VC Goes Institutional: The Hiring of a Chief Operating Officer –

Billion-dollar funds are a dime a dozen these days – no pun intended, of course – and with more money comes more responsibility. It should come as no surprise, then, that venture capitalists are feeling the burden of managing this incredible amount of capital. Their solution: Hire a chief operating officer.

Within the past year, the position has gained ground, most noticeably among the top-tier funds with the largest amounts of capital. Accel Partners, Sequoia Capital, Softbank Capital Partners and Benchmark Capital are just some of the early adopters.

“We are all older and have more funds to deal with, larger capital under management, more investment professionals to manage, and someone needs to manage the internal operations of our firm in a high-class fashion,” says Alan Frazier, founder of Seattle-based Frazier & Co., another firm that recently hired a chief operating officer.

Traditionally, partners at the firms dealt with recruiting and other financial intermediaries in an informal manner, usually done in the partners’ spare time and on a part-time basis, says Joshua Lerner, a professor at Harvard Business School. However, a growing head count – more companies, more partners, more limited partners – has increased the administrative responsibilities at many firms. When firms begin to double and triple their coffers, the responsibilities also increase two-fold and three-fold. And as groups increase capital under management and management fees, they have an opportunity to invest in systemizing their practices, Lerner says.

Investing in Infrastructure

Frazier & Co. set out to fill the position of chief operating officer before the firm knew of others doing the same thing. Wary that they were venturing into uncharted territory, the firm called Robin Painter, a partner at Boston-based law form Testa, Hurwitz & Thibeault LLP, the firm’s legal council, for her opinion. Painter said she had heard positive feedback about a few instances in which the position was created, and after some additional research, Frazier & Co. went ahead with the idea.

Frazier & Co., known for its domain expertise in health care, recently ventured into the information technology space, raising a fund that will back wireless, integrated Internet and bio-informatics entities (VCJ, July 2000, page 10). The vehicle will hold a final close by the end of October, Frazier says, but he would not reveal the target-size of the fund. With $350 million under management, the firm expects to raise its fifth health-care-focused fund in the first quarter 2001. The firm’s most recent health-care fund, the $220 million Frazier HealthCare III, which focuses on biopharmaceuticals, pharmaceutical services, medical devices and traditional health-care services companies, was between 50% and 60% invested at press time.

With the anticipated increase in the amount of capital under management, the timing was right to hire a chief operating officer. Tom Hodge, former general counsel and member of the executive management team at Loudeye Technologies, a publicly-traded company that provides technologies and services to incorporate digital media into Web communications, joined the firm as chief operating officer in July. After just two months with Hodge on board, Frazier says, “I just can’t understand what we did with out him.”

Frazier is creating an infrastructure within the firm by handing off some of his previous responsibilities. “Anything that Tom is doing, I’ve done four or five times,” Frazier says, which allows the veteran VC to get back to investing instead of managing the firm and its resources.

To be sure, the job responsibilities of a venture firm chief operating officer far exceed just paying bills. Complicated decisions including the best tax arrangements for sharing the carry with non-partners or determining the on-shore and off-shore tax ramifications of foreign investors fall on that person’s plate.

The proliferation of the chief operating officer position is not an unexpected occurrence, says Mark Heesen, president of the National Venture Capital Association. If a firm is managing a couple billion dollars, it makes perfect sense for it to hire one. “It’s a very sound thing to do,” he said.

Without a chief operating officer, practical matters – approving a new phone system, a new 401K plan or deciding when to hire another accountant – are burdens the partners end up shouldering.

Venture firms need someone to stay on top of cutting-edge business practices, to figure out when the firm should raise its next vehicle and to plan how many investors and support staff will be needed in the future.

Asset management firms have been hiring people to fill chief operating officer roles for sometime, says Gary Goldstein, president of the Whitney Group. Thus, it stands to reason that the venture community, which in many ways mirrors the asset management industry, would do the same thing, he says.

Some investors attribute the need for assistance in the operating area to the pace of the market. In years past, when the venture business moved slower, general partners had more time to manage investments, says Stuart Ellman, a co-founder and general partner at New York-based RRE Ventures. Making sure wire transfers go through, the American Express bill gets paid and the draw downs come in while on an airplane is not a professional way of conducting business, says Ellman, who is on the road between two and three weeks every month.

