Ask HN: What are the most innovative VC/Angel funds out there?

https://news.ycombinator.com/item?id=4237369

by diminium • 14 years ago

5 6 14 years ago

news.ycombinator.com

I've been looking at several VC portfolio and public statements they give and something about them just strikes the wrong nerve with me. I don't know how to explain it except with this analogy.

Before the iPhone came out, the world of cell phones was a mishmash disaster. Once the iPhone came out, you could definitely see what a smartphone was suppose to be. It was clear, Apple was a leader in this. So, what did all the other phone manufacturers do during this time? Ya.... Now imagine if Google didn't develop Android. Now imagine the competition....

When I'm looking at the VC/Angel field today, I'm getting the same feeling I did during the iPhone reveal. Some funds are like Apple but the vast majority seem to just want to copy however the top fund made it's money while faking it's investors like they are some major source of financial innovation. Or worse, hide old worthless techniques as new "venture" funds.

I can think of the obvious lilke Ron Conway's and Sequoia Capital, but who else is out there?

kdsudac• 14 years ago

I agree with your sentiments, and have also been frustrated by this. I don't have answers but can only offer apologies and rationalizations:

1) I think the smart phone mismash disaster was largely because of carrier's keeping phones lock down. Carrier's wanted a cut of every transaction so kept locking out features that could jeopardize their place as a gatekeeper and toll collector. Apple--high on success of iPod--had enough mojo to get AT&T to play ball. After Apple broke the carrier lock down the other carriers had to follow suit.

2) Finance is as much sales and marketing as any other business (perhaps even more). VC's want to buy a company and sell it for a profit (hopefully quickly). Once they see ABC startup being sold for $100 million, they'll start looking for the copycat DEF startup to buy a piece at $10 million that they can flip for $20 million. VCs have to look at the technical risk as well as the financial risk and arguably the financial risk trumps all.

E.g. say you handle all the technical risks, come up with a great company/product, but the VC finds out there is no market for them to sell your company. The financial risk trumped the technical risk. What does the VC do now? Hold onto the company for a few years and running it as a cash flow positive business until the market turns? That's what I'd personally do, but I'm not a VC.... and VC's aren't in the conglomerate business (running cash flow positive companies like Berkshire Hathaway, Danaher, etc).

Finally, I am encouraged by some posts like this from dshen that takes a somewhat contrarian view of VC/Angel: http://www.dshen.com/blogs/business/archives/the_case_for_ha... Some of the VCs/Angles he cites might be good to look into.

ten_fingers4• 14 years ago

Part I

Congratulations: Don't feel like the Lone Ranger! In your feelings, suspicions, observations, analyses, and conclusions, you've got plenty of company!

It took me too long to accept that what you describe was the actual reality. Or, you ask for

"innovative VC/Angel funds"

as if we should of course assume that some exist!

For my role and position in this issue, and the 'side of the table I'm on', I'm an entrepreneur writing software for a startup. For this startup I'm the founder, 100% owner, CEO, CFO, Chief Scientist, CIO, biz dev lead, development manager, developer lead, QA tester, software architect, 'full stack' developer, server farm bridge manager, NOC manager, hardware manager, network manager, systems administrator, and janitor. How else?

To help my response to your question I will say a little more: What kind of software? A Web site. Who are my candidate users? Maybe 70% of everyone in the world with Internet access -- that is everyone on the Internet except total dead heads and small children. Porn? No, not at all; actually, nothing objectionable at all. Need? My view is that it's out there, big time, and now served at best poorly. My role? If I'm correct, then my work will serve the need by far the best in the world, with a 'technological' barrier to entry that should last plenty long enough to get barriers to entry from brand, network effects, virality, lock in, users knowing how to use my site, and some cases of continuing contact. Key? Sure, some crucial, core 'secret sauce' that is, really, some applied math with some original theorems and proofs with some advanced prerequisites.

So, I'm addressing what seems clearly to be a huge need and for my 'seriousness' and technological 'credibility' am standing on a strong, i.e., mathematical, foundation.

Status? I have all the crucial, core software ready for at least significant production, likely for much more, and now am doing just routine, and relatively simple, Web site development.

Obstacles? I selected Windows instead of Linux and, thus, had to get good with Visual Basic .NET, ADO.NET, ASP.NET, significant parts of the rest of .NET, and some obscure points of SQL Server administration, and this learning has been only routine but, still, has taken far, Far too long. Otherwise, no obstacles.

