How Do I Love Thee Venture Capital? Let Me Count The Ways
I’d never heard of Marc Canter until yesterday, when I read that he’s moving to Northeast Ohio to help us become a hub for multi-media companies. According to his blog, he’s already connected to a bunch of influential Northeast Ohioans, including some of my colleagues here at JumpStart. His idea is big, bold and audacious — just what we need more of here in NEO - but will not be accomplished overnight nor by just wishing it so. It will take a city of people with the same vision and motivation all pulling in the same direction, so I hope he has the stick-to-itiveness to deal with the day-to-day blocking and tackling that it takes to change a culture.
While only a small part of the change trying to happen in NEO, JumpStart, since its founding in 2004, has been about trying to change a culture, primarily as it relates to the merits of a high growth business model funded by venture capital. Northeast Ohio has not generally been viewed by venture capitalists as a place to find high growth companies. Solid, slower growth manufacturing companies, yes, but high growth, high tech, get-in-early-and-sell-in-five-years companies, no. And, for most of the companies that are created here, the entrepreneurs who run them seem to be averse to venture investors who are viewed more as “vultures” rather than helpers.
Part of what JumpStart has been attempting to do over the past five years is help our clients understand that while very good things come from building a high growth company (personal wealth creation, jobs) these type of businesses can rarely get where they need to be, as fast as they need to be, without an infusion of capital from someone else. And, typically, this type of risk capital is only available from venture investors. So, while we’re often accused of “pushing” our companies toward raising venture capital, we’re really just focused on encouraging our entrepreneurs to pursue high growth business models that lead them to a logical exit (sale of company, IPO or recap). In so doing, we find ourselves trying to change a culture that, historically, has tended to view venture capitalists as the bad guys. The bottom line for us is this: if growth can occur without the use of someone else’s money, that’s great…it’s just that it’s more the exception than the rule.
But, don’t just take it from me. There are others out there reciting the same sonnet. There are a number of good articles out there on when to take VC money including: 5 Milestones to Reach Before Raising Venture Capital, and Should I Take Venture Capital Money?
Lynn-Ann Gries is the Chief Investment Officer of JumpStart Ventures. She previously worked in the investment banking departments at both McDonald Investments and Smith Barney (now part of Citigroup), and in the sales and trading area at Morgan Stanley. She received her MBA from New York University’s Stern School of Business and her BA in Economics from Smith College. She currently serves on the board of the Fund for the Future of Shaker Heights, the Great Lakes Science Center and Summer on the Cuyahoga (SOTC).
July 10th, 2009 at 12:47 pm
Ms. Gries,
You need to realize that your model is 10 years old and outdated. You are not alone in taking a while to see the change in landscape. I am from Cleveland but live in Silicon Valley and I deal with VCs and Startups in my business.
Just recently all of the VC firms out here realized that their model was outdated as well. Do you know how they figured that out? There has hardly been a fund raised by any VC firm since 2003 that has had an ROI better than the S&P and obviously not near the 20-30% annual gains that were promised to their investors.
The reason for this is that the public markets and/or potential acquirers learned their lesson that for a company to have value it needs a sustainable business model and not just a potential product. Ten years ago this was not the case as VC firms were able to exit their investments much easier. Now, you actually have to build a business by creating something that enough people want and are willing to pay a price high enough to allow that the company to profit.
Even with all the research in the world, you can never know if people will want your product and actually pay for it until they can actually experience/ use it. Although every startup is different, the vast majority of them do not need millions of dollars in investment to get to the beta stage. Once they are in beta, you can actually see if people want it.
You should take a look at the following article about a new VC model…http://www.inc.com/magazine/20090601/the-start-up-guru-y-combinators-paul-graham.html . Although this may be the extreme, it shows that startups can be very cheap to launch today. It seems that once a VC invests in a company, the first thing they want them to do is spend money, hire C level people, get office space and start looking like a real company. What they are forgetting is how many successful businesses began as startups in garages, basements and the spare bedroom. VCa are more likely to have an exit if they act like a real company (create products that people want) instead of look like a “real company” (Fancy office and C level hires with MBAs).
