Acp Keynote Vc Speech

8/6/2019 Acp Keynote Vc Speech

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Harvard Business Schools Venture Private Equity Conference

Venture Capital Keynote:BostonFebruary 13, 2010

Arthur C. Patterson - apatterson@

Partner @ www.facebook.com/ac


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Who We Are

Accel works in support of exceptional entrepreneurs to bucompanies. Our contributions extend far beyond pure fina

AT A GLANCE STRATEGY INV

Founded in 1983

Actively managing over $6 billion incapital

More than 300 U.S. investments- 100+ public offerings- 125+ mergers or sales- Over $175 billion in market valuegenerated

Initiating Lead Investor in mostsituations

Dedicated funds and teams in the U.S.,Europe, China and India

38 team members with experience asboth operators and investors

29 repeat entrepreneurs have chosenAccel at least twice

Prepared Mind: Build deep knowledgeof and relationships within a core set ofdomains:- Software- Infrastructure- Digital Media

Be First: Accel Companies leadfundamental industry transformationsrather than follow predefined markettrends

Combine investment expertise withoperational excellence

Leverage institutional knowledge to

assist companies through every phaseof the growth cycle

Provide a uniformed team approach-entrepreneurs gain access to Accelsglobal team and network

Accel X:

Exceptio

Potentiatechnolo

Accel Gr

Strong m

Bootstra

Profitab

History


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A Global Firm


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Who Weve Backed


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Entrepreneurs We Are ProudTo Work With

Edward Fenster and Lynn Jurich,SunRun

Mark Zuckerberg, Facebook Robert Kalin, EtsyJeremy

Brigh

Bud Colligan, Macromedia

Javier Soltero, Hyper

Chris Dury aG

Roger Linquist,MetroPCS

Jonathan Katzman,Xoopit

Dr. Amr Awadallah,Cloudera

Jef Graham & Brendon Mills,RGB Networks

Robert Seidl & David ThompsonGenius.com

Jameson Hsu & Bob Ippolito

Mochi Media

Omar Hamoui, AdMob

Tim Cadogan, OpenXSamir Arora, Glam Media Pete F

Dennis Fong, RaptrDuke Chung, ParatureJeff Hammerbacher, ClouderaIlja Laurs, GetJar

The best measure of Accel Partners is the energy and brilliance of our


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Stabilization After Scary 2009?


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Deal Volumes Around 3-4K Per Year


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First Time Financings Down Though


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Industry Pace Roughly Consistent Thru 2009But Is Still Far Below Q108 Investment Pace

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MonthlyDe

alVolume

Monthly VC Investment Volume


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Trend In Exits >$100MM Over Time2006 Q4 2009 activity

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Total Deals >$100MM 16 22 19 19 21 22 20 24 12 11 8 4

M&A >$100MM 13 17 14 11 13 10 12 12 10 11 7 4

IPOs >$100MM 3 5 5 8 8 12 8 12 2 0 1 0

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Volume Is Down, But Themes DrivingInvestment Are Largely Unchanged

In general, investors are following the same underlying themes as in the previous time pe Somewhat surprisingly, consumer-driven technology investment has remained consistent

Media/search and security investing dropped significantly

Open source investment has experienced a strong surge, from 3 investments to 8.

Theme # Companies % of Period Total # Companies

Consumer - driven Tech Economy 154 36.32% 89

Other 72 16.98% 35

Enterprise Applications and ASP's 52 12.26% 27

Messaging and Collaboration 22 5.19% 21

Media/Search Models and Enablers 50 11.79% 20

Mobile Services and Enablers 25 5.90% 19

Data Center Infrastructure 19 4.48% 13

Advertising Network 7 1.65% 9

Open Source 3 0.71% 8

Semiconductor Ecosystem 10 2.36% 4

Education 3 0.71% 3

Security 7 1.65% 1

Wireless Sensor Networks 0 0.00% 1

Total 424 250

1/ 1/ 2008 - 12/ 31/ 2008 1/ 1/ 2009

Themes Driving VC Investment


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Significant scale back on capital-intensive clean tech investments and interncontinue to grow ( 33% 44%), slight growth on mobile and SW on percentaabsolute #s down

