Draper Fisher Jurvetson toiled for 15 years before its network of affiliate funds produced its first major success in 2005. But the following year, in the span of just nine months, the elaborate network that Tim Draper had carefully assembled was looking wobbly, as three affiliates broke off to go in their own directions.
As other firms start to build their own affiliate networks—including Kleiner Perkins Caufield & Byers and Sequoia Capital—VCJ decided to take a closer look at what went wrong with DFJ’s network, how it plans to fix it and the likelihood that the plan will work.
First, a bit of history. The DFJ affiliate network started in the U.S. in 1990, when Draper, who was still investing his first fund from Silicon Valley, co-founded the Polaris Fund in Anchorage, Alaska.
Draper struck a partnership with Salt Lake City-based Wasatch Ventures in 1995, less than a year after he brought on Steve Jurvetson to what was then called Draper Associates. But the network didn’t really explode until 2000, when the firm added Denver-based Access Venture Partners, Reston, Va.-based Draper Atlantic, New York City-based Gotham Ventures, Pittsburgh-based Draper Triangle Ventures, Seattle-based Timberline Ventures, Los Angeles-based Zone Ventures and global affiliate DFJ ePlanet Ventures.
The network continued to expand even after the dot-com implosion, adding Northfield, Ill.-based Portage Ventures in 2001, Sacramento, Calif.-based DFJ Frontier in 2002, Toronto-based Primaxis Tech Ventures in 2003, and Houston, Texas-based DFJ Mercury and Sydney, Australia-based Southern Cross in 2004.
The DFJ affiliate network was designed to do the one thing that conventional wisdom said venture capital couldn’t do: scale. While firms such as New Enterprise Associates and Matrix Partners were working out of bi-costal offices, DFJ was shooting for something much larger. The firm wanted to get its fingers into as many hot spots around the globe as it could, with the hope of diving into any deal that looked particularly promising. The network was designed to funnel the world’s entrepreneurs through DFJ’s doors without putting the partners on airplanes.
The network expansion was a gamble and, as of mid-2005, it still wasn’t clear if it would pay off. Then ePlanet struck it rich with three big hits in a row: Focus Media (Nasdaq: FMCN), Baidu (Nasdaq: BIDU) and Skype (bought by eBay). It wasn’t until after DFJ had its global success that Silicon Valley seemed to truly wake up to the potential of global investing. Sequoia Capital opened offices in China and partnered with Westbridge Capital in India within a year of DFJ’s successes. Kleiner Perkins Caufield & Byers opened its first international fund, in China, after that.
But the success of 2005 quickly turned into disappointment when ePlanet broke off to pursue its own course in January 2006. (EPlanet co-founder Asad Jamal could not be reached for comment.) Then, in October, DFJ New England and Draper Atlantic Ventures broke away from the network to raise a fund for a joint effort called New Atlantic Ventures.
Show them the money
Tim was not being as reasonable as he is now. [The partners at New Atlantic Ventures] were the first ones that hit him up to rethink it. His first response wasn’t to give in. It was to say, ‘A deal’s a deal.’”
Frank Creer, Managing Director, Zone Ventures (a DFJ affiliate
The schism was driven by economics. The East Coast affiliates had finished investing their funds and were ready to go back to their LPs to raise fresh capital. Draper proposed that the affiliates accept the same economics they faced for their first funds, but they wanted to revisit their financial arrangement.
The affiliates’ reticence came as a surprise to Draper, according to Frank Creer, managing director of Zone Ventures, DFJ’s Los Angeles affiliate. “I just don’t think he was thinking about it,” Creer says. “He just said, ‘Let’s re-up,’ and they said, ‘No.’”
Negotiations were at an impasse. When New Atlantic Ventures split off from the network, “Tim was not being as reasonable as he is now,” Creer says. “They were the first ones that hit him up to rethink it. His first response wasn’t to give in. It was to say, ‘A deal’s a deal.’”
Draper says DFJ Atlantic and Draper New England left for multiple reasons. “Economics was probably one factor there, though other considerations came into play,” he says. He adds: “We think highly of the DFJ NE and Draper Atlantic teams and we may well decide to have them rejoin the DFJ Network at some point. I know they are interested in rejoining.”
It turned out that the partners at New Atlantic weren’t the only ones in the network who wanted to revisit economics. Some partners were asking themselves if the value of the DFJ brand was really worth what they were giving up in management fees and carry.