“Our core competency is making good investments and helping those companies grow. That’s what we should be focused on. We shouldn’t at all be focused on any of the ancillary issues of running a firm,” he says.

RRE Ventures hired Andrew Zalasin as general counsel, chief financial officer and administrative partner, around the time it held a first close on its debut fund in 1997. The firm now is investing its second vehicle, the $225 million RRE Ventures II, which closed in December 1999, in early-stage information technology, software and communications companies (see story page 48).

“I don’t want to delegate the benefit of 20 years of experience and perspective,” says William Collatos, founder and managing general partner of Spectrum Equity Investors, based in Menlo Park, Calif. and Boston. Collatos, who over the course of a year dedicates about 70% of his time to investing and about 30% to managing his business, says, “I don’t think you can bring in someone from the outside and make them chief operating officer of a business they have no historical experience with.”

Spectrum, in July, closed its fourth fund, the $1.75 billion Spectrum Fund IV. The firm has 60 portfolio companies and 20 investment professionals, and typically backs companies in the communications and infrastructure sectors.

Despite its size, Kleiner, Perkins, Caufield & Byers is conspicuously missing from the list of firms that have hired chief operating officers. General Partner Kevin Compton, who handles some of the so-called related responsibilities, says hiring a chief operating officer is “something we will probably do, but [we] haven’t given it much thought now.”

Ironically, the frim’s most recently hired general partner is a former chief operating officer. In late August, Kleiner Perkins hired Raymond Lane, former chief operating officer of Oracle Corp., (see story page 34). When asked about the possibility of playing the chief operating officer role Lane says, “I have no interest in doing that.” He does believe, however, that “the trend makes a lot of sense, and I wouldn’t be surprised if Kleiner did the same thing.”

To attract the best people, investors say, hiring a chief operating officer means giving up equity. “That is the perfect place to be penny wise and pound foolish,” RRE’s Ellman says. “You absolutely hire the best you can, and hiring the best you can is always going to mean giving away equity because the best people out there have the options. They’re not just going to you – they’re going to all these other start-ups or other large companies where the cash compensation is really high,” he says.

The Legal Edge

A number of venture firms have taken to hiring lawyers to fill the role of chief operating officers because the work the person ends up doing often tends to be law-related.

“We started to look at what they do – the scope of the job – and we looked at how much of the job has legal components, and felt that over time, we needed someone with legal background to spearhead some activities,” Frazier says.

While there are only a small group of lawyers suited to fill such roles, the chief operating officer could become a coveted position, Painter says. They will, however, want a piece of the carry, she says.

Another benefit to the new position, she says, is having one point person inside the firm. Before Frazier & Co. hired Hodge, Painter, as the firm’s legal counsel, had to poll the partners one-by-one to get their opinion or approval for something. “[Hodge] is a quick translator for the rest of the organization,” able to explain legal issues, as well as explain them to all the partners at one time, she says.

What Happens When…?

While at a first glance it’s hard for investors to find risks associated with hiring a chief operating officer, potential dangers do exist. If the market environment changes, and it becomes harder to raise capital, or the need to scale back management fees evolves, VC firms can have a problem on their hands in supporting the senior-level staff, Lerner says. On the flip side, he says, if you are a big VC firm and don’t change with the times, you run the risk of being left behind.

From the professional’s perspective, joining a venture firm can be considered a risky move because as a partner in a law firm, for example, you work with a variety of clients on a daily or weekly basis, Painter says. Going in-house, however, means putting all your eggs in one basket, which leads to a cultural risk. You can’t just disassociate from that one client, a luxury most lawyers working in law firms have, she says.

This evolution will lead to a separation between the top-tier firms and the others, Harvard’s Lerner says. The firms that institutionalize themselves will be able to offer more services, but the lean, smaller firms can make the argument that they have organizational flexibility, and are able to respond to issues more quickly, Lerner says.

“There does need to be a critical mass before you can justify the expense before committing someone to this role. [It’s] hard to define where that point is,” Frazier’s Hodge says.

A Selection of Venture Firms with Chief Operating Officers

Accel Partners Palo Alto, Calif.

Benchmark Capital Menlo Park, Calif.

Frazier & Co. Seattle

Hummer Winblad San Francisco

Sequoia Capital Menlo Park, Calif.

Softbank Capital Partners Newton Center, Ma.

Redpoint Ventures* Menlo Park, Calif.

*In the market for a chief operating officer.