All in the Family: The Networking Effect

Out of all the venture-backed companies that have successful exits, there is consistently a handful whose founders and early employees go on to produce even more successful exits.

Think of the “PayPal Mafia” and how a network of founders and early employees of the online payment services company—people such as Peter Thiel, Max Levchin, Ken Howery, Luke Nosek, Roelof Botha, Elon Musk, Chad Hurley, Steve Chen, Jawed Karim and Reid Hoffman, among others—have leveraged their connections to launch numerous startups and join the ranks of venture capitalists. Some have credited this interlacing PayPal group for setting off the Web 2.0 craze.

Working with people you already know and investing in former colleagues is nothing new. Examples abound of startup execs and VCs who trace their diasporas back to successful companies before them. Years ago in Silicon Valley, long before members of the PayPal Mafia were born, the semiconductor industry had its formation when a group of engineers, the “Traitorous Eight”—which included VC pioneer Eugene Kleiner and Intel Corp. co-founders Robert Noyce and Gordon Moore—left Shockley Semiconductor and ultimately founded Fairchild Semiconductor. The rest, as they say, is history, as about 65 companies were launched in the succeeding decades traced their roots to Shockley.

At VCJ, we wondered what successful companies have created the next so-called mafia, or tight-knit networking group. We eventually focused on three companies that have had successful exits in recent years—VMware, Tesla Motors and AdMob—that seem to share many qualities of successful alumni networks (see sidebar: PayPal Author Sees Four Keys to Strong Alumni Networks).

While none of them has yet produced a follow-on exit to rival YouTube or LinkedIn, scores of startups with a VMware, AdMob or Tesla connection are attracting serious attention from venture capitalists.

And as several move out of stealth mode or on to sizeable Series B and C funding rounds, it’s probable another big return is not far away.

VMware Execs Don’t Have to Knock on Many Doors on Sand Hill Road

If one had to bet on a startup team most likely to go onto other successful ventures, VMware would be a pretty good pick.

The Palo Alto, Calif.-based company pioneered the virtualization technology that turned largely single-purpose servers into multitasking machines. It’s grown into a business that today generates more than $3 billion in annual revenue and has a market cap of $43 billion. And it provides a core technology enabling the shift to cloud computing, a sector that’s been red-hot in venture circles in recent years.

Those reasons—along with a few others—help explain why investors have kept in close touch with VMware alumni and have been quite active in funding their follow-on ventures.

Over the past four years, VCs and strategic investors have put more than $340 million into at least 13 companies with a former VMware executive or high-level employee as a founder or key hire, according to Thomson Reuters (publisher of VCJ). Several firms have also recruited alums as partners, principals and entrepreneurs-in-residence, hoping to profit from the next wave of data center disruption.

“Every decade there are some pioneering technologies that pave the way for others,” says Pete Sonsini, a partner at New Enterprise Associates and a former director of strategic alliances at VMware. “A lot of venture guys recognized that virtualization was going to be one of those things.”

For early VMware veterans with startup ambitions, that means it doesn’t require much arm-twisting to get venture investors’ interest.

NEA, for instance, has invested in two companies with VMware alum in senior positions: Nicira Networks, a developer of software to transition data centers to cloud infrastructure and Tintri, a developer of hardware and software for storing data with virtualized machines.

Nicira, with $41 million in venture funding so far, counts Andrew Lambeth, an early principal engineer at VMware, as its senior software engineer. Tintri, which has raised $35 million to date, is led by Kieran Harty, former head of R&D at VMware.

Harty says he didn’t have to knock on many doors on Sand Hill Road to get backing.

Shortly after leaving VMware, he contacted Sonsini, who suggested an entrepreneur-in-residence post at NEA. Harty started Tintri in 2008, stayed in stealth mode for more than two years, and, with a product ready for market, closed an $18 million round in June from NEA and Lighstpeed Venture Partners.

Nand Mulchandani, who came to VMware through its acquisition of his prior startup, security provider Determina, had an even less grueling experience getting VCs interested in his next venture. He got to know partners at Accel Partners through a cocktail party the firm used to throw at VMware’s annual conference. One partner he met was Ping Li, a board member at several cloud computing startups.

VMware, because of that leadership position at a time when other companies were sucking air, could really pull in great talent.”

Pete SonsiniPartnerNEA

“When I left, I shot out an email to Ping, and he said to come hang out,” Mulchandani says.