The person who sent me the link to your blog is very involved in the early stage community in Northeast Ohio and is a member of the Angel Investor Group in the area. At first, he was thrilled that millions of State dollars were being used to fund groups like yours and his angel group. However, once he saw how these funds were used and the priorities both your group and his angel group forced on their portfolio companies, he nows sees it as a very expensive waste of taxpayer money.
I know a lot of people must be discouraged that you guys have made over 30 investments without a successful exit. Although I would hope for a little better batting average, I am upset you have only made 34 investments with all the money funded to your operation.
From your website, It seems that there must be 20-30 people working at JumpStart. Do you know that there are only 19 people working at Berkshire Hathaway’s main Omaha office? This is a corporate conglomerate that operates very similar to a VC firm but invests and buys mature companies instead of startups. Their operation is a little larger than JumpStart and they have 19 people in their main office. How can you expect your portfolio companies to be nimble when they look at your tax payer funded operation with all these people, salaries and overhead?
I hope to move back to Cleveland in the next five years and I hoping State funded groups like yours and the Angel Groups have gotten their act together. If done right and with a little luck they can create businesses, jobs and wealth.
My point in responding to your blog is that the startups you invest in should be nimble so the money they have will last longer and give them more time to prove their business. The same goes for Jumpstart. Just like you need to pull the plug on investments that don’t pan out, eventually, if there are not real results out of the companies you fund, taxpayers will wonder what they are funding. The lower you keep your overhead, the more companies you can fund and the more chances you have of creating a solid company. If they realize that after five or six years and that you have recieved tens of millions of dollars of funding and that the majority of jobs created are in your offices, there will be a lot of pressure to pull the plug on funding groups like yours. That would be a shame because this model can work.
July 10th, 2009 at 3:11 pm
Check out this great response from Marc Canter on his blog:
http://blog.broadbandmechanics.com/2009/07/09/why-do-i-love-lynn-anne-gries/
July 10th, 2009 at 5:51 pm
Richard,
Thanks for your post, it gives me a great chance to share how JumpStart is an unusual organization in that our mission is NOT to maximize financial returns, but to transform Northeast Ohio into a hotbed for starting and growing high-tech, equity-backed companies, with the expectation that these companies will ultimately create wealth in Northeast Ohio.
You should know we are a non-profit that, amongst the many other activities that the community has asked us to perform, provides over 30,000 hours of consulting, pro bono, to over 600 entrepreneurs each year (whether we invest in these companies or not.) For the line of business we call JumpStart Ventures, our goal is to fund a total of 60 new high-tech companies by June of 2011. To-date we have made investments in 39 such companies.
Typically we make investments in companies that, due to their stage of development (very early!), are unable to raise significant private sector capital. We choose the companies we do because we believe that with our help (money and consulting) these companies might be able to raise angel or venture investment within 18-36 months after we invest (and continue along a high-growth trajectory). Our board members (and founders) firmly believe that the combination of risk capital and consulting we provide (the latter by experienced entrepreneurs who are on JumpStart’s payroll and whose services are provided free to our portfolio companies) is what it takes to get first-time entrepreneurs (95% of our applicant pool) ready for follow-on investment.
Another unusual aspect of our Fund is its evergreen nature; all of the returns generated from our investments will ultimately recycle back into the Northeast Ohio community and allow us to invest in more start-ups. It is our expectation that this Fund will provide a steady source of high risk capital in Northeast Ohio for many years to come. (In regards to your comments about exits, we do not expect any major exits from our portfolio for at least another couple of years as we are investing well before the average “market” investor; in addition, please note that the average company in our portfolio is ~2.5 years old – about 5-7 years away from a potential exit in today’s economy).
I agree with you that the venture capital industry is going through significant and needed change. What I was trying to say in my blog post was not that venture funding is for everyone, or that it’s the only way to grow a company, but merely that entrepreneurs should view taking venture funding as a good way (and sometimes it’s the only way) to achieve rapid company growth. Instead, folks here have been anathema to VC funding, almost unreasonably so, and that is a culture issue we’re trying to change.
You might be asking at this point how JumpStart (and our funders) measure our performance.