Internet-Based Services Leads The Way

DATE: 1/1/2009 12/31/2009

VC LOCATION: US

Clean Tech

8%

Internet-based Services

44%

Software

18%

Semiconductors

3%

Other Services

3%

Infrastructure Systems

7%

Financial Services

3%

Consumer

Products/Services

4%

Mobile-based Services

10%


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Out Of Favor

Semiconductors

Telecommunications

Core network infrastructure

Old gen enterprise software

Nanotech (what is that anyway)


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Buzzwords around Silicon Valley Platform for the Future

Mobile technologyRise of smartphones, creation of open mobile environmentAndroid/iPhone catalystsLTE 10X

Real timeImpact of the Twitter and FB ecosystems

Social

Social is the new SEO/SEM extremely important for anyone t

Digital MediaMajor secular trend, picking your enemy a big part of things

Quantitative Ad technologiesMajor secular trend Google is still only the beginning

SaaS Software Models

Open Source Models

Cloud Standardized Back Ends

eCommerce


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Other Topics

Career VC Roles

Information Technology vs. Health Care and CleanTech

Power of Models vs. Human Frailties

Services vs. Capital Equipment

Persistence and Ambiguity in VC

VC vs. PE

Angels in VC

Annual Fundraising Discipline

Staying Coherent

Small Funds vs. Large, Globalization, and Growth

Episodic Returns in VC Normalcy


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Harvard Business Schools Venture Private Equity Conference

Venture Capital Keynote:BostonFebruary 13, 2010

Arthur C. Patterson - apatterson@

Partner @ www.facebook.com/ac


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Page 1

Thank you very much for hosting this outstanding annual event.It is always great to return here.

First, to put my remarks about Venture Capital in context, Id liketo discuss my firm, Accel Partners. Pages 2, 3, and 4 of the slidesgive you a good profile of the firm. As a firm we have found ourgrowth vector primarily through International Expansion. Thereare four separate teams of General Partners investing in the U.S.,Europe, China, and India -- all federated under the Accel brand

(IDG/Accel in Chinas case). We have found that minimalhierarchy within the entities and across the firm works best inattracting to Accel the type of individuals who will be mostsuccessful in partnering with great entrepreneurs. A flatpartnership also encourages strong internal teamwork to the greatbenefit of our portfolio companies.

Since we all have the common challenge of seeking to be thepartner of choice for exceptional entrepreneurs, we maintaincommon investment philosophies and best practice processesacross the firm. (See below under Careers in VC Roles).There are some differences between the geographies to reflectlocal conditions. For example, in China we can operate

successfully with more organizational hierarchy and portfoliodiversification because the growth rate and undeveloped nature ofthe economy permits greater emphasis on sheer start upinitiative and less emphasis on the proprietariness of ideas andtheir potential for leadership in emerging categories.Manufacturing new companies in China is simply like it was inthe U.S. or Europe in an earlier period.

THE IMPACT OF THE 09 FINANCIAL CRISIS

ON VC INVESTING

VC has scarcely been immune to the financial liquidity crisis of08 and the slides on pages 5 through 11 show the data. The

factors influencing this decline in VC activity are in theeconomists category of suppressed animal appetites/instinctswhile for Private Equity (PE), more tangible factors like changedinterest rates and terms had an immediate dramatic impact.

Longer term, the financial crisis will have minimal impact on VCreturns (at least Information Technology VC) because thesereturns are Supply Driven. The supply drivers for valuablenew entrepreneurial opportunities are primarily technologychanges and to a lesser extent customer preference shifts. Theonus of proof is on anyone who asserts that the pace of

ARTHUR PATTERSONS KEYNOTE VENTURE CAPITAL SPEECH FOR

HARVARD BUSINESS SCHOOLS ANNUAL VENTURE CAPITAL AND PRIVATE

EQUITY CONFERENCE

February 13, 2010

technology innovation, and the Creative Destruction processit drives, has slowed. While some older categories of ventureprojects are stable (and uninteresting for VC), the higher layersare extremely dynamic as the pace of Facebook or Twitterattest. The self renewing virtuous cycle of creativedestruction continues intact, driven by continued steep costperformance curves in semiconductors, wireless, fiber, andsoftware. The expansion of the worldwide market for theproducts of these technologies and the increased penetration of

these technologies into populations makes each wave of newcompanies bigger winners than the last. VCs andentrepreneurs are slaves of this causality. They never know ifthe party will stop, but again, the onus is on anyone whoasserts it has stopped.