He joined as an entrepreneur-in-residence at Accel, where he launched ScaleXtreme, a developer of systems management products for configuring and managing complex cloud architectures. The company raised $11 million in June from Accel and Ignition Partners, less than a year after raising its $2.5 million seed round.

Accel, like NEA, has made a serious effort to cement ties with VMware’s most talented team members. In addition to hosting parties, in June, it brought on as venture partner Kirk Bowman, former vice president of worldwide field operations at VMware. It’s also invested in Nimbula, a developer of enterprise cloud computing infrastructure that counts Reza Malekzadeh, VMware’s former director of marketing, as its marketing VP.

Other firms with multiple investments in companies with VMware veterans in leadership positions include Sequoia Capital and Lightspeed, which earlier this year promoted John Vrionis, a Determina and VMware alum, from principal to managing director.

Ask VCs or VMware’s alumni what it is about the virtualization company that has spawned such a strong post-exit entrepreneurial culture, and the answers reflect two key themes: talent and timing.

VMware’s founders, wife-and-husband team Diane Greene and Mendel Rosenblum, did a particularly skillful job assembling an elite team, says Cameron Lester, general partner at Azure Capital, which backed the company’s only venture round in 2000. The two relied heavily on talent culled from Stanford University’s computer science department, where Rosenblum was a professor.

“The original culture of the business was very much one of technologists with strong ties to Stanford, and inventors who were wanting to change the world,” Lester says. “It was pretty revolutionary.”

It was a gutsy group, as well, Lester recalls. After overcoming technical hurdles to develop an initial product for running multiple operating systems on a single desktop, at the time of its venture round VMware was moving into the server space. In conducting due diligence on the company, he noted they were competing directly against Microsoft and Intel.

Sonsini credits VMware’s success in attracting talent for its move into the server space to a mix of Greene’s knack for hiring smart people and of simple timing. At the time VMware was scaling up, a few years after cracking the code on desktop virtualization, the dot-com bust was taking its toll, and opportunities were scarce.

“This was one of the few companies that was still cranking,” Sonsini says. “VMware, because of that leadership position at a time when other companies were sucking air, could really pull in great talent.”

Eight or nine years ago, Lester says, VMware was one of the few companies—after Google and Salesforce.com—considered a strong candidate for going public. That helped bring in talent from both the business and technical side, Mulchandani recalls.

“It’s not Facebook. People don’t wake up in the morning thinking they have to do virtualization. But for people in the industry, they knew it was a hot thing,” he says. During that period, when he was attempting to make key hires for his own company, Mulchandani says, VMware was the one company to which they’d commonly lose candidates.

The stock option payout potential changed in spring of 2003, after EMC acquired VMware in a $635 million transaction, which it spun out through a public offering four years later. Still, many of the early members remain, including several in executive positions, such as Raghu Raghuram, general manager of virtualization and cloud platforms, who joined in 2003, and Carl Eschenbach, head of customer operations, who joined in 2002.

That’s helpful for former employees-turned-entrepreneurs, Mulchandani says, as it’s easier to network, pursue deals, and talk strategy with former co-workers.

Former executives have also been part of at least one highly successful exit already: Nuova Systems. Ed Bugnion, co-founder and former CTO of VMware was also CTO of Nuova, which formed in 2005 with funding from Cisco Systems. The company developed a data center platform that enhances performance of networks, servers and storage devices.

Cisco took an 80% stake in the company a year later, according to media reports, capping the potential payout for the remaining 20% at $678 million. In 2008, Cisco bought the rest of Nuovo for an undisclosed sum.

Part of the reason for the plethora of alumni startups, says Harty of Tintri, is that virtualization itself has created a huge set of opportunities, with potential for its work in servers to be extended to other areas of the data center. Tintri, for instance, is one of several startups focusing on the storage side, looking at how storage networking can be improved to keep up with the efficiencies virtualization has brought to servers.

Not only has VMware’s success opened up opportunities for follow-on startups, it’s also opened up a great new path to exit—acquisition by the mothership.

People don’t wake up in the morning thinking they have to do virtualization. But for people in the industry, they knew it was a hot thing.”

Nand MulchandaniCEO and Co-founderScaleXtreme

Over the past four years, VMware has made at least 16 disclosed acquisitions. Several were purchases of venture-backed companies, such as SpringSource Global, a developer of Java infrastructure software for enterprise, acquired for $362 million in 2009, and Socialcast, a developer of enterprise collaboration applications, for an undisclosed sum in May.