Basically, we are focused on a handful of things. I will list some of these below:
• How many companies are we assisting and investing in, and are those companies making substantive progress through stages? (i.e. from Imagining Stage to Incubating Stage to Demonstrating Stage etc.)
• How many direct investments does JumpStart Ventures make each year (as reported by PriceWaterhouseCoopers and Entrepreneur Magazine)? Note: over the last four years and we have averaged about 10 deals per year which has put us in the Top 10 most active seed stage funds in the country. JumpStart also provides pro-bono support to four other funds that make an additional 20+ investments as a group each year.
• How much angel and venture capital has followed the pre-seed and seed-stage investments we have made? So far, we have invested about $14M collectively in our companies. These companies have gone on to raise over $71M in additional, follow-on, capital.
• How large of an employment and economic impact are the firms making that JumpStart invests in or assists? To give you a sense for this, if you just evaluate the economic impact the companies that JumpStart Ventures has invested in to-date, the impact on GDP is $177M since 2006. (This data comes from a report compiled by the Levin College of Urban Affairs at Cleveland State University.) The companies we have invested in have generated just over 500 jobs.
So, I recognize that our business model is somewhat different than that of a traditional venture fund. We are really a “venture development organization,” meaning that we use many of the practices of the venture capital industry but we are more focused on economic development outcomes than we are on IRR. We do what we do with the blessing of our funders - the people who pay the bills at JumpStart.
Finally, just like Y-Combinator, the JumpStart model is recognized as being significant. In the last year, we have been featured in the New York Times (http://www.nytimes.com/2008/07/24/business/smallbusiness/24shift.html?_r=3&8dpc&oref=slogin), the Chronicle of Philanthropy and most recently by Secretary Locke of the Commerce department as being “the best and brightest in 21st century economic development”, http://www.eda.gov/xp/EDAPublic/NewsEvents/PressReleases/PROhio060509.xml.
I look forward to the chance to help you and other readers better understand what we do and why the success of the venture capital industry as it continues to morph will continue to be important to JumpStart and communities like Northeast Ohio.
Lynn-Ann
July 14th, 2009 at 11:29 am
Ms. Gries,
Thank you for your response. I agree with many of the things you wrote and I believe conceptually in groups like Jumpstart. My problem with your response is the way you (your board and investors) measure JumpStart’s success.
I believe that your success should be 100% measured on the total cost of funding JumpStart (which I imagine must be tens of millions of dollars since its inception), vs. the number of “real sustainable jobs” and the GDP growth and multiplier effect from only companies in your portfolio that have become “real sustainable companies”.
From what I can tell, this does not include the employees at most of your portfolio companies. The jobs created by startups are only temp jobs that last only 2-5 years if the company does not make it. The exact same positive GDP and Jobs the report claims were created would be accomplished if the state wanted to put people to work so they decided to build a road that wasn’t needed. Sure it would create a couple hundred jobs for 3-5 years plus the positive multiplier effect and GDP that comes from those jobs, but they are not sustainable jobs.
I urge your funders and board to realize that they should be judging your success on the cost of funding Jumpstart (which is not clear) vs. the number of “real sustainable jobs” (and average income of those jobs) from “real sustainable companies” and the GDP increase and multiplier effect from only these “real sustainable companies”. The report you cited does not distinguish at all between “real sustainable jobs” and the temp jobs that will be gone if the company doesn’t make it.
You should read the recent Fortune Magazine. The cover story is about Marc Andreessen. He was founder of Netscape, Mosiac, Ning (and others) and an investor at Twitter and sits on the board of Facebook. He just launched a fund and the perspective that comes from his successes and failures is very interesting.
I think the following paragraph is most interesting,
“Andreessen started the fund because he saw a chance to exploit a shift in the startup milieu. As he explains it, technology and software tools have driven down the cost of starting a tech company by more than 100 times compared with a couple of decades ago, when the modern venture capital structures were put in place. A company that needed $200 million to get a product out the door in the late 1980s now needs just $200k”.
Today launching a startup takes tremendously less capital. Some companies may need to raise follow on funding but many may not. Just because a company doesn’t want to raise more money, doesn’t mean they don’t want to grow. It seems that one of the main things your board and funders have decided to judge Jumpstart on is the amount of follow on funding your portfolio companies are able to secure. This is an outdated and irrelevant measuring stick as money isn’t always the barrier to a startup’s growth or success.
I dispute your claims that very VCs are willing to invest at the seed stage that Jumpstart invests in. The landscape has changed in the last 4 years. Many of the big VCs are now reserving 15-25% of their fund to invest $50k-$100k sums in seed businesses like JumpStart. Just like you, they will need to have some successes out of those investments if they want to raise future funds.
You claim in your response that Jumpstart does 30,000 hours of pro bono consulting. Any group that invests in companies probably funds 1-3 for every hundred deals they look at. Once a group like yours makes an investment in a company, they usually demand to have some sort of presence with the company most often as a board seat. I think it is misleading to classify this work as pro bono. This is the normal due diligence that is required for anyone who invests in companies. You got to kiss a lot of frogs to find a prince. When you find a prince, you want to help him become a king.
Back to my main point. When it comes to VCs, they have to answer to their investors. You get your money from foundations and the state and federal governments. I urge these investors and your board to set more relevant criteria to judge your success. It is simple…The amount it costs to fund Jumpstart vs. the number of “real sustainable jobs” your portfolio companies create and the GDP, multiplier effect that comes out of the companies that are sustainable.
Using data from companies that do not make it, doesn’t tell whether Jumpstart is creating any wealth. The bottom line is, you have to have some companies make it. If not, you should expect people to question your effectiveness, the need for your organization and the need for foundations and State and Federal governments to fund it. As the average age of your companies is only 2.5 years old, I agree that it is probably too early to tell on many of your investments. However, the people who fund Jumpstart really need to rework the way they judge their success and effectiveness towards their mission.
August 4th, 2009 at 5:15 pm
Rich,
Thanks for the follow-up comments. I’m guessing, like in most situations, our views about how to foster entrepreneurial activity and a healthy startup culture are more alike than they are different. Feel free to contact me via phone (JS general number 216 363-3400) to have a further discussion on the topic.
I do want to clarify a few items in your post. The pro-bono hours of consulting we do are not only for the companies that end up in our portfolio, but for almost all of the companies that approach us. Because of where we sit in the eco-system we feel strongly about responding to each and every applicant, even those who will never be candidates for venture funding. We often spend many hours talking through business models with entrepreneurs to help them further formulate their idea/vision. We do this in the hopes of growing a broad entrepreneurial culture here in Northeast Ohio which, as you know, has been lacking vis-à-vis other geographies.
Your comment about larger venture funds reserving a small portion of their funds for seed-stage investments is certainly true, however, those funds are not investing in Northeast Ohio last I checked. It is primarily for this reason — lack of significant seed funding in our region — that JumpStart was created. We would welcome private sector funds (that have reserves for seed-stage investing ) taking up residence in our region, we just haven’t seen it quite yet.
As for using follow-on funding as a metric, we understand that some companies may be able to grow significantly without taking venture capital. And we’re happy with that so long as the entrepreneur is thinking of an exit strategy that can generate returns for us. The truth is, however, that our average investment of $350K is, in most cases, not going to be enough (even for the leanest tech-based company) to grow significantly. So, we measure follow-on funding as a proxy for company growth and as a proxy that the company is thinking in terms of creating wealth for its shareholders.
Finally, we would be happy to be measured on the number of “real sustainable jobs” our companies create, which, if I read your post correctly means jobs in companies that are stable and won’t go out of business in 3-5 years. If we were to be measured against that metric, however, we would have no motivation to invest in any startup companies since startups, by their nature, have a high risk of not making it. I think that our founders (and current supporters) understand that some portion of our portfolio companies won’t make it and are willing to accept that fact in the spirit of growing a broader entrepreneurial culture in the region. Like the regions of the country where entrepreneurship is commonplace, we want to foster a culture where an entrepreneur, if he/she doesn’t succeed the first time, takes the knowledge gained and tries again, and again until they create a wildly successful company.
Thanks for the follow-up post. As you know, this is a topic that is difficult to encapsulate in a few sentences, but I’ve tried and welcome a further discussion in person or via phone.