Creer’s Zone Ventures was one of the firms thinking about leaving. It had just come off a big hit with DivX (Nasdaq: DIVX), which went public last September with a $145.6 million offering and that has since seen its stock price soar 45 percent. “There’s no way we’ll have anything near the same deal we had with Tim seven years ago,” Creer says. “Now that [Zone Ventures] has been successful and there’s money flowing around, it’s a painful deal.”
“The affiliate model was flopping,” says Paul Kedrosky, a venture fellow with Ventures West Management in Vancouver, B.C., and a professor at the University of California, San Diego. An overhaul was “long overdue,” he says.
Draper had talked about the synergies the affiliate network could provide for years, but it was quickly slipping out of his hands. Even some of the DFJ partners were against it.
The cavalry is coming
The affiliate model was flopping. [An overhaul] was long overdue.”
Paul Kedrosky, Venture Fellow, Ventures West Management
But Draper brought them around by promising to bring in somebody new to manage it. Last October, Draper brought on Don Wood, who had been a Managing Director at Vanguard Ventures. His assignment: tune the network to keep it humming along.
The thinking was that since Wood was an outsider, both Draper and the affiliates could trust him to arbitrate. “Tim needed to know he wasn’t being taken advantage of,” Creer says. “There are a lot of guys out there who wouldn’t have hired a thoughtful guy like Don. They would have said, ‘Screw you.’”
So, on a sunny day last November, Draper introduced Wood to a roomful of affiliate managing partners at the Ritz Carlton next to the ocean at Half Moon Bay, Calif. There was an upbeat feeling as Wood laid out the new economics the firm planed to offer its affiliate partners.
Matrix II, as it’s called, will include a shared carry pool that each of the affiliates contributes to and benefit from. The network would now generally get about 1 basis point of the returns from an affiliate, or about 4% of the affiliate’s carry. Many in the audience started to nod, realizing the diversity it would bring to their personal holdings.
This was a big step in the right direction. “There was a notion of shared carry before, but it wasn’t really material,” Wood says. “We increased it, which really glues the network together. It forces everyone to pay attention to each other’s deals.” DFJ also shares fees with its affiliates at different levels. A first-time affiliate might expect to pay a greater portion of its fees to DFJ than an affiliate with a longer track record.
Wood then talked about how DFJ would expand to new parts of the globe: Brazil, Vietnam, Russia, South Korea, Japan, Europe, Israel and India. There are also plans for new sector-focused funds, including funds targeting life sciences and media.
Ears really perked up when Wood laid out his plan to make it cheaper for each affiliate to do business. Just as the firm signs up its U.S. affiliates for the National Venture Capital Association at a discounted price, the affiliates should expect discounts on other products and services—from collective purchasing of health care plans to lawyer contracts to color printers. DFJ already handles the back-office processing for about half of its affiliates and plans to expand its operations to handle more of the work.
The firm and its affiliates would work more closely together, as well. Wood emphasized the importance of sharing intelligence between different regions and how he planned to launch an Internet portal that would make it easier for affiliates to exchange information. It would feature partner blogs, details of the deals each affiliate is examining and information on country trends.
There was, admittedly, instability in the network … so the partnership decided to bring somebody here to focus on it.
Don Wood, Managing Director in charge of Network Affiliate Funds, Draper Fisher Jurvetson
At the end of Wood’s presentation, Scott Lenet, a managing director at DFJ Frontier, remembers thinking: “This is going to be good, this is going to get better.”
Lenet sees the proposed changes as more of a tune-up than an overhaul. “Having a dedicated partner on the network shows that it’s a priority, and [Wood] is doing a great job,” he says.
Other partners at affiliate funds told VCJ that the economics of Matrix II are easier to understand and more compatible with the goal of information sharing.
Sitting in his office in the DFJ complex on Sand Hill Road, Wood keeps a map of the world on one wall, with pushpins indicating the locations of various DFJ affiliates. The other wall has two framed Roger Broders original travel posters. Their bright colors and art deco sensibility brighten the room. On his desk is a framed picture of himself decked out in golf gear standing with Arnold Palmer.
“There was, admittedly, instability in the network,” Wood says. “It was demonstrated, but it was being managed by Tim and by everybody, and Tim is doing a million things, so the partnership decided to bring somebody here to focus on it.”