So how should we interpret the current slowdown of new VCinvestments: A timing shift or permanent condition? Everygood venture idea created by technology change is capitalizedon by entrepreneurs and VCs but the timing can shiftsignificantly and the number of new companies formed toexploit the same new niche idea can expand significantly. Inperiods of limited VC availability and cautious entrepreneurs,

delays in funding ideas occur. In periods of exuberance (i.e.99) entrepreneurs and VCs will look ahead and optimisticallyassume changes which should happen have alreadyhappened. As a result, a given new venture idea may have itstiming shifted up to two years forward or back. However, theywill all get taken advantage of the value is just too extreme.The great ideas, especially when competition is suppressedby pessimism, are always highly capital efficient so that thequantity of VC money available is seldom a factor. Similarly,the exit valuations of the really great venture deals representsuch a high proportion of the total wealth creation from theventure process, that smaller number of exits will have limitedimpact on long term ROIs from the VC sector.

INDUSTRY SECTORS

There is a steady evolution in which sectors of InformationTechnology offer the best entrepreneurial returns. Usually, theopportunities are best on the top of the stack. That is, sit ontop of all the older technologies which enable the latest toplayers. For example, the slide on page 12 lists some olderareas which produced many valuable companies in the past buttoday are commoditized and offer little running room for a newcompany. Even if a product opportunity exits, there are


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seldom attractive growth vectors beyond the initial product. Page13 lists some of the Buzz words currently in vogue aroundSilicon Valley and reflect where innovation levels are highestnow. Generally, VCs are much better off with an inexperiencedentrepreneurial management team in a fresh area than anexceptionally experienced one in an un-dynamic segment.

CAREERS IN VC ROLES

In Start Up Venture Capital (unlike later stage or PE) the mostsuccessful role the VC can play in a new company is to be thepartner of the entrepreneur. To play this role effectivelyrequires a balance of skills: knowledge of the entrepreneurssegment, strong analytical capacity; personal communication andrelationship skills (to bond with entrepreneur and persuade himsubtly to do what is in the entrepreneurs own best self-interest);the common sense to know where you are on a fast movingmulti-variable field; being a good listener. The entrepreneurs weback are exceptionally capable individuals and he/she needs tobelieve that the time invested in their relationship with a VC is

going to make them more successful (and their business morevaluable) than time expended on another relationship.Experience seems essential to hone these skills and no substitutefor an apprenticeship model has been found; essentially the casestudy method business schools use but with live ammo.

Established VC firms are always looking to add individuals whoexhibit these potentials. VC firms tend to target individuals inthe 30 40 age range to strike an optimal balance betweenexperience and adaptive potential. In VC, it is necessary toalways get the entrepreneur to believe his/her Companysforward directions are their idea in order for it to be fullyunderstood and with responsibility fully owned by the

entrepreneur. Individuals coming to VC firms with outstandingexecutive credentials frequently struggle to make the transition tothis indirect role. In an ideal partnership between the entrepreneurand the VC, the VC is supplying a horizontal perspective of bestpractices from across his experience/contacts/ portfolio whichcomplements the entrepreneurs in-depth vertical understandingof his technology and market.

VC IN INFORMATION TECHNOLOGY (IT) VS.

HEALTH CARE VS. CLEANTECH

What distinguishes Venture Capital IT investments from theother two categories of VC investing is the rate of customer

adoption of the IT products and services. Rapid adoption meansfar lower up front capital requirements to see if it works andhigher odds of big multiples on deals. The holy grail ofHealthCare Biotech VC investing i.e., a successful new drug fora chronic disease can produce billions in profits annually butseldom are the VC firms still involved after the 10 years and $1.5Billion needed to get the rare example through the FDA approvalprocess. CleanTech projects be they solar cells, batteries, windturbines, biomass etc. are usually highly capital intensive and astheir ultimate output--energy-- is a commodity, they are highlysubject to the whims of government incentives and price signals.

Technology advantages are temporary and can seldom beleveraged into business success with such slow adoption.Utilities are central players in CleanTech and are soconservative in their new technology adoption practices thatnew has to be redefined. However, the economys shiftstoward cleaner energy and energy efficiency are so powerfulthat we are optimistic that an interesting second generation ofnew CleanTech startups will emerge. We are especiallyinterested in investments where the power of advances ininformation technology can be brought to bear on theseproblems. The smart grid infrastructure utilities aredeploying could provide an attractive enabling platform if thisgrid proves robust and open enough to offer entrepreneurialcompanies the opportunity to add significant value.

