Art Marks, who retired from New Enterprise Associates in June 2001, came out of self-imposed stealth mode in April to announce that he had joined forces with two other industry vets to start a new venture firm – Valhalla Partners.
Marks, 57, has been thinking about the effort for months and even went so far as to write a Jerry McGuire-type memo about the VC industry to help him figure out how Valhalla should be structured.
Valhalla, based in Potomac, Maryland, got its start in the homes of its three founding general partners: Marks, Gene Riechers and Hooks Johnston. (The latter two left top positions at FBR Technology Ventures last year.) Marks says he gave the firm a lot of thought, but it didn’t really come together until he hooked up with Riechers and Johnston and found that they had similar ideas about creating a new firm that went back to the basics.
The Valhalla partners will focus exclusively on deals in the Mid-Atlantic region and stay away from over-picked spots like Boston and Silicon Valley. They’ll also do few deals – about one per partner per year – making sure they have enough time to really give their portfolio companies hands-on help.
Since the firm is in the middle of fundraising, Marks declines to talk about the specifics of the planned fund (he won’t even give the approximate size). But he was more than happy to chat about what’s wrong with the industry, why Valhalla is in the right place at the right time and his almost-famous memo about the VC industry.
VCJ: You had a lot of time to think about how to do VC. What were your conclusions?
Marks: You really get a chance to kind of start all over and we all kind of put up our feet and talked a lot about what’s happened to the business. What are the good lessons you’ve learned? What are the bad lessons? What do you learn from your mistakes and say: “How could you build a great firm in this environment?”
One thing that we concluded is that you have to have the right amount of capital per partner. You can’t have too much or too little. You’ve got to have the right amount. The second thing is: What strategy is defensible and one that we can achieve? We determined that a regional strategy can be pretty good because you can be efficient, you can work the same contacts, the same region, and we can exploit the relationships we have. And this particular region, the Mid-Atlantic, happens to be pretty rich in opportunities, and there’s no dominant firm like in Boston or California. The big firms here are national rather than local. This is a good place for a competitive firm.
So then we said: “The biggest mistake you can make as a regional fund is to decide to invest in the best company in the region – not the best company – because you don’t know what’s going on in other places.” So we had to have an extraordinarily deep diligence and research function and to really understand industries, not just companies. So if we’re going to invest in that area, we’re going to need to know the industry first and look at all the companies through that lens. Then we said, “Gee, this is also valuable after you’re in the investment.” So, we anticipate having a quarterly review of the industry, not just the company, and we’ll feed that back to the company, if they’re interested, as well as to our partners.
The high ratio of dollars to people is going to give us a lot more time and we are going to operate at a relatively slower pace than the rest of the industry. We sort of think our target is around a deal, or a deal and a half, per year per partner. That will give us time to help the companies. That will give us time to be smart about the investments and maybe time to have a life.
Given your career and how successful you’ve been, why decide to found a new firm? What are you hoping to accomplish?
I thought about not doing anything, to be honest. Or not doing anything in the venture business, anyway. But my personal jollies come from working with entrepreneurs and being able to look around corners to see where the next technology is coming from. Once you get that in your blood, you’re addicted. So I see this as a way to continue to do that for many years.
The second thing is that I feel like there’s a better way to do venture. I’ve talked about it as the new-and-improved version, but I want to tell you, a lot of people say: “Well, this is the way it used to be.” So I would say it’s the way it used to be with a couple of improvements.
My other motivation is that I really like my partners. You can do some things on your own but there’s a value and a chemistry of people working off each other that brings you to a new level.
Are there some specific things that you plan to do differently with entrepreneurs?
The other element we’re trying to do without taking a cookie-cutter approach is to institute and share best practices so that in helping them we can be as efficient as possible. I’ll give you a few examples: One of the worst experiences you can have in the venture business is to find out that your CEO doesn’t know how to do an interview of a direct report when you’re in the middle of a decision about an employee. He goes, “I love him,” and you go, “I hate him,” and you find out at that point that he doesn’t interview the same way you do. That’s not the point to find that out.
Helping people to figure out a very simple thing how to do good interviews would be one example. A second would be giving them a head start on doing an option plan and saying: “Well, here are the regional option plan averages. Here are some typical models.” It’s a much stronger basis on which the guy can make offers to people instead of the guy saying: “Well, you offered me $100,000, but I want 200,000 shares.” Instead of having him reinvent the wheel, you can start at a certain point with again not a cookie cutter but “Here are a few examples. You ought to be in this range, in our opinion.”
What sort of things do you want to do differently from other firms and why are you taking the approach you will take?
