Henry McCance, resident graybeard of venture capital firm Greylock, knows all about the perils of succession planning. Greylock, after all, rose from the ashes of an older firm called American Research & Development. The name probably doesn’t ring a bell, but back in the 1970s it carried the same heft and legitimacy as Kleiner Perkins Caufield & Byers does today.
But something happened to American Research & Development that is not so uncommon in the venture industry. The founder of the firm, the legendary General Georges Doriot, refused to hand over control till well past his 70th birthday. But by that time it was too late. Inner turmoil and management squabbles had crippled the firm. Many of its young, ambitious professionals simply abandoned American Research & Development and started their own VC outfits. So, just like that, a firm that should still be an industry leader is now a mere footnote.
With all the earthshaking events rocking the venture industry these days, succession planning may not seem like the most riveting issue. It’s not as sexy as the bitter battles between LPs and GPs or the dismantling of billion-dollar funds. But succession planning just may be the most critical issue facing every venture fund. After all, it could mean the difference between evolution and extinction.
|“The VC business is one of the last great crafts, and it takes time to learn how to be good at it. Losing the talent that you worked long and hard to train is a costly mistake.”|
Years as VC: 33
There are no hard figures about the failure rate of succession planning at VC firms, but you can get some idea about how difficult the transition is by looking at family businesses. That’s not too much of a stretch since many VCs have made lifelong commitments to their firms. The unsettling fact is that just three out of 10 family-owned businesses succeed at making the transition from the first to second generation, according to the Small Business Administration. Knowing how most VC firms operate, it’s easy to see how, like a family business, they could trip up in trying to pass the firm from one generation to the next. Even if you hire bright and talented young people, there is no guarantee that they will have the same skills (like an uncanny ability to hire the perfect CEO or sales manager) that made an older team successful.
“The VC business is one of the last great crafts and it takes a long time to learn how to be good at it,” says McCance. “Losing the talent that you worked long and hard to train is a very costly mistake.” The founders of Greylock agreed from the start they would create a non-hierarchical firm where junior partners and young associates had an equal voice at the table. They also decided it was in the firm’s best interest to push a greater chunk of the ownership and management duties to the younger partners as quickly as they could handle the responsibilities.
“Greylock was innovative from the beginning,” says McCance. “We would put together a new fund every four or five years and reallocate ownership to reward younger GPs with a greater piece of the carry. In my opinion, we transferred management responsibilities sooner than other firms.” There is no denying that Greylock’s strategy has been a winning one. The firm is now on its 11th fund and shows absolutely no signs of slowing down. True to form, Greylock’s current fund is co-managed by Aneel Bhusri, a relative newcomer to the firm who earned his stripes making enterprise software investments. In fact, Greylock has had more managing or co-managing partners than its total number of funds. “We are like the 1950 Chicago Cubs with a manager a month,” jokes McCance. “I think the good side of that is we don’t have a lot of egos around here.”
Egos are a disruptive factor in every industry, and venture capital is no exception. Egos exist on both sides of the equation. On one hand, there are the founders of venture firms who are reluctant to relinquish control. On the other, there are the younger partners who work hard, learn the ropes and eventually desire a leadership role. It’s a delicate balancing act to get both these egos in check, to know exactly when the older guys should step aside and the younger guys should rise up.
The Young Turks
One of the most dramatic clashes in the venture industry occurred back in 1999 when disaffected partners at blue chip firms Brentwood Venture Capital and Institutional Venture Partners (IVP) rebelled against their elders and formed their own firm, Redpoint Ventures. Some argued that the Young Turks were disrespectful and were not yet ready to assume control, which may have been legitimate criticism given Redpoint’s less-than-spectacular performance to date. Others, though, believed the founders were hanging on for too long and were preventing younger partners from making their mark.
Reid Dennis, who founded IVP in 1974, admits he was caught off guard by the defections. “I now realize it is very, very difficult to plan for succession,” he says. “I thought I had done a good job, but it turned out that some people wanted to start their own firm.” He says the absolute kiss of death is for any founder to hang on too long and draw a huge salary when his bright young partners are achieving all the results. Dennis believes the best thing any firm can do is attract bright young people and then give them a large enough piece of the pie to keep them interested enough to stick around. That’s what he tried to do. But even that wasn’t enough. The Internet bubble came along and changed everything. “Too many people flew into the industry,” he says. “They thought they were terribly smart but they were just lucky to be in a bull market.”
|“It’s not impossible that our firm could break up, but I think we have a culture that prevents that. We invite the young guys to speak their minds and challenge the established ways… plus their carry increases with each fund.”|
Years as VC: 33
Sam Collela, a senior partner at IVP at the time who has since gone on to help found life sciences firm Versant Ventures, says there should be an obligation on both sides. “In general, I believe that all egos should be parked at the door,” he says. “Young partners should respect the founders and founders, likewise, should make sacrifices and have the generosity to let everyone share in the economics.”
