I met some time ago with Brad Wisler, co-Founder of SproutBox, and shared with him our research on portfolio value creation by venture capitalists. He wrote a thoughtful note, which I’ve shared below, with permission:
Thanks for sharing this paper with me. I love the title, which almost perfectly sums up our philosophy. What follows is a bit of a brain dump, but I’d be happy to provide my thoughts in a more formal manner, if you think it would be useful.
I love the concept of a spectrum of involvement, but there may be additional categories here. SproutBox might accurately be placed in the Mentor category or Portfolio Operator category, but our primary value is very specifically in hands-on product development. I suppose this is part of operating the company, but we don’t consider ourselves Operators. We aim to focus our operational involvement on finding the product-market fit. We seek founders who have expertise in sales, marketing, content, and organizational management and do our best to equip them with great products or platforms. Once we’ve found that fit, our role is dramatically diminished. I also agree to an extent with Mike Hirshland‘s quote, “First of all: do no harm and let the entrepreneur run the company.” Once there are multiple investors involved, it can become overwhelming to the founder to have conflicting management advice because they feel compelled to make an effort to implement the suggestions of all investors. After all, being “coachable” was probably key to raising the money in the first place.
The point about impact on decision process – that you need to invest in companies where you can add value — is spot-on. For obvious reasons, we choose to invest in companies where our product development services can create the greatest value.
It’s interesting to me that recruiting assistance is the most prevailing service offered by Portfolio Operators. I believe turnover and recruiting are some of the biggest capital leaks in startups, so it makes sense for VC’s to try to plug this hole. After all, it’s their capital that is being spent on recruiting, or being burned while a team is understaffed and unproductive. This is certainly part of our motivation for providing product development services. In short, we plug that hole with our own staff while the portfolio company searches for permanent technical staff.
Strong connections to a top university (in our case, Indiana University), are an invaluable asset in creating a talent pipeline for portfolio companies. I serve on the Dean’s Advisory Council for IU’s School of Informatics and Computing and my partners and I are regular guest lecturers at IU’s Kelley School of Business. This has a direct and measurable impact on recruiting within our portfolio.
The Extreme Venture Partners (EVP) example of a dev shop/VC hybrid is an interesting one. While there is obvious benefit in getting preferred access to a top development shop, there is opportunity for conflict if portfolio companies are encouraged to use a for-profit company owned by the VC’s. I’m not familiar with the details of the EVP/Extreme Labs relationship, but it’s certainly one that requires caution. Our funds are the only customers of our development shop, which intentionally operates at break-even in order to avoid any potential conflicts. If our dev shop had shareholders expecting a profit, or if I personally took distributions from it, it would be dangerously tempting to overpay for development services. [Note from David Teten: we have the same logic at ff VC; that’s why we charge portfolio companies at cost for our accounting services, to avoid a conflict of interest between General Partners and Limited Partners.] The success of the dev shop would be in constant conflict with capital efficiency within the portfolio. Google Ventures essentially acquired Milk in order to bring development talent in-house, which I believe is the best way to provide these services. In addition to avoiding conflicts, bringing the dev team in-house and giving them a portion of the carry ensures that they will build products to last. Conversely, outsourced developers compensated solely by payment for services have an incentive to keep projects going and ensure continued dependency.
I’ve heard great things about the First Round Capital methodology and technology that encourages support between portfolio companies. This could be an area for further investigation. We’re trying to replicate some of the things they’ve done by creating more opportunities for collaboration and idea/resource sharing in our portfolio.
Finally, SproutBox is still way too young to measure the success of our level of involvement in terms of total return, but there is strong evidence that our services have led to a lower failure rate. After 3 years of investing, and 20 investments, we haven’t had a single company cease operations. Some may argue that we give too much support to struggling companies, to the detriment of the winners, but our strategy is one that requires fewer home runs than most funds. You’ve probably read Paul Graham’s Swan Farming article. His take on variation in the portfolio is probably correct for his “spray and pray” model, but we are shooting for a far smaller variation in outcomes, as I’m sure many others are.
I hope this is useful. Please let me know if there’s anything else I can provide.