If you’re an entrepreneur and you work with us, you’re going to be more accountable than some of the other venture guys. In other words, our preference would be that if you come out with a business plan, instead of spending the first two weeks on the term sheet, we’d rather spend the first two weeks on the business plan and say: “Look, we want to bring our experience to bear and we think it would be better to look at it this way. We think that this is a better milestone to fund to than perhaps the one you have. Gee, we think maybe you’d better go slower or faster or different.” And when we’re done, we’ll probably sit more on the same side of the table than we would if we just focused on a term sheet.
With that I think also some of the terms on the term sheet would fall out. In other words it might be that instead of raising $10 million you ought to raise $12 million. Whatever the terms might be, some of them will fall out. So our hope is to kind of establish a trusting working relationship early on.
It’s not remedial CEOs. It’s just that if we’ve funded 150 companies between us and the CEOs are on their third, there’s going to be some things we can bring to the party.
When the business plan is done, there are going to be deliverables from our firm. We’ll have in the business plan: “Valhalla or Art Marks or Gene Riechers is supposed to do this by this date.” At the end of the year, instead of saying, “CEO, you screwed up,” we can have a discussion that says, “Hey, we missed the plan. We did this, we didn’t do this, and where do we go from here?”
Reading your memo reminded me of the memo that Tom Cruise’s character wrote in the movie “Jerry McGuire.” How have people reacted to your memo?
Marks: This is probably version 15 of the memo. What I’ve done is incorporate other people’s thoughts and input as they comment. I would say the following: There’s pretty much universal agreement on the industry diagnosis that the boom and bust has gone on. I’ve had people trying to rationalize the performance of different funds by size and say: “Well, people don’t know how to manage billion dollar funds now but in 10 years some guys will learn how to do it.”
There is much, much more dialog about the issue of fund size from the limited partners and from the general partners than I reflect in the letter. I would say there’s a significant debate going on there, and the resolution is going to be important to the future a number of firms and their relationships.
Another thing about the letter is that I have a bunch of soft recommendations on the back about what people ought to do, and I’ve gotten a lot of good feedback from GPs saying: “Gee, we were thinking about doing some of these things and this reinforces it. This is a good debate we can have.” But not everybody agrees with everything.
Has anyone said: “You’re just dead wrong and here are the reasons why?”
The strongest arguments have to do with my saying: “Go slow,” and “It’s hard to invest the money.” Other people say: “We’ve been doing it for years,” and, “We’re going to invest slower than we thought but not that slow,” and, We can manage.” Or I’ll get this kind of comment: “We already sorted through the portfolio. We’re done. Now we’re focused on new investments. Deals are better than ever and it’s a really good time to invest and we’re deploying more rapidly than you say.”
My argument back and the reason I didn’t reflect their view, if you wish, is that I don’t think the adjustments in the portfolio are over. I think we’re through the first wave. I forget what the industry statistics were last year: 12% of the portfolio companies were written off last year, 30% got funded, and the rest didn’t need any money this year. Well, the test of whether you’re through the portfolio is when you don’t need any money anymore so there’s going to be another run of them this year that are going to have adjustments. [Funding statistics not confirmed by VCJ.]
Given your 18 years in the business, why do you think this is the right approach?
I think this is the right approach mostly from experience. There’s some empirical data that seems to argue that medium sized funds and I have a theory on that do the best. The better guys attract capital and they get larger, but the problem is if you get too much money it’s really hard to do. You’re turned into sort of a momentum player, and right now we got caught out of step with the momentum. Momentum is good if you’re in the right spot at the right time but I don’t think you can count on that. We feel like if we go back to some old-fashioned values, like getting cash-flow positive and helping the company to get to that point earlier, would be better year in and year out.
How do you think the venture industry got to where it is today? Why did funds get as big as they got, and are they at fault for taking too much money?
I don’t know if anybody is at fault, but the formula used to be: “These guys have made money and lets give them some more capital, remembering that they’re giving us a lot back and they’re investing it at a faster and faster rate.” What happened is this is a boom-and-bust business and we just had the greatest of all booms. And most venture firms went out at the top of the boom, say 2000 to 2001, and raised enormous amounts of money.
If you’re still in the boom and things are turning over in a year or two and the returns are unbelievable, then that’s OK. We just had the biggest sustained boom ever and we’re definitely in a bust now. How long it’s going to be, I don’t know. The problem is that the industry now has a lot more capital than it can deploy effectively in the same normal time period.
You sort of have a choice: You can deploy not that effectively a large amount of money in three years. That would probably be very hard to do these days because people are very busy with their old portfolios.
The alternative is and I think it’s appropriate to invest a lot slower. That means that instead of having a three-year fund you might have a six-year fund or an eight-year fund.
How are LPs going to respond to that?
That gives some of the limiteds angina, because they’re used to having an option every three years whether to re-up or not. Now they’re going: “Well, gee, why should I lose my options?”