Though VMware has yet to announce an acquisition of a sizeable, venture-backed company started by one of its alums, it has generated a second exit for its original VCs. In June, Lester was consulting some of his contacts at VMware as part of diligence for one of Azure’s portfolio companies, presentation application developer SlideRocket, when a deal unexpectedly materialized.

VMware, which has been assembling a suite of cloud-based applications for e-mail, project collaboration, and other office work-oriented tasks, decided that SlideRocket would make a nice addition to its stable.

It bought the company in June for undisclosed sum that Lester says generated a venture-scale return.

From AdMob Members, More Ventures Expected

As CEO of AdMob, Omar Hamoui was famous for starting sentences with the phrase: “Wouldn’t it be cool if…..”

The “if,” recalls Mike Mettler, an early employee, would invariably be followed by a description of some incredibly useful, but impossibly difficult to develop technology that Hamoui really seemed to wish he could tackle, if only he had the time.

But Hamoui had enough on his hands with AdMob. Two years after launching the mobile advertising company as a first-year MBA student at Philadelphia’s Wharton School in 2006, Hamoui had managed to draw the attention of Sequoia Capital, relocate to Silicon Valley, and build up what, according to partner and board member Jim Goetz said was at the time the world’s biggest mobile ad network.

Within four years of its launch, AdMob had raised nearly $50 million in venture funding from Accel Partners, Sequoia, Draper Fisher Jurvetson, and a number of high-profile angels, and was serving more than 4.5 billion mobile banner and text ads per month. The rapid growth trajectory culminated in 2010 with a $750 million acquisition by Google.

And as if often the case with big company acquisitions, within a few months after the deal gained regulatory approval, the AdMob diaspora began.

Just over a year after the Google deal, the “AdMob mob,” as Mettler likes to call the group, are showing their entrepreneurial stripes. At least four companies with AdMob alumni in either founding or executive-level positions have raised venture rounds this past year, including Mettler’s startup, Card.io, a provider of mobile credit card scanning technology. Others include MoPub, developer of an advertising platform for mobile publishers, Eagle Eye Solutions, a provider of mobile voucher and redemption technology, and Mojiva, a developer of a mobile ad network and ad serving platform.

Hamoui and Mike Rowehl, AdMob’s former director of technology, meanwhile, are looking to churn out a raft of startup ventures. Earlier this year, in partnership with Sequoia, the two launched Churn Labs, essentially a laboratory in which the former AdMobbers will hire engineers and come up with businesses and technologies with a mobile focus.

“We’re taking all the “wouldn’t it be cool” ideas Omar’s had in the back of his mind, and ferreting out which have the potential to be businesses,” Rowehl says. A key unifying theme of their ventures, he says, will be to look for applications in the Internet or offline world that have not yet effectively crossed over into mobile. Possibilities he mentions include invitation and polling services, social networking applications optimized for mobile, and, potentially, a tool for inputting and organizing business cards.

Churn is also using an unusual spinout model. Unlike the typical incubator or accelerator model, in which entrepreneurs compete for seed funding, Churn’s startups will all be crafted in-house. Then, if a business looks strong enough to spin out, Churn will do so, keeping 40% of the equity and allocating the remaining 60% for the company’s team and future investors.

In June, the lab announced its first release, called Gnonstop Gnomes, an application for iPhone and Android that allows users to create, share and track the adventures of gnomes they create on their mobile devices. Eventually, Rowehl says, the team hopes to incorporate some group-buying element.

Other entrepreneurial AdMob alum are sticking with mobile advertising.

Among them is MoPub, which runs a service for publishers to book and manage ads in rich media and other formats on mobile devices. The San Francisco-based company raised $6.5 million in a July round led by Accel Partners and joined by Harrison Metal Capital, both of which also provided seed funding. The company’s founders include Nafis Jamal, a former AdMob engineer and Jim Payne, who joined the AdMob team after the Google acquisition.

“Just like we’ve seen on the Web, advertising dollars tend to flow where people spend the most time, and people are spending a lot of time on their mobile phones,” says Payne, CEO of MoPub. With the rapid growth in smartphone and tablet adoption, Payne says, there’s also greater demand for technologies to enable richer, more immersive, and more interactive advertising.

One of the remarkable achievements of “AdMobbers” is that they were able to take the company through a period of exponential growth and still maintain a reasonable life-work balance.”