Even at Greylock, generational transfers do not always go according to plan. The venerable firm recently lost 34-year-old Chip Hazard, who had worked his way up to general partner in record time before bolting for IDG Ventures in May. “The thing that ultimately led me to find this really exciting was a chance to get in on the ground floor, and really develop IDG’s presence in the East Cost,” Hazard told the Boston Globe. It’s not clear whether there were other internal problems at the firm, but some critics believe the defection deals a blow to the notion that any succession plan is failsafe.
Summit Partners is one firm that believes in learning from the mistakes of others. “It wasn’t too long ago that you saw very significant firms in our industry blow up right and left,” says founding managing partner Steve Woodsum. “It was with an eye toward this problem that made us address the transition issue. The only responsible thing to do for both our general partners and our limited partners is to think about succession planning.” But Summit is doing more than just thinking. It’s acting. Woodsum says that the firm was not named after any of the founders because from day one back in 1984, the goal was to create something that would outlive them. It took 16 years of grooming and mentoring before the founding partners officially handed the wheel over to a new team of managing partners when it closed its latest fund in 2000.
As they were marketing the new fund, Summit’s partners, young and old, made it clear to LPs that they were not just buying into a new fund but a new firm. New in the sense that its team of five managing partners is made up entirely of young bucks: Bruce Evans, Walter Kortschak, Martin Mannion (on the cover of this issue), Thomas Roberts and Joseph Trustey.
Today, even though the industry is going through unprecedented turmoil, the firm remains committed to recruiting fresh talent that will someday replace the current management team. “Staffing up is important as we continue to expand our franchise into newer areas,” says Kortschak, who joined the firm some 14 years ago straight out of business school. “It will take multiple generations of grooming before [young associates] are ready to run the firm.”
Meanwhile, at Morgenthaler Ventures, 82-year-old founder Dave Morgenthaler says it was no mean feat stepping back from the firm he founded in 1968. “It’s not easy to let somebody else make the decisions and doubly if you have some doubt about the decisions that are being made,” he says. “But you have to do it.”
Morgenthaler, who is still active in his firm, relinquished control in 1995 and was officially replaced at the top by four senior partners who are in their 50s and 60s. When the firm raised its latest $850 million fund late last year, it added four more partners, who are all roughly in their mid-40s, to the management structure. “Each firm has its own culture, and from the beginning our firm was supposed to last beyond Dave,” says general partner Bob Pavey. “It’s not impossible that our firm could break up, but I think we have a culture that prevents against that. We invite the young guys to speak their minds and challenge the established ways. Plus we have a structure for wealth sharing where their carry increases with each fund as they contribute more to the firm.”
|“LPs are now deciding which funds they will remain with and which funds they will abandon. If they see a team where a couple of guys are taking home 90% of the carry and the rest only get 10%, they’re afraid a team like that could implode.”|
President and Founder
Whereas two or three years ago succession planning was on almost no one’s radar screen, today it is fast becoming a hot-button issue for GPs and LPs alike. That’s because the venture business has become hard again. Senior partners who made big money during the Internet feeding frenzy now realize that hanging out at the beach house is a lot more fun than fixing bad investments. But many firms are unprepared to make the transition from the old guard to the new. “Firms grew quickly in the last few years and took on young people who were quickly thrust into big decisions and serious roles before they had a chance to apprentice and learn the ropes,” says Lucy Marcus, founder of Marcus Venture Consulting. “Even the best firms suffer from not mentoring and training people. Some of today’s top firms may lose their leadership positions while [up-and-coming] funds nip at their heals to take those top spots.”
In today’s topsy-turvy environment, LPs are increasingly hesitant to commit to any firm, even those with whom they have long-standing relationships. Art Marks, a retired general partner of New Enterprise Associates who is building a new firm called Valhalla Partners, says LPs are concerned on at least three counts. One, they don’t know the junior partners because the junior partners haven’t raised money from them before. Two, “LPs are concerned that many of the younger partners are only proven in a bull market and do not know what it is like to successfully invest and develop companies in a bear market.” Finally, LPs are genuinely concerned that the vets who made all the money on the earlier funds are going to find it much more difficult to repeat their success and may just chuck it because they don’t want the headaches.
Generational change touched a nerve on a panel of limited partners during the National Venture Capital Association’s annual meeting in May. The most vocal LP was Mike McCaffery, chief executive officer of Stanford Management Co., which has $7 billion under management and has invested in the likes of Accel Partners, Menlo Ventures and Oak Investment Partners. “You don’t have enough people in this industry who’ve worked through down cycles, and this is going to be a long one,” he told a packed house at the old-money Westin St. Francis hotel in San Francisco. The issue is: “How motivated are people who went through the past 15 or 20 years, which was a bull market?”