Financial status? For VCs and angels, at present my project and a dime wouldn't cover a ten cent cup of coffee.

Next steps? Finish the software, get some initial data, plug together a first server, say, an 8 core AMD processor on a $125 motherboard with 16 GB of ECC main memory and several 2 TB hard disks. Use the Microsoft BizSpark program to get needed copies of Windows Server and SQL Server. Get a static IP address, a domain name, and 15 Mbps upload bandwidth to the Internet. Get some ads from ad networks. Go live and get publicity, users, and ad revenue.

So, assume can get paid $1 per 1000 ads displayed, a Web page with 3 ads can be sent for 200,000 bits, and half fill the 15 Mbps upload bandwidth 24 x 7. Then revenue should be

1 * 3 * 15 * 10^6 * 3600 * 24 * 30 / ( 2 * 200,000 * 1000 ) = 291,600

dollars a month. Ah, grade school arithmetic!

As far as I can tell, equity investors will be interested in my work about the time -- and NOT before -- I have monthly revenue of $291,600 growing rapidly. Then they might want to invest a few million dollars for about 30% of my company. They would get 1-2 Board seats with power to set my compensation, replace me, and sell my company, and I would own 0.00% of my company and get back maybe 55% of my company after a 4 years vesting period if the Board didn't fire me first.

But with monthly revenue of $291,600, why, just why, would I need any equity investment at all? And more seriously, why, just why, would I accept such investment terms?

Basically the soonest equity investors would write a check is some months after I would no longer be interested in their check.

That's my company.

To generalize a little, this grade school arithmetic

1 * 3 * 15 * 10^6 * 3600 * 24 * 30 / ( 2 * 200,000 * 1000 ) = 291,600

is widely understood! So, from the first day I started on this project all the way through 'traction' significant and growing rapidly, I do and pay for everything.

Then, with $291,600 a month in revenue growing rapidly, and thus, qualify for equity funding, suddenly I need an equity investment?

Let's see: From the assumptions above we're talking a peak of

15 * 10^6 / ( 200,000 ) = 75

Web pages a second. An 8 core server for about $1000 might be able to do that, but even if not a week or so of an 8 core server being busy would generate enough revenue for some nice shelf units full of such servers that could deliver 75 pages a second. That is, the computers and bandwidth are cheap; given traction enough to keep a server busy, should have revenue enough to grow server capacity quickly; similarly for bandwidth; net, given the traction equity investors want, don't really need equity funding for computers and bandwidth.

The equity funders insist on all the development already being done, so can't get equity funding for that. What's left for the equity funding?

A lot of people can see this situation: Likely business is in line to see a lot of startups that don't take equity funding: If they get traction, they don't need equity funding. If they don't get traction, they can't get equity funding. Equity funding is beginning to look useless.

Now for more general remarks for this thread: As far as I can tell, for my work or essentially anything in 'information technology', the idea of

"innovative VC/Angel funds"

is nearly irrelevant. That is, as far as I can tell, one could count on one hand all the 'information technology' equity investors in the US who would be at all "innovative". That is, they just will not, Not, NOT look at anything technical. They just will NOT do it. Instead, their investment criteria boils down to one word: Traction. Being 'innovative' has nothing, nichts, nil, nada, zip, zilch, zero to do with their investing.

In more detail, for such equity investors 'traction' is numerical evidence that can be a surrogate for what a private equity investor would get from an audited financial statement. That is, the early stage information technology equity investors are thinking like accountants except are willing to use surrogate measures instead of just strict accounting measures. Then anything 'innovative' and a dime won't cover a 10 cent cup of coffee.

There is some evidence that biomedical venture capital can be more 'innovative', but I concentrate on 'information technology' and set aside biomedical, 'clean energy', materials science, etc.

Moreover I concentrate on just US early stage information technology equity investment.

ten_fingers4• 14 years ago

Part II

So, what's going on here?

I start with five general points:

(1) Status of Venture Capital.

In a word, now and for the past 10 years or so, there is just one appropriate word for venture capital -- it sucks. To be more clear, the returns to the limited partners from the VC 'asset class' have been not just poor but commonly negative. It may be that there are fewer than 20 VC firms in the US that have a good track record for their limited partners.

