The recipe for a successful start-up seems to have three main ingredients: an idea, money and people. While the majority of would-be entrepreneurs probably believe the difference between success and failure is funding, any number of venture capitalists will tell you that the quality of a portfolio company’s management team is often the real determining factor in a company’s development.
“Human capital is extremely important to a developing business. It is probably the number one single concern to a founding chief executive officer,” says David Spreng, a partner at Crescendo Ventures. Human capital is such an important factor in the investment decision making process that a strong management team can compel a VC to invest in a less than entirely overwhelming deal. “I will do an A quality management team with a B quality deal,” says Russell Hirsch, a general partner at the Mayfield Fund.
So while it might sound like a tired cliche, most VCs really do mean it when they say they invest in people, not simply ideas. However, VCs do more than simply invest in smart people. They have always been in the business of helping to fill out their portfolio companies’ management teams in an effort to try to ensure a positive return on their investments. These recruiting efforts have traditionally relied heavily on an individual VC’s personal network of contacts – business school classmates, professional acquaintances and, perhaps, even golfing buddies – to locate a chief executive officer for one company and a vice president of sales for another fledgling enterprise.
This approach seemed to work just fine in the old days, but anyone who has paid attention to the ever-growing list of firms raising $1 billion plus funds knows, the old days are over. In today’s marketplace more and more firms are touting their ability, through strategic relationships with search firms, or their own internal recruiting coordinators, to aid their portfolio companies in their search to find the right executive.
Why the sudden emphasis on recruiting, if it is a service VCs have always been providing in some fashion? To some extent, it is simply the next evolution in the development of value-added services firms’ offer to their portfolio companies, VCs say. “As the VC industry grows and seeks to add more services, this is a natural area to focus on,” Crescendo’s Spreng notes.
While having special recruiting services available for your portfolio companies is an easy way for a VC firm to demonstrate that it brings more value-added services to a deal than one of its competitors, a number of VCs say a bigger factor in the recent focus on recruiting is simple math: There are not as many executive-level candidates in the marketplace as there are jobs. Super-size funds have invested in a breathtaking number of new ventures that have seriously ramped up the demand for talented people, making recruiting more difficult than it has ever been before.
“Recruiting has gotten tougher because of supply-and-demand in the marketplace. The Internet has created a ton of new opportunities. Asset allocation can rise to meet this right away, but population growth takes a lot longer,” notes David Cowan, managing partner at Bessemer Venture Partners.
Don Wood, a general partner at Vanguard Venture Partners agrees with Cowan. Last year he heard that there might have been as many as 180 unfilled chief executive officer or chief financial officer positions at Silicon Valley start-ups, whether or not this story is true, Wood says it clearly illustrates the growing level of demand for talent that exists in the marketplace. “There is more need for qualified management candidates than ever before… it would not surprise me at all if demand in the marketplace has doubled in the last two years,” he says.
The Hurdle Gets Even Higher
In addition to increased demand, VC firms recruiting for their portfolio companies are finding that with the Internet bubble finally having burst, many management candidates are not willing to jump to some start-up, whatever industry it’s in, just because it offers them an equity stake in a developing company. “Fear has overcome greed, so now people are asking the right, hard questions about a company before they join it,” says Ron Celmer, a general partner at Constellation Ventures.
Vanguard’s Wood echoes Celmer’s opinion. “If you have a business-to-consumer dotcom, you will have a hell of a time recruiting anyone right now, whereas a year-and-a-half ago, people were jumping ship to join these places,” he says. And don’t think that everyone who worked for a nascent, venture-backed company will be eager to join the fray again, he notes. “For a 25 year-old who was just laid off by a dotcom, the lure of good, well known company – like a Microsoft Corp. – with a good boss who can teach you the business would probably be great right now.”
“Recruits are being more careful, because they have simply gotten a reality check recently. Businesses do fail, and a successful company needs something more than a bucket of money and a poster child CEO,” says Christopher Kidd, managing director of recruiting company Korn/Ferry International’s private equity and venture capital practice.
Candidates who are considering joining a VC’s portfolio company are conducting a lot of due diligence on their own to make sure they are joining an entity with a reasonable chance at success, he adds. “If a candidate is smart enough to be your company’s president, he is smart enough to really review the company, because someone’s career is the only non-renewable resource in the marketplace,” he notes. This means a candidate wants to know if the company in question has enough money to operate and reach its developmental milestones, and if it has the full support of its venture backers, who, preferably are well known VC firms, Kidd says.
John Menkart, who joined Mayfield portfolio company WEGO Inc. in April as a vice president of sales, says knowing that an established VC player like Mayfield stood behind WEGO was an important part of his decision-making process as he considered joining the company. Mayfield’s Hirsch explained to Menkart what working for a Mayfield portfolio company meant.
“Russell’s involvement in the recruiting process was critical in providing a level of comfort that got me here,” Menkart says. “He made it clear that downstream I can work with Mayfield again depending on what happens here… there are a lot of opportunities that will be available to me now that I could not get if WEGO was not backed by such a top-tier VC.”
Not only does a candidate want to know that he is joining a company that has solid venture backers, he also wants more money up-front today than a year or two ago, executive recruiters say. Fluctuations in the public market have made equity less attractive to candidates now, because a record-breaking initial public offering seems much less likely.