Not only does McCaffery expect to see some veteran VCs retire, he predicted that “if management fees aren’t realized, the young smart people will leave.”
Fund-of-funds manager Gary Bridge is concerned about the generational issue, too. Bridge, who also sat on the NVCA panel, is managing director of Horsley Bridge Partners, which manages more than $2 billion for clients such as Deere & Co., Du Pont, Rice University and Xerox. Bridge told the crowd that a changing of the guard is a “natural phenomenon,” and he expects to see much more disruption in the next couple of years. “Firms break up, people get together who were in separate firms. It’ll happen, and it’ll happen again,” he said. “My concern is that the younger people haven’t been properly mentored. There wasn’t enough time in the last few years.”
Paul Yett, a vice president with fund-of-funds Hamilton Lane Advisors, says he is experiencing a lot of heartache deciding whether to re-invest in a certain East Coast fund. “The senior team made tons of money, and I’m just not sure the next level of partners is as good,” he says. “The firm has just gone through a generational transition, but from my perspective the transition was rapid and I just don’t think the new group has had enough time to prove itself. At this stage, they just haven’t demonstrated to me whether they are good or not.”
That’s exactly the kind of criticism that Battery Ventures wanted to avoid when it completed its generational transfer in June 2000. Founding partner Rick Frisbie says the firm was careful to take an evolutionary approach to succession planning and not try to execute the change overnight. “Long before I and [founding partner] Bob Barrett handed over the reins, we knew we wanted to create a firm that would outlive us,” says Frisbie. “By definition, that meant agreeing to turn over the firm to the younger guys.” But it also meant working closely with the younger partners and incrementally expanding their roles, so when the time came for them to run the firm, they would be fully prepared. In $200 million Battery IV, raised in 1997, Barrett and Frisbie had “ultimate authority,” explains Frisbie. But in the following fund, a $400 million vehicle raised in 1999, authority over the software and telecom groups was turned over to Oliver Curme and Tom Crotty, respectively. Finally, in $1 billion Battery VI, raised in 2000, Curme and Crotty became the managing partners and assumed full responsibility for the fund.
|“If you’re not flat, you invite discord… If you have junior partners doing all the heavy lifting and [getting a small piece of the pie], then they will rebel against the senior guys who are simply managing the firm’s internal doings.”|
Financial Technology Ventures
Years as VC: 21
With the new management team in place, the founding partners have blended into the background. Barrett left the firm entirely (see story, page 26) while Frisbie cut his involvement in half and now takes home a much smaller piece of the carry. “Our approach was to grow the firm internally,” says Frisbie. “By the time your associates grow to be managing partners, you already know they have developed into good investors.”
It’s hard to say exactly which firms will successfully make the transition and which firms will stumble. One top-tier firm with a murky future is Crosspoint Venture Partners. It made headlines two years ago when it had commitments for $1 billion and then shocked the industry by announcing that it would not raise the fund after all. The firm’s partners explained at the time that they felt they simply could not put that much money to work. Two years later, its LPs are still wondering if it will ever raise a new fund. At its annual meeting for LPs in April, Crosspoint said it had no plans to raise a new fund “anytime soon,” says John Mumford, who founded the firm in 1970. It still has plenty of money from two funds totaling $1.1 billion raised in 2000, and that cash will last for “the next several years,” he explains. And when that fund is fully invested? “We’ll decide what to do at that point,” says Mumford, 58, who officially retired two years ago but is staying on until the 2000 funds are invested.
Mumford’s open-ended answers have left LPs speculating about whether the firm is winding down, especially since it doesn’t have a stable of young partners to take over down the road. Crosspoint LPs who spoke on condition of anonymity say that Mumford, for whatever reason, decided not pass the baton to his junior partners. Crosspoint, the LPs say, has decided to fade into the twilight rather than raise another fund. “I guess they weren’t very good at succession planning,” says one disconsolate LP. “It now seems very unlikely they will raise another fund. I think it’s a shame.”
The stability of every venture firm is now in question. There is genuine fear in the LP community that any VC firm could break apart at any moment. For one thing, VC carry is likely to shrink going forward, which means that some senior partners may decide to squeeze out their junior partners and hold on to as much wealth as possible. Moreover, many of the junior partners who made huge sums for their firms in the late 90s did not get to share in the wealth to the same extent. And with current funds performing so poorly, it is unlikely these young partners will get rich anytime soon. The industry is rife with discontent and disruptive forces. Without a clear and equitable succession plan, these problems could be greatly exacerbated.