From a graph posted some months ago by VC Mark Suster, over the past 10 years the number of venture partners has fallen from a few thousand to a few hundred, or some such. The VC layoff rate compares with the UAW Detroit layoff rate.

(2) What's Available in Practice.

It's easy to guess that, being on the VC side of the table, it's not easy to find really promising projects. That is, VCs that say that they need and want more and better proposals likely have a good point. For me, I'd rather be on my side of the table so that if I want a better project all I have to do is think of one; on the VC side of the table I'd have to wait for such a project from entrepreneurs -- bummer.

(3) What's Available in Principle

Still, whatever the daily reality is for VCs as they read their e-mail, in principle the entrepreneurs and their VCs should be printing money in huge piles.

Why? There is one, just one, key to printing money: Create economic value. For that key, there is one, just one, main approach: Increase economic productivity, that is, turn out more, much more, value per person-hour worked. For more productivity there is essentially just one good approach -- automate the work. For automation, there is now exactly one, unique in all of history, grand champion technique -- computing, especially aided by the Internet and readily available infrastructure software. So, find some much needed activity and automate it.

(4) What's Available with Some Effort.

Whatever work X the entrepreneurs and their VCs are doing, there's more, much more, that is clearly available, with a fantastic track record, far better than the VC track record, that clearly totally blows the doors off X.

We get the examples of how to do such powerful technology from the all-time, unique world-class, grand champion of everything technical, the US DoD who, thankfully for US national security, has been wildly successful for about 70 years now.

War story: Around 1940, the American Chemical Society, seeing war coming, sent a representative to the US War Department offering to be a liaison with the US community of chemistry. Soon he got back a letter of thanks but saying that the War Department already has a chemist. About five years later, there had been a, uh, change of attitude: Eisenhower said "Never again will US science be permitted to operate independent of the US military.". Vannevar Bush, James Conant, etc. arranged that US research universities would get "an offer they couldn't refuse": Take DoD money for research or cease to be a competitive research university. Result: Since then the top few dozen US research universities have gotten about 60% of their annual budgets from research grants and have dominated academic research in the world, and the US DoD is right there, sure they are not falling behind in fundamental research and getting a good stream of well selected and trained researchers.

Congress and the US DoD take research and technology very, very seriously.

So, comparing with entrepreneurs and their VCs, I will mention two differences:

(A) In the system set up by the DoD, given a problem, it is common to attack it by doing some original research, e.g., that can pass peer review. Often the work -- in physics, electronic engineering, mechanical engineering, chemistry -- has been highly mathematical.

This research, where to do it, how to do it, the standards, and the culture, are rooted in the best US research universities but also extend to many laboratories and companies working on US national security.

(B) Given some research, the results can quickly receive quite competent and serious evaluation, often from presentations just on paper. With that evaluation passed, the project can move quickly through prototype software, breadboard hardware, demonstration systems, fully militarized design and prototype development, full testing, and large scale production and deployment.

Given a good evaluation of the research, the rest has an excellent track record of success.

E.g,, at one time I was programming in the group that did the orbit determination for the Navy's version of GPS, and there I learned the story of how that system had been proposed to the Navy: Not much more than some physicists scratching on the back of an envelope. And the final system worked as planned, and a test receiver on the roof routinely 'navigated' its position to less than one foot. Yes, the later Air Force GPS is more accurate. But the Navy's system was just crucial for the US SSBN fleet and its missile targeting for years.

So, in strong contrast, for the VCs, for (A), they just will NOT take research seriously. They just will NOT do it.

Indeed, we might look at how the US research universities and the US DoD evaluate research and the qualifications they use: A researcher who publishes some good research can be invited to be a reviewer of a journal or of proposals for funded research. A good reviewer can be invited to be a journal editor. A good editor can be invited to be a journal editor in chief. Etc. Then that system just will not permit itself to be seen as unable to evaluate original research, no matter how advanced, no matter what the prerequisites, no matter how involved. Period. Write a paper with title "P = NP" and submit it to any of at least a dozen journals, and within a year will get back a letter with "The first serious error is at line n on page m" or "Your check for $1 million from Clay Mathematics is in the mail.".

Sure, the path to reviewing papers is usually a long and challenging Ph.D. followed by a few years of successful research. Editors in chief typically have plenty of gray hairs. This system for evaluating research is highly competent but challenging.