That seems to be a debate that’s happening right now. I’m sure if you talk to people who are going to annual meetings, or coming back from them, that’s a hot debate. And it’s a difficult one. There’s no contractual basis for the limiteds to say: “OK, cut it short.” So I think they’re kind of using moral suasion, as well as politics, as well as: “You guys are going to come back one day to the market and we’re going to feel differently about you if you hang us out here to dry.”
Where is the industry headed?
I think we’re headed into a period of significant transitions. I think this boom-to-bust is going to ripple through in ways we can’t fully anticipate, and I think returns are going to be down for awhile. Some firms are going to come up with great new strategies and some are going to break apart.
Medical was out of favor, for example. Now it’s in favor. Medical partners are probably producing the only real returns in the venture business. I’m sure that’s going to have a psychological impact on the dynamics between partnerships. They got beat up for so long and now they’re doing well and there’s probably going to be some tensions between partners.
When that transition period is over, what do you see as the result? Fewer firms? Less professionals? Firms managing less money, going slower?
I think there may be more firms. You had a period of great concentration in fewer and fewer firms and we all have a question of where is the scale economy. This transition period is probably another three years or so.
There’s definitely going to be some novel approaches. I don’t know what they are. People that’ll look at the situation and say: “OK, if I’m going to do anything here, I’m going to try something different.” Some of them are going to be really successful and some will be failures. I think some of the guys who have been in it for awhile are going to look at this long period of poor economic returns and say: “Is it worth it? Do I want to keep doing it?” Because you’ve got guys who’ve made a lot of money and [they can walk away if they want to].
For most of the people out there who raise big funds, would the best course of action be to trim back?
It needs to be looked at separately, based on each firm and its characteristics and the limited partner set. You know different guys charge different fees, invest at different rates, invest at different points in their life cycle. I think it varies greatly.
How do you expect potential LPs to respond to your message? Are they going to be excited about someone turning back the clock a little bit, or do you think they’re going to be nervous that the liquidity events are going to take five to seven years again?
They are all very well educated with respect to the economic cycle and boom and bust. They understand that completely. I have heard that the amount of capital that they have to deploy now is down from previous years, but I’ve also heard that very few people are out there raising money because all of the name firms raised most of their money in 2000 and they probably won’t be back, given this high level of capital, until 2004 or so. Most limiteds that I’ve talked to have said: “I’m under-allocated.”
Why is now a good time to start a fund?
I think this is a much better time than maybe the last three or four years because the resources to start new companies are more available than they’ve been. Manpower is cheaper, better-quality people are available, real estate’s available, service resources everything from good intellectual property lawyers to great audit teams (you could probably hire the guys from Arthur Andersen direct, huh?).
I think a second reason is deal quality is much higher. You had everybody chasing the rainbow the last three years and first-year MBA students that tried to build Internet companies around SIC codes. You don’t see them anymore. What you see are guys who have passion, believe in a business, and are very careful about their use of capital.
What you’re not going to have is immediate liquidity or capital liquidity. You can’t arbitrage a private investment today into a public investment in 12 months. All you’ve got to do is build a viable company with the idea that in four or five or six years you’re going to see some liquidity. The work level to help companies is going to be high.
Co-founding General Partner, Valhalla Partners
Education: MBA with high distinction (Baker Scholar), Harvard University Graduate School of Business, 1971; B.S. in industrial engineering, University of Michigan, 1967.
Work History: Marketing, sales and finance positions, Baxter-Travenol Laboratories, 1971-75; General Manager, X-Ray Products Department, GE Medical Systems, 1975-80; Senior VP and President, Software Products and GE Information Services, 1980-1984; General Partner, New Enterprise Associates, 1984-2001; General Partner, Valhalla Partners, 2001-present.
Biggest Accomplishment: Set up GE joint venture in Japan that is now market leader with $2 billion in annual sales.
Biggest Mistake: “Passed on opportunity to invest in Ciena because all carriers except Sprint denied interest.”
Personal: Father of four. Married for eight years. Avid fly fisherman.
Did You Know? Marks loves to plant flowers, especially bulbs. “Just like CEOs, you can supply the water and fertilizer, but the outcome depends a lot on the product you start with and the forces of nature.”
The Undercapacity Problem
(Capacity = full-time experienced partners)
“The number of venture professionals (not the number of experienced partners) over the last 20 years has increased from 890 to 8,300.
[But] the capital per partner has increased just under 10 times, and that number includes professionals who are new, young and unproven…
A number of firms have attempted to free up general partner time by experimenting with new resources, such as part-time venture partners, executives in residence and analysts. While we applaud the use of these resources, we think firms should not be seduced into thinking they represent equivalent capacity.”
Source: Exerpted from the Valhalla Partners memo.
Contact Alistair Christopher at: