word “venture” in the phrase “venture capital” is a romantic euphemism for risk. But that’s
not to say that every new startup business is a “gamble.” One gambles with the expectation of
loss, and the delight of having cheated expectations when one wins. Taking risks, on the other
hand, comes with the expectation of success. If you fail, it often means that the risk was not
properly managed.
If venture capital firms don’t expect to win, they don’t take the risk. But in just the past few
years, that risk has been transformed for startup companies. To gain insight into the current
environment for startups, and how emerging growth companies (EGCs) can best manage
growth and risk, we gathered a panel of six prominent venture capitalists:
DUNCAN DAVIDSON SATISH DHARMARAJ BRAD FELD
Managing Director, Bullpen General Partner, Redpoint Managing Director, Foundry
Capital; founder, Xumii Ventures; former CEO, Group; chair, National Center
Inc.; founder, SkyPilot Zimbra communications for Women & Information
Networks; founder, Covad and collaboration platform Technology; former CTO,
Communications (purchased by Yahoo in 2007 for AmeriData Technologies
$350 million)
BULLPEN CAPITAL FOUNDRY GROUP
Initial fund size: $50 million REDPOINT VENTURES Fund size: $100+ million
Headquarters: Menlo Park, Fund size: $500+ million Headquarters: Boulder, Colo.
Calif. Headquarters: Menlo Park, Portfolio includes
Portfolio includes Calif. Cheezburger Network
Appboy mobile application Portfolio includes Netflix entertainment media publisher,
management platform, Chart.io streaming video network, Federated Media Publishing
cloud-based business analytics, Fortinet corporate security, Path Web advertising platform,
Byliner e-book discovery mobile social network platform, Zynga social gaming platforms,
platform, Backyard local video Cloud.com infrastructure TopSpin marketing software
advertising platform management platform provider
ReadWriteWeb | Growing Your Business In The Modern Economy: 6 VCs Weigh In | 1
3. Venture Capitalists (cont.)
DAVID HORNIK JOHN LILLY KATE MITCHELL
Partner, August Capital; lecturer, Partner, Greylock Partners; Managing Director, Scale
Stanford Graduate School of former CEO, Mozilla Venture Partners (ScaleVP);
Business; entrepreneurship Corporation; former senior former chair, National Venture
lecturer, Harvard Law School; research scientist, Apple Capital Association; former
former intellectual property Computer chair, IPO Task Force, United
attorney, Venture Law Group States Dept. of the Treasury
GREYLOCK PARTNERS
AUGUST CAPITAL Fund size: $1+ billion SCALE VENTURE PARTNERS
Fund size: $1+ billion; Headquarters: Menlo Park, Size: $255 million;
Headquarters: Menlo Park, Calif. Headquarters: Foster City, Calif.
Calif. Portfolio includes Tumblr Portfolio includes Box.
Portfolio includes Ebates social sharing platform, net cloud services, Enpirion
Internet shopping portal, Dropbox cloud-based storage Semiconductor, ExactTarget
StumbleUpon website discovery platform, Groupon discount- interactive marketing,
platform, ThreatMatrix device discovery system, Pandora NComputing desktop
identification system, SAY Media music-discovery system virtualization
software producer for media
management (publisher of this
report)
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4. Growth and Risk: Old Variables
for a New Equation
The buzz machine surrounding new tech startups may leave you with the impression that
entrepreneurs are taking more risks and reaping more rewards than ever before. In fact, initial public
offerings, at least, have never recovered from the bursting of the “Internet bubble” in 2001. The number
of IPOs each year since has never even tested 1980s levels, and improved only slightly from the historic
lows of 2008. Prior to 2001 and the bubble burst, some 42% of successful exits were attributed to initial
public offerings. In 2010, IPOs accounted for just 8%. And it’s not that IPOs have steadily declined.
They’ve actually bottomed out, and then stayed on the bottom.
But the decline in IPOs masks a
U.S. EMERGING GROWTH COMPANIES ENTERING THE IPO PHASE more complex picture. Instead
1990 - 1996 1,272 of going public, more and
2004 - 2010 324 more tech startups are getting
Source: U.S. Treasury Dept. IPO Task Force briefing, December 2011 bought by established players.
Satish Dharmaraj, Redpoint Ventures
We VCs traditionally like to build big companies that can IPO. However, this is fully a
management decision, and we typically support them. Going IPO is a very cumbersome
process, as there is a ton of groundwork and compliance issues. Increasingly, we see startups
wanting to go the M&A route rather than file for IPOs because of this.