Then, for the VCs, in strong contrast, apparently one could count with shoes on all the VCs who could even direct a competent evaluation of some research; this is not a surprise since one could count with shoes on all the VCs with a relevant Ph.D. and a solid research record.

Next, for (B), funding based just on research just on paper, the VCs won't do it. At most all a proposal will get back are laughs. Send a VC a paper with some research, and the VC may break a leg slapping his thigh in wild laughter.

The US DoD has been funding projects based on research just on paper to knock balls out of the park and into orbit with high reliability from early in WWII to the present, and VCs won't even come to the ballpark.

So, net, we have to suspect that much more ROI would be available to the VCs "with some effort", that is, by taking research seriously.

(5) Fundamental Issue.

If we ask that each entrepreneur found "another Google" and be worth $200 billion, we start to have doubts. E.g., the whole US economic pie is not that big, and we wonder if computing, etc. is powerful enough to grow that pie that big soon.

So, without a big change in pie size, the number of $200 billion successes is small, only a few each decade.

I believe that by taking research seriously we can multiply this few by several quickly. So, a fundamental issue is that we are still limited to not very many $200 billion successes per decade.

But apparently for my claim of "multiply this few by several quickly", there is hardly a VC or limited partner in the country who would believe any such thing and fewer still, say, zero, who would bet more than 10 cents on it. They would be afraid they were just being swindled, and they don't want to be swindled out of even a 10 cent cup of coffee.

Again, VCs and their limited partners seem to be suck solidly in evaluating projects just by traditional financial accounting but using some surrogate measures. In particular, they look at 'traction' but will NOT look at research.

ten_fingers4• 14 years ago

Part III

I move on to two more issues:

(1) The Hay Stack.

Apparently a venture firm can have a polished Web site put up for them, get some publicity by writing columns in the tech media, and then, presto, get in their e-mail a huge stream of contacts from entrepreneurs.

Maybe they will fairly quickly get 2000 such contacts a year.

So, such a VC gets a huge stack of hay in which they are looking for golden needles.

Here's my guess at where the VCs are making a huge mistake: They are trying to learn from the hay. They start to conclude that the hay is 'representative' of 'what is going on in information technology', read a few hundred such contacts, and conclude that they are developing "deep domain knowledge". They start to believe that the best possible investments are from the better looking stalks of hay.

A huge problem here is that they just have no other very good criteria. In strong contrast, the guys who did the physics for the Navy's version of GPS had physics going for them; they were correct, knew they were correct, knew just why they were correct, and could convince Navy technical problem sponsors that beyond any doubt they were correct, feasible, practical, realistic, etc. No important role for guessing or intuition. Not a lot of doubt. Not much risk. And whatever else was in whatever stack of hay was just irrelevant. And revolutionize military strategy.

As an explanation there is:

"It is still an unending source of surprise for me how a few scribbles on a blackboard or on a piece of paper can change the course of human affairs."

Stanislaw Ulam

VCs and their limited partners might want to start to listen up. Especially from Ulam: On its first try, his second contribution yielded the energy of 15 million tons of TNT. On its first try, his first contribution yielded about 15 thousand tons. Before that he had a nice result in probability the French probabilist Le Cam called 'tightness' with a nice presentation in Billingsley's 'Convergence of Probability Measures'.

(2) The Research

I can believe that the VCs don't receive many promising proposals based on research. One reason is that not many talented, well trained researchers cross over to become entrepreneurs. A second reason is, researchers who contact VCs get such a poor reception that researchers have been discouraged.

So, VCs don't see much promising research in their incoming e-mail.

We might also anticipate that a VC has described to their limited partners what projects they will fund, and research on paper is NOT included!

There have long been plenty of US DoD technical problem sponsors who were 'innovative' with astoundingly high batting averages. Somehow VCs seem to have ignored such work. Net, looking for an 'innovative' angel or VC looks like looking for hen's teeth.

Final remark: What to do about the situation? For me, as an entrepreneur, just be successful, thus, solve the problem for myself, and let others draw what they will from my example.

More generally, I don't know what VCs would say to what limited partners to make a significant difference, and then I don't know how they would get good projects based on research.

So for now for me, the flip side of the problem is an opportunity.

Ask HN: What are the most innovative VC/Angel funds out there?

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