Mike MettlerCEO and Co-founderCard.io

Mojiva, a New York-based provider of a mobile advertising network and ad-serving platform, is betting on similar growth prospects. The company, which raised $25 million in Series C round led by Shamrock Capital Advisors in July, cited in its funding announcement a Gartner Research forecast that worldwide spending on mobile advertising will reach $3.3 billion in 2011 and will top $20 billion by 2015.

Momentum in the space is palpable, says Tony Nethercut, a former AdMob sales VP and currently Mojiva’s general manager for North America.

“It’s a big difference from a few years ago, where you had to find marketers and get them interested in mobile,” he says. “Now they’re coming to us.”

The same could also be said of venture backers. So far this year, VCs have invested more than $100 million in more than a dozen startups developing advertising platforms, ad-serving technologies, analytic tools, and networks for mobile, according to Thomson Reuters. At least three companies—JiWire, JumpTap and Mojiva—have raised rounds of $20 million or more.

For those with a track record in the space, fundraising has been fairly brisk.

“We didn’t have to do a lot of up-and-down Sand Hill Road pitching,” says Payne of MoPub.

He credits founders of the ex-Googler incubator AngelPad, where MoPub got its start, along with former AdMob product manager Ali Diab, with introducing him to investors, including Rich Wong of Accel, who is currently on the company’s board.

The company’s other venture backer, Harrison Metal Capital, was an investor in AdMob and appears to be actively courting its alums, as well. The two-partner firm, which declined to discuss its investments, has backed MoPub and Card.io.

More than year after AdMob’s acquisition by Google, Mettler says it’s likely there will be more follow-on ventures from members of the AdMob. That’s not the fault of Google, he says, so much as the way entrepreneurial types can be expected to behave.

“Google for a big company is a wonderful place to work,” he says. “What you see is what you see in a lot of startup environments, where you have people who are used to being productive in small teams wanting to go back to that. There’s always a desire to go back to those startup roots where you can be very innovative.”

Moreover, Mettler says, the AdMob experience taught him that succeeding in a startup venture doesn’t have to require 20-hour workdays and coding to the point of exhaustion. One of the remarkable achievements of “AdMobbers,” he says, is that they were able to take the company through a period of exponential growth and still maintain a reasonable life-work balance.

“Most people got there around 9, and left around 6,” he says. “But when we were there, we worked really hard.”

Tesla Alums Focusing on Adoption of Electric Vehicles

Looking at companies that have spawned large post-exit networks, often there’s a common narrative.

A charismatic founder assembles a team of rare talent. They work like dogs for years to get a product to market and build earnings. Then, after a successful exit, with cash in their pockets, they go off to launch or fund the next great thing.

Tesla Motors’ story doesn’t play out that way. The largest portion of ex-Teslans-turned-entrepreneurs didn’t even stick around for the company’s public offering in June 2010. That includes Martin Eberhard, the company’s co-founder and first CEO, who left nearly three years ago, along with co-founder Marc Tarpenning. Several engineers who worked on the early prototype of the Tesla Roadster also left long before an exit was on the horizon.

Moreover, though the company has built and sold more than 1,500 of its iconic electric Roadsters and raised more than $400 million in its primary and secondary offerings, it remains far from turning a profit. It’s posted losses of more than $170 million in the past year, with investors still waiting to see if the Palo Alto, Calif.-based company can deliver on plans to build and sell a sub-$50,000 electric sedan.

But Tesla’s entrepreneurial alumni remain committed to the vision that someday, the electric car business will be a very rewarding place to be. That’s largely on track with forecasts by industry analysts, who see the electric car business as still in the early stages of what will develop into a robust, multi-million-auto industry over the next decade.

There was definitely something magical that happened at Tesla, and it happened very early on.”

Jessica SwitzerFormer Director of MarketingTesla Motors

And as Tesla alumni move on to new ventures, they’re largely sticking to the same sector, developing components, cars, scooters and charging infrastructure to enable broader adoption of electric vehicles.

Currently, Tesla alums are founders or executives in at least eight companies in those areas, including several that have raised venture and angel funding.

Xatori, provider of an electric vehicle charging network called PlugShare, has raised money from Estag Capital, Quest Venture Partners and angel investors, including Tarpenning and Max Levchin, who formerly worked with Tesla CEO Elon Musk at PayPal.Also, Atieva, a stealth-mode developer of lithium-ion storage technology, has raised $7.1 million from Venrock and Tsing Capital. And KLD Energy Technologies, which is developing a transmission-less electric drive system, has raised $11 million since 2009 from backers, including Daylight Partners.

