Venture capitalists spend a lot of time imagining what the future will look like. And right now is the time to imagine what the venture capital industry itself will look like 10 years down the road. To be sure, the venture capital industry will continue to play an important role in the global economy by fostering entrepreneurialism. At the same time, it is clear that the list of the top tier venture firms and what those firms look like will be significantly different.
Venture firms are dealing with a number of key issues, including succession planning, aligning interests with limited partners and keeping pace with the evolution of this ever-changing industry. As the industry approaches an inflection point, some firms will take a proactive approach in assessing their strategy and will become leaders. Other firms will be reactive and will fall by the wayside. In trying to peer into the future, it would be useful to examine the past of both the venture industry and other mature industries that have followed a similar trajectory.
Back To School
If history is a teacher, then the most innovative firms will lead the industry to the next level. At Crescendo, we believe that success is a function of how well a firm uses organizational leverage and synergy to change the additive formula of its team into one with a significant multiplier effect. It takes more than simply the sum of a firm’s individual parts or its partners.
As any industry matures, it becomes more organizationally sophisticated in a number of ways. Roles functionalize, efficiency multipliers are discovered and systems are developed to derive increasing value from the same set of assets. A spectrum of industries have undergone this transition range from the Industrial Revolution’s textile mills to the investment banking industry in the 1970s. Like the venture capital industry, these diverse industries also began as “craft” businesses. As the industries matured and their scale and economic contributions increased, so did their level of professionalism.
The venture capital industry is no different. Believing that the venture capital industry can somehow defy the fundamental forces that shape all maturing industries is like the belief all too common just a few years ago that the “new economy” somehow defied all previous economic rules. We can learn a valuable lesson from the innovative textile mills and investment banks that emerged as market leaders after their industries transitioned. Professionalism offers a critical edge.
No time more than the present illustrates the need for professional management and organizational discipline on the part of venture capitalists. As the venture capital industry emerges from its present state of disarray, venture firms that want to take their organizations to the next level of performance will have to reassess their traditional methods of making decisions, adding value and serving their various constituencies. But, an “institutionalized” investment and firm management approach doesn’t materialize out of thin air. It is just one extension of a huge undercurrent of professionalization rippling through our industry. The recent boom-to-bust cycle is making VCs do a lot of soul searching. One of the positive outcomes of this cycle will be turning the way venture capital firms are run into the way real businesses are run.
Venture capital firms are turning an introspective eye to improving their own firm’s processes and achieving better performance. Venture capital is going from its beginnings as a cottage industry to what institutional investors see as a more “mainstreamed” asset class.
Too Much Pressure
There will be greater pressure to deliver not only compelling performance numbers but also consistent, high-quality service to every player in the food chain from the entrepreneur in the trenches to the limited partner watching ROI.
VCs must focus on three constituencies to take their organizations to the next level of professionalism and performance: their firms, their limited partners and their entrepreneurs.
Venture capital firms have traditionally used ad hoc processes. For example, how many funds actually have a business plan? Codified, systematic, and repeatable processes have been virtually non-existent in the industry. While it is true that it is impossible to institutionalize good judgment and intuition, there are some fundamental principles, along with firm-wide knowledge, that can be captured and systematically embedded into the fabric of a firm’s operations. A disciplined investment process that incorporates a consistent due diligence and deal structuring plan is the simplest example of a professional system. Where professionalism and institutionalization get challenging and where the future winners and losers will be created is in the post-investment part of the venture process.
New Tool Set
In the future, the key won’t just be adding value on a one-off basis or knowing the guy who knows the guy your portfolio company wants a meeting with. In the future, firm professionalism will center on knowledge sharing systems, post-investment risk-management tools, second-generation decision support technologies and improved communication programs that increase the effectiveness and transparency of the value-creation food chain. The fundamental traits that make a firm successful, such as good networks, deep domain knowledge, a value-added focus and business building experience won’t change. They will, however, be supercharged by those firms developing the organizational structures, systems and tools that multiply their impact on an enterprise-wide basis.
No “I” In Team
Venture firms also need to take care of everyone in their organization, not just a few “superstars.” This means providing performance-based financial incentives to their entire team, creating engaging and rewarding career paths, and actively mentoring younger professionals. VCs need to invest the time to develop future generations of investment professionals. Keeping the benefits of the entire firm in mind is the cornerstone of any great organization. Venture capital firms, in this respect as well, are no different.
Another area of our industry that demands greater professionalism and organizational maturity is the relationship between a firm and its limited partners.
About Those LPs
LPs want to associate with firms that have systematic and repeatable processes, organizational continuity without transition risk and accountability for the success or failure of portfolio companies. LPs have been to enough venture firm annual meetings that focus on presentations that highlight the best companies in the portfolio. The message is clear from our extensive dialogue with the LP community. Communication is a critical part of every long-term relationship and LPs value candor, straightforwardness and integrity.
The next level of portfolio company discussion will focus on an in-depth analysis of risk and potential along with the performance goals that have been set on a quarterly and annual basis. Limited partners must be kept in the loop about the status of portfolio companies more frequently and be provided sound analytic metrics by which to gauge their progress as well as our progress in helping those companies.
As the industry builds on the foundation of what it has learned from its successes and failures over more than three decades, the overriding question in our minds is always: “How do we make money for our limited partners?” As industry pioneer Reid Dennis said in the late 1970’s: “The portfolio companies we build are our products and we are measured by how successful they are.” As an industry, we need to continually move forward in the evolution of what it takes to build successful companies. And today, that means challenging the wisdom of many historical practices, adopting more leverageable business models and implementing new methods of delivering value to both portfolio companies and investors alike. These will be the determinants of future success. t
R. David Spreng is co-founder and managing general partner of Crescendo Ventures, which is based in Palo Alto, Calif. He was previously a founder of IAI Ventures, which became Crescendo Ventures. He started out as an investment banker, working at firms such as Salomon Brothers and Dain Bosworth. He sits on the boards of Allied Riser Communications, CoSine Communications, Digital Island, and Tut Systems.
Vishesh Kumar, a research associate for Crescendo Ventures, contributed to this article.