U.S. VENTURE CAPITAL EXITS: IPOS VS. M&AS, 1998-2010
Source: Dow Jones Venture One via Wilmer Hale Venture Capital Market Review 2011
ReadWriteWeb | Growing Your Business In The Modern Economy: 6 VCs Weigh In | 3
5. From 2002 until 2010, investors found growth primarily through acquisitions, fundamentally changing
the role of the IPO as a measure of success — and thus of risk. In an August 2011 study by the Treasury
Department’s IPO Task Force, 86% of the 35 public company CEOs surveyed agreed that going public
was not as attractive an option as it had been in 1995.
Kate Mitchell, ScaleVP
When we spoke to institutional investors, the biggest challenge for their portfolios was
growth. Their challenge was getting that 50x to 100x they could get when they bought
Symantec or McAfee or Microsoft or Apple. That growth now only occurs in the private
market; it’s not available to the public investors.
There are two theories as to what’s behind the continued lack of IPOs. One theory suggests that
a tightened regulatory environment intended to increase transparency for large firms ended up
creating undue strain for new firms. In the IPO Task Force survey, CEOs of startups reported spending
an average of $2.5 million in administrative costs associated with preparing to go public. Some
40% of those costs could be reduced, the task force estimated, through relaxation of SEC reporting
requirements.
Kate Mitchell, ScaleVP
It has become so distasteful to go public... All these companies are high-growth
when they’re young; they’re sometimes doubling and tripling in size. So they’ve
already demonstrated they can grow. Once you’ve demonstrated they have customer
demand, that you can reliably manufacture a product, that you can deliver a service,
and you can sell the product in an efficient way (and by the way, public investors care
greatly about that), until the late ’90s, at that point when you’re Intel, Apple, Cisco,
you would then take public capital to scale out and expand your business globally.
You were ready for the public markets. Today, what we’re seeing is, it’s so unattractive
to go that route because it’s daunting to go public. Instead, you take your hands off
the steering wheel and you sell the company — which is not a desired outcome from
an innovation and job-creation point of view.
The other theory is that the turbulent global economy has led to rapidly fluctuating market conditions,
making startup companies worth more as an acquired division of a larger firm than as an independent
entity.
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6. IPOs, Growth and Profitability
The dearth of IPOs is not necessarily a bad sign for startups, however. A March 2012 study paints a clear
picture of a Grand Canyon-sized gap between new IPOs and profitability.
Percentages of Small U.S. Firms Reporting Positive Annual EPS
Source: “Where Have All the IPOs Gone” by Prof.
Jay R. Ritter, et al, March 13, 2012
Produced by professors from the University of Florida and two leading Hong Kong universities, the
study is the basis for the chart above, which compares two groups of companies: U.S. firms with less
than $250 million in annual sales within three years of their IPO (lighter), and more seasoned U.S.
firms that are more than three years past their IPO — also with less than $250 million in annual sales
(darker). The percentages represent the relative number of companies in both groups that reported
positive earnings per share in the given year. While the trend is down for both groups over time,
it’s very clear that happens well beyond the first three years of life — that companies do not show
earnings growth out of the IPO gate.
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7. Brewing a Perfect Storm
Conditions are starting to change in ways that promise a major turnaround in the growth prospects
and exit opportunities for startups. Beginning in 2011, a confluence of factors have been creating a
perfect storm, changing how startups are formed and funded:
1 2
The emergence of new crowdfunding sources — A new and sometimes chaotic force,
capital funds that are usually somewhat smaller sometimes dubbed discovery effects channels,
than VC funds, pooled together through small but more commonly known as app stores.
investments via a website or social network. These channels help developers quickly and
These new funds are making smaller amounts of cheaply deploy new applications to dynamic
seed money available, enabling the formation of and thriving platforms and markets on a global
larger numbers of smaller startups. scale.
3 4
The passage of a law creating a new classification A turbulent global economy — pockmarked by
for U.S. startups: emerging growth companies — European bailouts, the Japanese tsunami, conflict
firms in the first five years of existence with less in Syria and the Middle East and the continued
than $1 billion of annual revenue. The JOBS Act, fallout from the banking and mortgage crises
signed into law in April 2012, entitles EGCs to in the U.S.—is turning institutional investors’
relaxed regulation and reporting requirements, attention away from startups.
reducing the cost of going public.
Just since 2009, the very definition of a “startup company” has been altered. With it, the role of the
venture capitalist is itself in transformation — a kind of disruption that VCs never expected would
happen to them.