POWER OF MODELS VS. HUMAN

FRAILTIES

Both VCs and entrepreneurs (in the developed economies) aretoday placing far greater emphasis on the business model,particularly the economics of the distribution model.Previously, most IT technology products were sold with adirect sales force on the basis of their better, faster, cheaperROI cost justification. Now, customers have such largecomplicated installed bases of IT infrastructure that additionsor changes are made reluctantly and carefully. The cost of adirect sale (people/time/complexity) has become prohibitive.Models such as SaaS, freemium/Open Source, or viralmarketing are designed to minimize sales friction andmaximize customer self-learning. Getting the right modelworking also makes the companies inherently more stable andvaluable than their predecessors who only had a betterproduct. They are also less dependent on strenuous human

endeavor and the potential failure of the human parts of themachine/company.

SERVICES VS. CAPITAL EQUIPMENT

Over the last 10 years, one of the significant shifts in ventureportfolios (and Silicon Valley) is the move to deliveringtechnology as a service vs. a product. The companies incomestreams have become recurring revenue streams.Traditionally, IT hardware and software were very much a onetime capital equipment purchase to improve the productivityof the purchasing company. For a variety of end market andtechnology reasons, a high percent of VC companies now

sell their technology as a recurring service i.e. SaaS, opensource, advertising supported, cloud services, subscription, etc.This has made the VC portfolios far more stable and lessdependent on the corporate capital spending cycle. It has alsomeant that growth rates of the individual portfolio companiesare more restrained. The higher percentage success rates andhigher valuation multiples will more than offset the absence ofthe explosive growth rates possible with hot boxes or enterprisesoftware sales.


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PERSISTENCE AND AMBIGUITY IN VC

New venture companies are essentially experiments. Thedevelopment of companies is a process of the management team(and Board) learning about the technology, product/services,customers preferences and constantly adjusting all the companys

parameters to optimize success. (Uncertainty with respect tomarket growth, company growth, or personal growth createconstant instability). Usually, the better controlled theexperiment, the faster the learning process and better the chancesof success (with the least amount of capital).

However, the more unique and original the core entrepreneurialidea, the more latitude demanded in conducting the experiment.Recognizing a high degree of uncertainty (or creativebreakthroughs needed) at the front end of the process can make abig difference to the ultimate success. Most obviously, modestburn rates will make possible far more adjustments in directionswith new feedback from the market. Evaluating progress withthe traditional financial metrics of budget vs. actual results can

have sharply limited utility. Depending on whether your VCapproach is development drilling (in an area well known toyou) or wild catting in a green field area, the percent ofportfolio companies which will be able to stay on the trajectoryof their start up projections is between 10-30%. Many bigwinners are still in the remaining 70-90% if they can be patientlynurtured. (Of course, quality control at the front end is anessential condition for achieving success with a strategy ofpersistence in backing off plan portfolio companies).

The most difficult judgments (investment decisions) a VC firmmust make is what to do on the Series B/C/D investments whenthe management is off the original plan. (Startup decisions are

easy - big idea, good guys, no known problems - and later stagesupport of on plan companies is obvious). This is when theintellectual property and culture of the VC firm are put to thetest. Obviously, some companies need to be shut down butothers should be supported because real value/progress is beingachieved, albeit perhaps orthogonally to the plan. Theoptionality value of staying in the game with companies(assuming high quality people and a generally promisingsegment) is not adequately appreciated by some.

VENTURE CAPITAL VS. PRIVATE EQUITY

For purposes of portfolio construction some Asset AllocationAdvisors group VC and PE together. In their purest forms start up VC vs. LBO private equity the two have little incommon. (A blurring of roles occurs when both VC and PEfirms make growth investments in the equity of existingcompanies but for the purposes of these remarks, I will just becontrasting the pure forms).

