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London is the grandfather of economic excess and perhaps an appropriate role model for New York and San Francisco, the new Babylons of the post-millennial world. It is hard to escape the presence of money — fancy super cars, fancier homes and fancy financiers — where the stench of excess is masked by the sweet scent of success. Except for one small difference — New York (aka Wall Street) and San Francisco do one thing better than London: branding money.
Actually, money — whether it is in Bogota or Bombay (Mumbai, if you insist) or Boston — is just money. Borrowing it, investing it or generally rolling around in a bed made of $100 bills is pretty much the same experience regardless of the source or geography of money. Except, somehow, some kinds of “money” are better than other kinds of “money.”
From bulge-bracket banks to white-shoe Sand Hill Road firms in Menlo Park, many of the hallowed names such as Kleiner Perkins Caufield & Byers have done a great job in creating a brand and mystique around money. During the Internet boom of the 1990s, Kleiner was the ultimate money brand, thanks to their backing of Netscape.
This ability to brand money has allowed big banks such as Goldman Sachs and JP Morgan Chase to thrive, even amidst a financial crisis. Massive amounts of capital and the eminence of their networks of contacts has allowed these two giants to brand money like none other.
Silicon Valley has been playing a variation of the same game: there are gobs of money, networks of famous people, and all are sitting on stacks of cash improved by the names of the successful startup founders that earned it. This often translates into a bigger brand, and thus giving more eminence to the money provided by the investors.
Up and down Sand Hill Road, everyone played from the same playbook. It was a perfectly lovely game plan, except the world changed with the arrival of first, the internet and then the social media. But before we get to that, let’s turn back the clock to the 1990s.
In my life, I have been very fortunate to chronicle the emergence of the commercial internet (as we know it) from its early days. Over next decade or so, I came to realize the amazing deflationary powers of the internet. It was — and still is — a great deflator, squeezing out middle men, friction and of course, profits.
There have been many such examples. In the late 1990s, fueled by the internet stock bubble/boom, a new class of traders came to exist: day traders. In a 1998 cover story, Forbes chronicled the escapades of this group of what it called “guerrilla market makers” who competed against major brand-name market makers such as Merrill Lynch, Goldman Sachs, Morgan Stanley, and Knight Securities. With little overhead, playing with their own money and risking it like those crazy poker players, the day traders reduced the spread in over-the-counter stocks and in the process squeezed what was a profitable (and inefficient) system. Before the day trading dudes showed up, the market as Forbes described so well was like a club.
For years, if you wanted to buy a company’s stock, your order went to a market maker who got you the stock at your offer price, even if they got it for less. They pocketed the difference and that was the spread. It cost millions of dollars to become market makers and thus be part of this special club. The Securities & Exchange Commission, having gotten wise to these dreaded and excessive spreads (thanks in part to some excellent reporting by Forbes magazine) changed the rules and let the barbarians into the game.
In 1998, about 2,000 of such day trading dudes (and they were mostly dudes) accounted for nearly 12 percent of Nasdaq’s trading volume. I learned about this specific day trading business when freelancing for Traders’ magazine and writing about electronic crossing networks.
This was all driven by financial innovation. The cost of trading collapsed for both regulatory and technology reasons, which allowed many, many more people to trade. More traders meant more wild behavior in the markets, and the phenomenon eventually collapsed in the dot-com bust — but the innovation (lower-cost trading) remains.
The history of financial markets is full of these kinds of stories. Some innovation makes some financial product or technique less costly, and it, in turn, becomes more widely available. People race to try it, hoping to earn higher returns, and that works; for a while, anyway. Inevitably, however, the innovation attracts too many newcomers that those returns collapse, leaving huge losses, but also leaving the innovation behind for the future to benefit from.
JOBS and Angels
Fast forward to 2013 and we are seeing history repeat itself with new financial innovation dropping regulatory barriers, lower costs, and driving much wider participation in a previously closed market. The club-like closed ecosystem of startup investing is about to be pried open, thanks to new rules from the Securities & Exchange Commission, which has approved many reforms as part of the Jump Start our Business Startups (JOBS) Act. On Monday an 80-year-old rule on general solicitation (by companies) was changed and it is a key part of the JOBS Act. Soon, another more sweeping change to the rules is going to be implemented and that will totally redefine the way startups are built and financed.
During the day-trading revolution, the biggest beneficiary was Island/Datek Online, a day trading platform started by Joshua Levine and Jeffrey Citron. The analogy in the startup world is AngelList, a startup funding platform co-founded by Naval Ravikant and Babak Nivi. Also on Monday, the company received a whopping $27 million in funding from a group of 116 investors including Google Ventures and Kleiner Perkins Caufield & Byers and Draper Fisher Jurvetson. In short, AngelList is a marketplace that allows the buyers (angels) and sellers (startups) to come together.
In reporting on the funding, Businessweek reporter Ari Levy wrote: “he’s focused on eliminating inefficiencies, like the amount of time and money early-stage companies have to spend on setting up meetings, traveling to pitch sessions and finding and paying lawyers.” AngelList expects to make money by helping with recruitment, Business Week added. But Levy’s article’s title says it all: Are VCs Investing in Their Own Disruption?
The answer to that question is Yes. The venture capital business, as Naval has pointed in many previous interviews (with me), is wrought with inefficiencies and inconsistencies. It has many sources of burdensome and irritating friction. (That friction is the equivalent of the “spread” in the old over-the-counter trading.) When I last wrote about AngelList (which was long before it became the media darling it is today) it was fairly obvious that it was a major disruption in the old way of doing things, i.e., investing in startups. And while it is difficult to predict its future, the change it has unleashed will continue to have longer term implications.
AngelList and 500startups are the most visible manifestations of the changing of the guard in our corner of the world. Betaworks, the New York-based idea factory co-founded by John Borthwick, has teamed up with AngelList and is going to use it for many of its future ideas.
AngelList is not alone — others such as WeFunder, RockThePost, TechShop and Circleup have become part of the crowd-fund-the-startups movement. The ultimate democratization of investing in startups has already begun, and while some might call it the idiocy of the crowds (for many of the right reasons), the reality is that the (angel investor) mob is on Sand Hill Road.
Once again, financial innovation has cut costs and driven wider participation in a previously closed and clubby market. We have seen it over and over, from derivatives to mortgage-backed securities, and it is playing out again in angel investing.
And while the barriers to entry are coming down, the fact remains that startups remain an inexact science and are good ones are few and far-between. The trick is identifying the right one and then betting it would turn out to be a big-winner. As my former boss says, startups are like brilliant novels — there’s only so many out there among the crap.
The rise of the social VC
In the very near term, I don’t think anything major happens to the venture capital industry. After all, the industry has been slowly contracting since its 1990s-bubble heydays. Eventually, however, the impact of the new investment approach that allows angels to band together and plow money into startups is going to have an impact on venture capital. In a sense, social media is already transforming the venture business. The emergence of blogs, Facebook and Twitter have reshaped the idea of a VC brand and how it is created in the 21st century.
For nearly four decades, the historical success of a partnership gave it its imprimatur and that in turn created a flywheel of success. The best investors had the best returns because they saw the best deals. It was their moat.
Lately, however, that competitive advantage has increasingly has been replaced by the “reach” provided by social media. Dave McClure was an obscure and quirky guy when I first met him in mid-2000s. A colorful blogging style, an orally eclectic twitter feed and tireless approach to investing in anyplace across the planet has made him (and his company 500Startups) a new VC brand — not a big one, but not ignorable either.
Is McClure the only one? No! Hunter Walk was a Google/YouTube executive who catapulted from anonymity, thanks to his understanding of social media and now co-runs Homebrew Capital, a seed fund with Satya Patel, formerly of Twitter.
I have often argued that one of the (good and bad) side effects of social media is that it amplifies both reality and fiction. And we are seeing emergence of newer investor brands, ones that are validated less by their decades of success, and more by followers and ability to attract attention. Attention, begets deals, and the circle turns.
AngelList fits neatly into this new investor model: it gives founders of startups, metrics about an angel — their track record, deals they are involved in and the size of their network. Yes, AngelList, like other tools of social validation, focus on the positive feedback loops, and thus one needs to be prudent by being skeptical.
Boom or bust, AngelList or CircleUp — the game has changed and it will continue to change, and that will keep sending the traditional venture community scrambling for ways to find an edge — one that allows them to keep branding their money and standout in this sea of noise.