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8. Case in Point: Omniture
During the mid 2000s, Kate Mitchell’s ScaleVP colleague Rory O’Driscoll was on the board of directors
for Omniture, a social/mobile Web analytics platform. Omniture was founded in 1996, while its key
competition during O’Driscoll’s tenure, WebSideStory, was founded in 2002.
While WebSideStory went public in 2004, Omniture opted to remain private, raising capital through
ScaleVP and other sources. But even though WebSideStory started out with four times Omniture’s
annual revenues, by 2007 Omniture’s growth rate during the four-year period was about 2,200%, while
WebSideStory’s was only 400%. Omniture’s growth was not steady, however — it accrued net losses
before regaining strong profitability in 2007. WebSideStory found itself being acquired by Omniture
(now known as Adobe Digital Marketing Suite) in 2007. Writes O’Driscoll, “The value was created by the
aggressive winner. Fortunately for me, this time, I was on the winning team.” Omniture’s story breaks
the illusion that only newer, smaller companies have bigger growth numbers.
ANNUAL REVENUES COMPARISON 2002 - 2007 (MILLIONS)
2002 2003 2004 2005 2006 2007
Omniture 2 9 21 43 80 143
WebSideStory 14 16 23 39 55 n/a
Omni./WSS size ratio 27% 53% 91% 109% 145%
Source: Rory O’Driscoll, Scale Venture Partners
A Longer-Term Perspective on Growth
The common wisdom that growth happens only during the emerging years of a company’s existence
has been disproven by history — as the earlier charts showed. The JOBS Act legalizes crowdfunding,
and relaxes the Sarbanes-Oxley (SOX) reporting requirements for EGCs during the first five years. After
five years is up, companies are no longer considered “emerging,” but Foundry Group’s Brad Feld points
out this should not mean their growth rate must slow down.
Brad Feld, Foundry Group
Our view is, companies should build themselves for the long term; and if they are a market
leader, appropriate opportunities — whether IPO or M&A — will be available. I’m focused on
a time frame of a decade or more, and I think most entrepreneurs are, as well.
ReadWriteWeb | Growing Your Business In The Modern Economy: 6 VCs Weigh In | 7
9. The statement that it’s common knowledge that a growth path that leads to M&A is by
definition short-term, doesn’t seem right to me at all. I don’t think this is common knowledge,
and I think [looking for an M&A exit] is a terrible way for entrepreneurs to approach building
their businesses. If their hope is they create something exciting in a year or two and then a
big company buys them, it’s unlikely that they’ll actually be creating something particularly
interesting.
However, if a big company appears in a year or two after they get started and wants to buy
them — for the people, the product, the users or customers, or some other reason — that’s
something that’s always going to be interesting, and at least worth considering. Note the
causality: The entrepreneurs don’t set out to build something that gets bought quickly. They
set out to build something significant, and that attracts someone’s attention.
Feld notes M&A events can occur at any time in a company’s life cycle. Many companies grow on their
own for decades, and eventually end up being acquired. Others — like Autonomy, which found itself
acquired by Hewlett-Packard in 2011 — are public companies for several years before being bought.
Still others take a path such as SuccessFactors’, which was acquired by SAP just four years after its IPO.
Other VCs report similar variations in growth patterns.
Satish Dharmaraj, Redpoint Ventures
If it’s a Series A, early-stage company, we typically expect it to go from zero to $4 million to
$10 million in revenue in years 1, 2 and 3. However, this can vary widely. The key thing we
look for in a plan is whether there is sufficient pain that is being solved. Is the willingness to
pay commiserate with the pain that is being alleviated?
David Hornik, August Capital
There is no one growth rate that any investor is looking for. There are lots of different indicia
of growth in startups. For some startups, all that matters is user growth. For others, all that
matters is revenue growth; for others, net revenue growth. It really depends upon what sort
of business you are building.
It is easy to achieve 100% growth on $1 million in revenue. It is much more challenging on
$100 million… And if you are a tiny little company attacking a giant market, one thing is
8 | ReadWriteWeb | Growing Your Business In The Modern Economy: 6 VCs Weigh In
10. certain: You have nowhere to go but up. In which case, there is an opportunity for double- and
triple-digit growth on a sustained basis, year after year.
It’s not just the rate of growth that’s variable. So is the right way to measure growth. The rise of app
stores can make that even more important.
John Lilly, Greylock Partners
App stores are essentially PR and discovery effects. A network effect means that a product
becomes more valuable to me if I convince others to use it as well — that’s what generates
real growth. So you need to nurture the products, the team, and yes, [the customer base]
to figure out the most natural ways of building a working business on top of it. That’s the
same as it ever was.