“Candidates are taking more cash and are less focused on equity because of the uncertainty of its value,” says Adam Zoia, managing partner of Glocap Search LLC. Korn/Ferry’s Kidd says the price may even be higher than this, with candidates wanting both more cash and at least the same or more equity now than before. “But if you get a good candidate, you make up the money you spend to get him in a successful IPO,” he adds.
Looking for Help
More available jobs and fewer willing candidates have sent portfolio companies scurrying to venture backers looking for recruiting help, VCs say. “Our entrepreneurs said to us over and over that they needed help,” Crescendo’s Spreng says. In situations like this, VCs have always turned to search firms to find executives, Bessemer’s Cowan says. But in today’s recruitment marketplace, it is hard to get a search firm to take on a new search, unless you have an existing relationship, Hirsch says.
“Yes, frankly, we are turning work away because of limited bandwidth,” says Korn/Ferry’s Kidd. In addition to manpower restrictions, search firms simply are not willing to take on searches they do not think they can complete, he adds. “There is a lot of froth in the market and a lot of companies out there that should not be companies. And the fee we get for a search is wasted, if we cannot complete it and then end up with a black eye in the marketplace,” Kidd says. “All searches are hard and we just do not take on the impossible ones.” For a smaller and/or lesser known VC firm, this can mean getting a well-known search firm to take on an executive search is a near impossibility, VCs note.
In order to counteract this situation many firms are doing their best to maintain solid relationships with search firms – i.e. bringing them executable, interesting searches for solid portfolio companies, in order to make sure their searches get done.
New Enterprise Associates, for one, does its best to have good relationships with a number of best-of-breed search firms, says Scott Sandell, a general partner at the firm. Ultimately, NEA – like other VCs who try to maintain solid relationships with search firms – relies to a certain degree on its size and reputation. “We have a significant market share in the industry, so we represent a lot of business,” he says. “We also have a significant track record of good investments, so if a search firm is investing their time they want to do it for a firm that has proven ability.”
Crescendo has brought an employee of a search firm into its offices to coordinate its search efforts for engineers, Spreng notes. The VC has also entered into relationships with other search firms that guarantee those firms will take on executive searches for Crescendo’s portfolio companies, he adds. The firm even held a job fair for its portfolio companies in early October, he says. “We did all of this because of our obsession with helping entrepreneurs,” he notes.
After surveying the status of the recruitment marketplace and considering entering into a strategic relationship with a search firm, Bessemer decided the best way to make sure its portfolio companies received timely and adequate attention from a search firm was to acquire one. In February, Bessemer acquired search group Lexington Partners, now Bessemer Search Group LLC (BSG). “As we considered it, it became clear that our portfolio companies had more than enough work to keep one firm busy, so a strategic relationship would not be enough,” he explains. Now Bessemer’s portfolio companies do not have to worry about getting a search firm’s attention. Instead the portfolio company can choose to work with the internal search group that already knows the company and does not need to waste time establishing a relationship.
Bessemer benefits because it owns the results of its search groups efforts. “A regular search firm might locate seven to eight candidates for a particular position, but only one gets the job, but there were six or seven other attractive candidates who we would like for our other portfolio companies,” Cowan says. “But the firm owns that information, so if we hire one of those candidates for another company we have to pay for a whole new search that did not take place.” But now, Bessemer owns the results of a search conducted by its search group and can put the other candidates to use instantly, he notes. “It’s a beautiful thing, because as soon as a search is done and one candidate is placed, I am on the phone the next day with another one of our portfolio companies saying have I got a guy for you’.”
Cowan says he believes that Bessemer’s co-investors are uniformly impressed with BSG’s degree of service. “I would be surprised if they are not thinking about a way to deliver these same services to their portfolio companies in which Bessemer Venture Partners is not a co-investor,” he comments. The search group has placed 12 to 14 executives to date, he says. Bessemer’s portfolio companies do not have to use BSG for an executive search, he adds.
While other VCs acknowledge the logic behind Bessemer’s move, they still wonder how effective an internal search service really can be. Vanguard’s Wood says his firm prefers to try to maintain working relationships with a number of search firms because it believes recruiting is a specialist talent that requires a certain amount of expertise and scale. Not so surprisingly, Korn/Ferry’s Kidd is skeptical of in-house recruiting group’s ability to compete with an established search firm. “You cannot convince me that your 30 guys can be as effective as Korn/Ferry’s 4,000 people,” he says.
What Does the Future Hold?
Some VCs say they believe recruiting for their portfolio companies is actually getting a little bit easier, thanks to all the “dotbombs” that are falling by the wayside. Polly Schneck, a partner at Labrador Ventures, says failing dotcoms are throwing off a fair number of battle-tested executives, which is actually making recruiting for portfolio companies easier. Kidd, on the other hand, says while its true that a number of potential executives are once again entering into the job market, he believes the number of new positions still being created means demand is as high as ever. “For every dotcom flameout, there are five other start-ups,” he notes. “So yes, there maybe some more candidates coming into the marketplace, but they have a number of opportunities that are as good as the one they just left, so it is not alleviating demand in anyway.”
In fact, Kidd warns if you think the recruiting crunch is bad now, our nation’s demographics are only going to make it grow worse. “Ten years from now, there are not going to be as many 40-year olds as there are today,” he says. “Also, we pretty much know how many people were born this year and we, Korn/Ferry, can project how many technology-based slots there will be, say, 18 years from now and how many managers will be needed 10 years after that and there is a shortage of people. After that, it becomes more acute, not less.”