Josh Kopelman’s First Round Capital is doing this through a founder platform and a publication, First Round Review. Even the tony Sequoia Capital is not immune to the changes and is launching Grove, a knowledge and information hub that is supposed to help its companies and founders. Andreessen Horowitz, a new firm than never misses a chance at publicity (and rightfully so) has hired my former colleague and partner in print, Michael Copeland, in order to create their own knowledge hub.
The reason? Perhaps it can be summed up by these words from Andreessen Horowitz PR chief Margit Wennmachers: the firm is “so connected, it’s the equivalent of the White House.” If there was a gold medal for PR, then Wennmachers should get one — she has ruthlessly helped turn A16z (as Andreessen Horowitz is known) into a PR force, from obscure conferences to Charlie Rose, founders Ben Horowitz and Marc Andreessen becoming first call for all comments on anything.
The success of A16z in the PR game has sent the entire Sand Hill Road community scrambling to hire communication partners (reminiscent of a similar scramble in the late 1990s). All of this hoopla is driven by one harsh reality: VC is now a game of attention. Less attention equals less attractive deals and these platforms/publications are a way to get that attention.
As great as these platforms might be for their firms, the approach I find most laudable is that of two of my favorite investors: Fred Wilson and Bill Gurley. Union Square Partners’ Wilson has been writing his AVC blog for almost a decade. It is less a marketing platform for his companies (he does some of that, but tastefully), but more a reflection of his life, his family, his thinking and the learnings he continues to share with his community. His blog only augments his track record as the winningest VC of the social generation.
If a founder wanted to understand Wilson, she would sit down and read everything Fred wrote in past year and get a fair sense of how and why he is thinking. You can see his flaws and also his strengths in those words. Others have tried to mimic his approach to blogging, but you can’t imitate and be authentic.
Same goes for Benchmark Capital general partner Bill Gurley, who probably makes the list of my top ten favorite human beings. Gurley and I met a long time ago when he was a financial analyst and I was a junior reporter back in New York. He used to write a column, Above the crowd, for CNET’s News.com. It was packed with detailed and interesting information and as a result I became more of a fan of his thinking.
He recently resumed writing the column, but as his own blog. His posts are deeply analytical and provide insights, which reflect his intellect. He is candid and you can see it on his Twitter feed. As a founder, Gurley’s blog and social feed are an authentic view into how he thinks about the technology landscape (and college baseball.) Again, the operative word is authentic.
Like I said on Twitter the other day, these days all content is marketing — but if I was making my choice, I would take Gurley and Wilson over portals and platforms. Call it authenticity over professionalism.
Sarah Lacy earlier this year wrote a wonderful defense of the classic venture capital model and this one paragraph perhaps sums everything up well:
And, by the way, as is almost always the case when it comes to Silicon Valley, it bears noting that none of this is new. The late 1990s saw talk of keiretsus and marketing partners and accelerators and incubators. Likewise, a desire to go international has come and gone a few times in the venture business. Even crowd funding had roots in Draper Fisher Jurvetson’s ill fated “meVC” fund. Sure a lot of these trends are being explored today in more sober and sustainable ways. But the ideas aren’t new, just as the idea of classic risk capital isn’t an anachronism.
Having spent over twenty years writing about Silicon Valley and its inner workings, one thing I have observed is that since 1999 is that the focus has become increasingly on winning “the deal.” That phenomenon was accelerated by the entry of newer funds into the business during the boom-boom years of the Internet. The upstarts competed with the traditionalists, offering outrageous valuations and using media as a way to stand out among the crowds.
Many of those hot funds are gone, forgotten or will soon be like the fading ink of a high-school notebook. Still, that relentless focus on “getting the deal” and using it as a success metric has stuck. In reality, it is an appropriate metric and reflection of our dopamine-addicted times: deals get attention… blah! blah!
I think the only metrics that should matter to a founder are the ability of an investor to empathize with them (especially when the going gets rough) and their ability to understand that startups are unpredictable. A really great investor knows that, and so should every founder. The bad investors are the polar opposite — just ask the folks behind the startups they backed in the past.
In a world where money is a commodity and startup funding is just a matter of being part of a platform, there is one thing that will always be unique: people and what they bring to the table. In London, the bankers to the billionaires are never seen — and are rarely talked about — they are busy making billionaires more money. You want that in your investor.