|  
  
March 2005  
  
A couple months ago I got an email from a recruiter asking if I was interested
in being a "technologist in residence" at a new venture capital fund. I think
the idea was to play Karl Rove to the VCs' George Bush.  
  
I considered it for about four seconds. Work for a VC fund? Ick.  
  
One of my most vivid memories from our startup is going to visit Greylock, the
famous Boston VCs. They were the most arrogant people I've met in my life. And
I've met a lot of arrogant people.   
  
I'm not alone in feeling this way, of course. Even a VC friend of mine
dislikes VCs. "Assholes," he says.  
  
But lately I've been learning more about how the VC world works,  and a few
days ago it hit me that there's a reason VCs are the way they are. It's not so
much that the business attracts jerks, or even that the power they wield
corrupts them. The real problem is the way they're paid.  
  
The problem with VC funds is that they're _funds_. Like the managers of mutual
funds or hedge funds, VCs get paid a percentage of the money they manage:
about 2% a year in management fees, plus a percentage of the gains. So they
want the fund to be huge-- hundreds of millions of dollars, if possible. But
that means each partner ends up being responsible for investing a lot of
money. And since one person can only manage so many deals, each deal has to be
for multiple millions of dollars.  
  
This turns out to explain nearly all the characteristics of VCs that founders
hate.  
  
It explains why VCs take so agonizingly long to make up their minds, and why
their due diligence feels like a body cavity search.  With so much at
stake, they have to be paranoid.  
  
It explains why they steal your ideas. Every founder knows that VCs will tell
your secrets to your competitors if they end up investing in them. It's not
unheard of for VCs to meet you when they have no intention of funding you,
just to pick your brain for a competitor. This prospect makes naive founders
clumsily secretive. Experienced founders treat it as a cost of doing business.
Either way it sucks. But again, the only reason VCs are so sneaky is the giant
deals they do. With so much at stake, they have to be devious.  
  
It explains why VCs tend to interfere in the companies they invest in. They
want to be on your board not just so that they can advise you, but so that
they can watch you. Often they even install a new CEO. Yes, he may have
extensive business experience. But he's also their man: these newly installed
CEOs always play something of the role of a political commissar in a Red Army
unit. With so much at stake, VCs can't resist micromanaging you.  
  
The huge investments themselves are something founders would dislike, if they
realized how damaging they can be. VCs don't invest $x million because that's
the amount you need, but because that's the amount the structure of their
business requires them to invest. Like steroids, these sudden huge investments
can do more harm than good. Google survived enormous VC funding because it
could legitimately absorb large amounts of money. They had to buy a lot of
servers and a lot of bandwidth to crawl the whole Web. Less fortunate startups
just end up hiring armies of people to sit around having meetings.  
  
In principle you could take a huge VC investment, put it in treasury bills,
and continue to operate frugally. You just try it.  
  
And of course giant investments mean giant valuations. They have to, or
there's not enough stock left to keep the founders interested. You might think
a high valuation is a great thing. Many founders do. But you can't eat paper.
You can't benefit from a high valuation unless you can somehow achieve what
those in the business  call a "liquidity event," and the higher your
valuation, the narrower your options for doing that. Many a founder would be
happy to sell his company for $15 million, but VCs who've just invested at a
pre-money valuation of $8 million won't hear of that. You're rolling the dice
again, whether you like it or not.  
  
Back in 1997, one of our competitors raised $20 million in a single round of
VC funding. This was at the time more than the valuation of our entire
company. Was I worried? Not at all: I was delighted. It was like watching a
car you're chasing turn down a street that you know has no outlet.  
  
Their smartest move at that point would have been to take every penny of the
$20 million and use it to buy us. We would have sold. Their investors would
have been furious of course. But I think the main reason they never considered
this was that they never imagined we could be had so cheap. They probably
assumed we were on the same VC gravy train they were.  
  
In fact we only spent about $2 million in our entire existence. And that gave
us flexibility. We could sell ourselves to Yahoo for $50 million, and everyone
was delighted. If our competitor had done that, the last round of investors
would presumably have lost money. I assume they could have vetoed such a deal.
But no one those days was paying a lot more than Yahoo. So unless their
founders could pull off an IPO (which would be difficult with Yahoo as a
competitor), they had no choice but to ride the thing down.  
  
The puffed-up companies that went public during the Bubble didn't do it just
because they were pulled into it by unscrupulous investment bankers. Most were
pushed just as hard from the other side by VCs who'd invested at high
valuations, leaving an IPO as the only way out. The only people dumber were
retail investors. So it was literally IPO or bust. Or rather, IPO then bust,
or just bust.  
  
Add up all the evidence of VCs' behavior, and the resulting personality is not
attractive. In fact, it's the classic villain: alternately cowardly, greedy,
sneaky, and overbearing.  
  
I used to take it for granted that VCs were like this. Complaining that VCs
were jerks used to seem as naive to me as complaining that users didn't read
the reference manual. Of course VCs were jerks. How could it be otherwise?  
  
But I realize now that they're not intrinsically jerks. VCs are like car
salesmen or bureaucrats: the nature of their work turns them into jerks.  
  
I've met a few VCs I like. Mike Moritz seems a good guy. He even has a sense
of humor, which is almost unheard of among VCs. From what I've read about John
Doerr, he sounds like a good guy too, almost a hacker. But they work for the
very best VC funds. And my theory explains why they'd tend to be different:
just as the very most popular kids don't have to persecute nerds, the very
best VCs don't have to act like VCs. They get the pick of all the best deals.
So they don't have to be so paranoid and sneaky, and they can choose those
rare companies, like Google, that will actually benefit from the giant sums
they're compelled to invest.  
  
VCs often complain that in their business there's too much money chasing too
few deals. Few realize that this also describes a flaw in the way funding
works at the level of individual firms.  
  
Perhaps this was the sort of strategic insight I was supposed to come up with
as a "technologist in residence." If so, the good news is that they're getting
it for free. The bad news is it means that if you're not one of the very top
funds, you're condemned to be the bad guys.  
  
  
  
**