Wood has already delivered on a lot of his promises. DFJ has announced a final close on its first Brazilian fund, a first close on its Vietnam fund and a first close on a second fund from affiliate DFJ Frontier.
With some success under his belt, Wood is brainstorming again. “We’ve got to get smarter about this,” he says.
Part of being smarter means applying numbers to the seemingly scattershot affiliate expansion efforts. He recently commissioned a group of Stanford Business School students to do a country-by-country analysis of where the ripest places for venture capital investment were.
France scored surprisingly high, because of its high number of engineers and the relative deficit of other technology investors. Nigeria showed well, too, but DFJ has no plans to go to Africa any time soon, Wood says.
Having a dedicated partner on the network shows that it’s a priority, and [Don Wood] is doing a great job.”
Scott Lenet, Managing Director, DFJ Frontier (a DFJ affiliate)
But wait, there’s more!
Instead, Wood has come up with something even more ambitious. He wants to raise as much as $500 million for a new co-investment vehicle called the Network Fund, which would invest alongside its growing worldwide affiliate partners.
The new global network fund would look similar to a fund of funds, but would manage parallel investment vehicles to each of the existing affiliates. Each investment from the network fund would be done on a deal-by-deal basis and individual affiliates would have the right to block any investment.
The fund would have a 25% carry and a 2.5% fee, the same terms as the DFJ core fund, and it might include an evergreen fund structure. It could provide capital up to 20% of each affiliate’s fund size.
The structure could be appealing to limited partners who want to invest globally but don’t have the resources to do the due-diligence on multiple funds. It may even help each of the affiliates raise money by putting their results in front of LPs invested in the Network Fund.
But for all of Wood’s work in tuning up the DFJ affiliate network, challenges remain.
One of the biggest challenges is getting the network to share information and deals. The economic advantages of general partners sharing a hot deal within the network may be dwarfed by the potential benefit to the entrepreneur of partnering with a top-tier firm. Once an entrepreneur has chosen one affiliate, he or she may not perceive a real added value to bringing additional DFJ-related resources to bear.
Then there’s the problem of complexity. Although there will no doubt be economies of scale as the firm adds more affiliates, there’s the risk that the network will become unwieldy and impossible to manage.
We have learned a lot from our experience and have made changes along the way. We now believe we have refined our model and the DFJ Network is working well and growing quickly.”
Tim Draper, Founder/Managing Director, Draper Fisher Jurvetson
Yet it doesn’t seem to concern the affiliates. “All the people who are running affiliate funds are confident enough of their own thing so that they won’t get lost in the shuffle,” Frontier’s Lenet says. “I think if I had the mindset that I needed to be babysat by DFJ, I wouldn’t be running an affiliate.” If anything, Lenet says he’s glad there will be more experts in more locations he can tap into.
And even if entrepreneurs and affiliate general partners buy into the new plans, there’s no guarantee limited partners will. “LPs were confused by [the affiliate network],” Wood confesses. “They call them sponsored funds, but they’re not. We hadn’t done as good a job as we needed to in explaining the network.”
It’s amazing what a tune up can do. Wood has been in contact with New Atlantic Ventures—the firm that resulted from the combination of DFJ New England and Draper Atlantic Ventures. The interaction has been positive.
“We think the world of the team at DFJ, Don Wood and their global network,” says John Backus, a managing partner at New Atlantic. He predicts the two groups will continue doing deals together. Wood seems to agree. “There is a strong likelihood we will reconnect after their fund is in place,” he says. “It could make sense for us to have them rejoin the network. Crazier things have happened.”
The affiliate network model itself may have seemed a little crazy when Draper first launched it. Some LPs, other VCs and even DFJ partners questioned if it would work. Then, just as the investment effort seemed to be paying dividends, the network looked tenuous once again.
“We have learned a lot from our experience and have made changes along the way,” Draper says. “We now believe we have refined our model and the DFJ Network is working well and growing quickly.”
Managing the network must seem to Draper a lot like running a startup. It takes a delicate touch to reign in growth and manage success and expectations. You have to act fast to correct any instability. It’s easy to imagine the words of his song “The Riskmaster” ringing in his ears: “Lives fast drives faster, skates on the edge of disaster.” Sequoia, KP and any other firm thinking about building its own affiliate network had better take note.