However, fundraising remains difficult for startups in the electric vehicle industry. While there are small amounts of angel money available, there’s a big void in the “valley of death” between seed and growth capital rounds, says John Thomas, a former Tesla general manager who’s also worked as an engineer for General Motors and Ford Motor Co. Thomas is also CEO of ALTe, an Auburn Hills, Mich.-based startup that retrofits fleet vehicles to run on an electric charge and develops an electric powertrain system. The company is pursuing a mix of government funding and private investment, and while fund-raising is tough, Thomas says he’s committed to the startup route.

“My experience at Tesla was very eye-opening in terms of the inner workings of Silicon Valley,” he says. “Part of the reason was the audacity to not be intimidated by all of the reasons that generally prevent a new car company from starting and succeeding.”

Thomas’s approach, however, marries his Detroit background with lessons learned from his tenure at Tesla. Although eventually he hopes to sell electric powertrain systems to large automakers en masse, he expects it will take years and lengthy road-testing to establish a reputation.

That’s why ALTe is first selling electrically converted vehicles to fleet operators. Currently, it has five prototypes “road-ready” for drive and durability testing and expects to begin shipping units in about a year.

Others are focusing on electric motorcycles and scooters. KLD Energy Technologies—who’s CTO, Rob Ferber, was formerly CTO at Tesla—develops an electric drive system currently used in scooters. The company is looking to incorporate its technology in a broader array of vehicles, but sees potential for earlier adoption in scooters, particularly in emerging markets.

Mission Motors, founded by former Tesla engineer Forrest North, currently CEO of Xatori, is concentrating on performance, developing a line of electric motorcycles suitable for racing.

Tesla alum, who were there when the company was developing its earliest prototypes, say they’re not surprised at the entrepreneurial bent of its team.

“There was definitely something magical that happened at Tesla, and it happened very early on,” says Jessica Switzer, who joined as director of marketing in 2005. “The people the company attracted were just the kind of crazy enough engineers who were motivated to revolutionize the transportation industry.”

PayPal Author Sees Four Keys to Strong Alumni Networks

PayPal’s founders and early employees made a lot of money selling their online payments network to eBay for $1.5 billion nine years ago. But they made a lot more after that, founding or funding Facebook, LinkedIn, Tesla Motors, YouTube, Zynga Game Network and Yelp, among others.

Just how they did that is a question that Eric M. Jackson has spent considerable time pondering.

Jackson, a Stanford University colleague of Peter Thiel and an early marketing hire at PayPal, writes in detail about the inside workings of the company in “The PayPal Wars,” his 2010 tome. In a recent interview with VCJ, he summarizes what he believes are the four core elements of a startup that indicates its alumni will go on to other lucrative ventures.

1. At the top of the list, and perhaps most obvious, is that it has to be a success. While people may learn valuable lessons from partaking in failed ventures, they won’t gain the financial resources to launch an ambitious new venture or the cred with investors to get funding for it. Moreover, Jackson says, one won’t have the “richness of experience” that comes from overcoming challenges and prevailing against long odds.

2. Corporate culture plays a role, in particular whether the company takes a top-down or decentralized approach to management. A more decentralized company, where individual and smaller teams are encouraged to take risks and make independent decisions, is more likely to attract employees with an entrepreneurial bent and spawn an alumni network of startup founders.

3. Hiring is perhaps the most crucial. The questions to ask, Jackson says, are: “Are you hiring the best of the best? And are you willing to hire people who are as good as you?” If company founders can answer affirmatively to both questions, then they have a better chance of having both a successful exit and an impressive alumni network.

4. The fourth and final element, Jackson says, has to do with the difficulty of building the company. If the process of getting the company to a successful position was really tough, it’s likely that the founders and early team members will carry some of that mettle into their next venture. PayPal, which had to deal with the challenges of rolling out a brand new payments system on a massive scale, warding off multiple international fraud rings, assuaging government investigators and regulators, and out-innovating deep-pocketed competition, was a case in point of that sort of “real stress test,” Jackson says.

Joanna Glasner is Senior Editor of Venture Capital and can be reached at joanna.glasner@thomsonreuters.com. She tweets at @jglasner.