What we look for in consumer Internet companies are products that people love, and that
have natural (network effect-oriented) distribution strengths. On the modern consumer
Internet, we’ve got the massive distribution platforms of Facebook, the Apple App Store,
the Amazon Appstore and Google Play, so startups can get access to something on the
order of a billion users nearly instantaneously. It’s incredible. What we look for is growth
that has network effects… but also has tons of highly engaged early adopters.
And sometimes, VCs look at growth not by the numbers, but in terms of people and
attitudes and ambitions.
Duncan Davidson, Bullpen Capital
You look for the attitude of the founders to create something, not to make a lot of money,
not to have a job and get paid, not to have a nice business that can grow and give them
a lifestyle. You look for a person who wants to change, disrupt. Some call it ‘creative
deconstruction;’ I call it creative reconstruction. You’re trying to reconstruct the economy in
a new way, and you want people who have that vision and want to do that.
Kate Mitchell, ScaleVP
What we don’t want is for companies to aim low. That would start at the very inception of
the company. If I really think, like 86% of serial entrepreneur CEOs, that public markets are
not friendly, they’ll design themselves from the first day they put together the company to
sell themselves as a feature of Facebook, Google, eBay, Cisco... It changes the dynamic of
what they do from the first day they start.
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11. Case in Point: Zaarly
Bullpen’s Duncan Davidson tells the story of Mark Ecko, the man who helped coin the concept
democratization of entrepreneurship. An artist who made himself a billionaire, Ecko began by
fashioning desirable products literally from a studio in his parents’ garage. Today, Ecko is one of three
partners behind New York City-based Artists & Instigators, among whose recent success stories is a
social platform called Zaarly.
Its purpose is to connect local services to local customers. One example Zaarly likes to share involves
emergency catering: small firms that can rescue parties and get-togethers by rapidly acquiring and
delivering party goods. (Literally, “Help, we’ve run out of hors d’oeuvres!”) After a $1 million seed round,
A&I participated in a $14.1 million Series A round. Zaarly is an example of a “tech startup” that isn’t
about delivering technology, but rather delivering service — on a level so local that customers can’t
help but perceive it as personal.
Smaller Startups Spread the Risk
Step One in the instruction manual for building your business used to be: Prepare your business plan
to be reviewed by a prospective source of capital, particularly a VC. Today, VCs may not enter the
picture until Step 5 or 6.
Bullpen Capital describes itself as a “super-angel follow-on,” looking for companies that have already
launched, often with just one or two people, and whose seed capital is in the six- or even five-digit
range. These companies may have a good idea, but they need more time to mature and implement
a plan. Duncan Davidson explains that Bullpen focuses on sustained growth potential, including
companies that may not be growing as fast as they should.
At the turn of the last century, Davidson says, startups would raise their “seed” capital through very
local sources, which sometimes involved friends and family, and sometimes second mortgages. The
first round of institutional funding for a startup — called Series A — totaled an average of $5 million.
That’s what a firm required just to experiment with whatever technology it wanted to try and see if it
was viable.
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12. Today, says Davidson, the funding rounds may look a bit more like this:
TYPICAL FUNDING ROUNDS FOR U.S. STARTUPS
Incubator round $ 50,000
Accelerator round 250,000
Seed fund round 1,000,000
Super-angel round (Bullpen) 2,250,000
“Series A” 5,000,000+
Source: Duncan Davidson, Bullpen Capital
Duncan Davidson, Bullpen Capital
I think the JOBS Act may accelerate a trend toward the democratization of entrepreneurship,
funding things that normally wouldn’t be venture-fundable, but are quite worthy of
becoming businesses. They may be businesses of a different sort — they’re not really on a
track to go public or have Zynga-like growth. They’re trying to create really nice businesses
for people who can’t get a job to create a job and join the revolution... What’s happened in
the last decade, the cost of launching an Internet product — forget other technologies, let’s
focus on Internet — has dropped from $5 million to $500,000 in 2005, to $50,000 today. Two
orders of magnitude! That’s why a couple of kids in their dorm room can start a company,
launch it and see if anybody cares out there.
For some VCs, though, there is such a thing as too small.
Kate Mitchell, ScaleVP
Over the last 10 years, you go to these conferences where there are a lot of entrepreneurs,
and there’s so much enthusiasm and so much innovation in the audience. But when some
of them come up and you think, “This may be an interesting cash flow idea for a small
company for you, sir or ma’am, but it probably isn’t a big enough company to get behind,
where you can picture people sitting in the headquarters building. It’s a nice idea probably
for you to pursue on your own. It’s not really a company; it’s something smaller than that.”