“Team stability is a big question mark today,” says Michael Hoffman, president and founder of Probitas Partners, a private placement agency. “Many LPs, such as pension funds, are over-allocated and are now deciding which funds they will remain with and which they will abandon. This is where the succession issue is of critical importance. LPs aren’t worried so much about alignment of interests between themselves and the GPs, but among the GPs themselves. If they see a team where a couple guys are taking home 90% of the carry and the rest only get 10%, well, that worries LPs. They’re legitimately afraid a team like that could implode.”
Barrett, co-founding partner of Battery Ventures and now a general partner at Financial Technology Ventures, has similar concerns. He believes venture firms should be flat organizations where everyone shares equally in the work and in the wealth. He actually championed that very notion at Battery, but he was overruled by the other partners. Instead of standing on principle, he felt it best to leave the firm. “If you’re not flat, you invite discord and risk losing good guys who don’t get elevated to managing partner,” he argues. “This is a real hindrance to succession planning. The venture industry is a partnership business, and just like in any business, if you have junior partners doing all the heavy lifting and [getting a smaller piece of the pie], then they will rebel against the senior guys who are simply managing the firm’s internal doings and not out there making deals.”
Not everyone agrees with this viewpoint. Josh Lerner, a Harvard Business School professor who specializes in venture capital, says it is increasingly imperative for firms to transform themselves from a collection of individual partners to formally organized entities with a clear operational structure.
He believes venture firms are gradually becoming more systemized and are now spending more energy looking at many of their internal processes, such as hiring and succession planning. “Venture capital is moving from a loose association to more of a pyramid structure,” says Lerner. “This is part of the natural maturation process of the industry. It’s an important development, especially as newer, less-sophisticated investors enter the industry and demand greater communication between themselves and VCs. VC firms will have to invest more in infrastructure and be able to articulate what they are doing and why they are doing it.”
|“Succession planning is attrocious at most venture firms… Venture capital can no longer afford to be run like a tiny craft industry… LPs have entrusted these firms with astronomical amounts of money, and it’s only a matter of time before they start applying the pressure.”|
University of British Columbia
These sentiments are echoed by firms like Summit Partners. “We hope to model ourselves after large institutional firms like Goldman Sachs and McKinsey,” says Summit’s Kortschak. “We believe in hiring smart young people and then mentoring and grooming them to become our successors.” Adds founding partner Steve Woodsum, “I’m a firm believer that you have to have a coherent management strategy. We do not have a flat model because that is not the way we staff the organization. We believe in creating an organization that has multiple levels of professional talent. The way you become a strong institution is by hiring smart, aggressive people and then working side by side with them along the way.”
The great irony, argues Paul Kedrosky, a University of British Columbia business professor who specializes in VC, is that while venture capitalists insist their portfolio companies be well managed, they themselves do not follow their own good advice. “Succession planning is atrocious at most venture firms,” he says. “VCs, for example, often insist that the CEO, COO and CFO of a portfolio company never travel together on the same plane, yet they would never think of imposing the same kind of stipulation on themselves. Venture capital can no longer afford to be run like a tiny craft industry. It must evolve into a true professional services organization. LPs have entrusted these firms with astronomical amounts of money, and it is only a matter of time before they start applying the pressure.”
Much Ado About Nothing
Of course, some people still don’t believe that succession planning has any relevance to the venture industry at all. This group subscribes to the notion that either you got it or you don’t, and no amount of mentoring and training will make you a good investor if you’re not cut out for the job. “I have no idea what makes a great VC, but whatever that special ingredient is, I know it’s impossible to pass it on,” says one LP at a large endowment who requested anonymity. “I think some GPs and industry consultants spend a disproportionate amount of time on the succession issue. Honestly, this is not something we pay too much attention to. We take a fresh look every time we see a firm doing fundraising. It’s incredibly difficult to create a firm with franchise entity value. As for the few firms who have actually pulled it off, I attribute their success to luck as much as anything else.”
Most firms would naturally take issue with these remarks. So would many LPs. “Succession planning is of paramount importance, especially now,” says Joseph Malick, a director with Crossroads Group, which has committed more than $2 billion to private equity over the years. “It’s not something that can be accomplished overnight or as an afterthought, but it can be done. Firms like New Enterprise Associates have built an institution by bringing young talent up to speed, by weeding out under-performers and by having a fair and equitable distribution of wealth.”
Greylock’s McCance is convinced that the VC industry is increasingly becoming a young person’s game and the firms that successfully pass the torch to a new generation of investors will emerge as industry leaders. “The technology industry changes rapidly, and VC firms have to change along with it,” he says. “The entrepreneurial sprit in this country is getting younger and the technology is getting more sophisticated. We don’t ever want to give the impression that our firm is being run by yesterday’s news.” And at a time when the industry is riddled with bad news, a good succession plan is one sure way to avoid making headlines. t
Tom Stein is a freelance writer who specializes in writing about the Silicon Valley venture capital community.
Additional reporting by Lawrence Aragon.
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