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13. The JOBS Act and the New Endgame
Will the JOBS Act really lead to more IPOs? Redpoint Ventures’ Satish Dharmaraj believes the JOBS Act’s
main impact will be secondary stock sales — transfers made by shareholders to other shareholders,
rather than from the company or from a broker. A key provision, Sec. 201(b)(1), eliminates the
requirement for a startup’s existing shareholders to register themselves as dealers or brokers before
making a secondary sale of their shares. It’s one of a multitude of relaxations to existing regulations,
such as increasing the shareholder count threshold for companies subject to SOX reporting
requirements from 500 to 2,000.
Satish Dharmaraj, Redpoint Ventures
There are two classes of entrepreneurs and company-builders. There’s the class that never
wants to be owned by someone else, and is always trying to build a big, independent
company. The JOBS Act and the thawing economy doesn’t faze these guys. Then there’s a
majority of entrepreneurs who will take a great M&A offer if the multiples are right —and
investors will like it as well, if the multiples are right. So in my mind, the JOBS Act doesn’t
materially affect the proclivity to go public as much as individual desire to do so. Going IPO
and the time to liquidity are so painful. But then, freedom and independence are never easy.
David Hornik, August Capital
If you aren’t pursuing a game changing opportunity, it is hard to build a meaningfully large
business... I think it is always in the best interest of a startup to pursue the public markets. In
the long run, a company may decide that the best course is to sell to a larger company. But if
you don’t have the option of being an independent company, it will be reflected in the price
any acquirer might pay... I don’t think the JOBS Act changes how top-tier venture capitalists
will look at investing [and] at company-building.
John Lilly, Greylock Partners
I don’t think the JOBS Act has any effect on things. Great teams building great products that
people love are the key to everything, and thinking long-term about who will pay and why,
building a business around it — that’s all fundamentals-type stuff, it’s the same in every era.
12 | ReadWriteWeb | Growing Your Business In The Modern Economy: 6 VCs Weigh In
14. Case in Point: BeachMint
Scale Venture Partners looks for companies that can demonstrate continued progress with their key
metrics. One company whose evolution it helped accelerate is BeachMint —a fashion e-commerce site
with an innovative customer curation model.
Imagine a store that sells itself like a magazine — or, from the other direction, Vogue if it were a
storefront. Customers subscribe to BeachMint, which means they actually contribute to the cost of
customer acquisition. And the company keeps customers active and involved with one another the
same way fashion magazines attract readers, by bringing in celebrities to serve as models for the
merchandise and the faces for the store. As a retailer, BeachMint collects more valuable information
about its customers — information that it can put to use in spinning new boutiques like JewelMint
and ShoeMint.
It’s not so much a disruptive business model as a collective one: taking the best ideas from what
worked in the past, and fusing the parts together in a new and innovative way.
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15. The Takeaways
Balancing growth and risk in the new economy isn’t easy for anyone, and it’s especially challenging for
startups. But these rules of thumb can begin to help demystify the choices.
1. STARTING SMALL INVOLVES STARTING.
You can dream small, you can obtain a small purse of incubator capital, and you can build a small
market for yourself. And that’s not bad — at least, not any more. There’s now a defined growth
path for big businesses that multiply small ideas and distribute them over wide territories. You
don’t have to wait until your idea is big enough to deserve a $5 million investment.
2. YOUR OBJECTIVE AND YOUR FUNDER’S ENDGAME NEED NO LONGER
BE THE SAME MILESTONE.
Sure, a VC may want to exit and turn your company over to public ownership or perhaps a private
parent. But that doesn’t have to mean the end of your involvement with your company — you
don’t have to exit just because the VC does.
3. GROWTH CAN, AND OFTEN DOES, START SLOW.
The typical growth path, where a business takes off like a rocket and slows to cruising speed upon
its maturity, isn’t always realistic today. Sometimes growth peaks when a company has moved
beyond its startup phase.
4. TAKE GOOD ADVICE, SEEK VALUABLE COUNSEL, BUT DON’T
OUTSOURCE YOUR WISDOM.
Prospective sources of capital are looking for folks who can learn from their mistakes in the
early going. They’re looking for companies that recognize and repeat their successes, and that
recognize failures fast and nip them in the bud.
5. THERE’S A BIG DIFFERENCE BETWEEN DISRUPTION AND DESTRUCTION.
You can still pattern your business model upon what has worked in the past. Changing markets is
about building products and services so valuable that your competitors must change to compete
with you — that’s the level of disruption you want.
14 | ReadWriteWeb | Growing Your Business In The Modern Economy: 6 VCs Weigh In
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