Both forms of investing play critical roles in maintaining thevitality of our economy. The PE firm revitalizes companieswhich inevitably (and with best intentions) drift fromshareholder best interest behavior when they are public. VC

firms create completely new companies, playing the role of theeconomys pilot light or catalyst enabling entrepreneurs tocapitalize on new changes in technologies or consumerpreferences by launching new enterprises to deliver uniqueproducts and services. In contrast to VC where starting newactivities is the primary goal, in PE, turning aroundestablished companies, usually entails stopping a bunch of ill-considered activities the company has wandered into. Theactivity of both types of firms inject critical initiative into oureconomy and are essential enablers of the vital creativedestruction process and without which we would have astagnant ossified economy offering little in upward mobilityand no rising standards of living based on productivity.

How big can PE be? The ideal theoretical mix public orprivate of companies at public scale could be 1 private in PEfirms hands vs. 2 publicly traded. This ratio is based on thetime it takes a PE firm to fix up a previously public company about 3-4 years vs. the amount of time -- 6 to 8 years -- ittakes most public companies to drift far enough from acting in

the shareholders interests to be economically worthrestructuring by a PE firm. Sarbanes- Oxley, by adding aheavy layer of non-economic compliance legal processes forBoards, has further aggravated the governance problem forpublic companies. In many subtle ways this has made the roleof the PE firm even more critical to a competitive economy.This suggests the PE industry has a long way to grow.

Organizationally, PE firms can be far more hierarchical, andtherefore, scalable than VC firms. In PE, tasks around finding,analyzing, and managing each of the portfolio companies canbe separated and assigned to different individuals with differentspecialized skills or economics. In VC, a new start up offers

little data to analyze and tends to be a messy situation withunusual individuals and bold unsubstantiated ideas. A lot ofexperientially based instinct is usually required to recognize thepatterns of success within such messy situations. Thisexperience requirement means the most senior individuals areneeded for the startup task where the least capital is initiallyinvested.

Supply considerations are very different in PE vs. VC. InPE, since it is targeting existing public or private companies,there is always an unlimited supply (assuming no priceconstraints). Of course, in practice, interest rates (and loanterms) have a large impact on supply because the economicprice which can be paid is so sensitive to the cost and risk ofthe debt portion of the deal. In VC, where the supply of newopportunities is being generated by shifts in technology andcustomer needs, there is never any forward visibility of howmany more good new entrepreneurial opportunities will begenerated. In PE, the new business has become substantiallyauction driven, where the lucky winner is also the mostoptimistic or smartest about the target businesses abilityservice debt and grow. In VC, startup financings seldom havean auction flavor simply because the uncertainties are too greatto support conducting an organized auction. Relationships and


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credibility of the VCs and entrepreneurs are decisive factors.

ANGELS IN VC

Many studies have shown that in the U.S. the absolute dollaramount of Angel investing far exceeds the amount ofinstitutional VC invested annually, making this financing sourcea critical contributor to our economys vitality. Angels andSuper Angels investing in Silicon Valley where the number ofwealthy entrepreneurs and venture opportunities abound is aspecialized case of this and significantly increases the vibrancy ofSV entrepreneurship. We partner frequently with Angels.Sometimes they co-invest with us in an initial startup round andsometimes we make a first institutional investment in projectswhich they have seeded.

Entrepreneurs need to decide which funding source best matchesthe needs of his company at that point in time. If anentrepreneurs business idea is still in the Research phase(where small amounts of capital are needed to clarify the

business model or team) then Angels can be great partners. If theentrepreneurs business idea is in the Development phase withmeaningful expenditure goals, milestones, and delivery dates, theentrepreneur should be interested partnering immediately with aventure firm whose resources of relationships, capital andexperience can dramatically accelerate their companysdevelopment. (Of course, the situation of a new company isseldom so clear cut).

VC firms need to have a higher bar than Angels for moreforward visibility because they have a far higher opportunitycost for each investment. They make only a small number ofinvestments per partner, invest significant capital, and devote

tremendous effort to each. For the VC firms financial model towork, they need to have backed companies which scale to be ofpublic size even if they are sold through M&A. Moreimportantly, because the VC firms are investing the capitalbelonging to others (e.g. universities and pension funds as well astheir own personal capital) they have a fiduciary responsibilityin the deployment of that capital. Successful Angels have adifferent financial model, which requires them to invest at verylow prices, small amounts in a large number of situations.Because they are investing primarily their own capital, Angelscan take this approach expecting that a super return on a fewwill offset the write offs of 80 90% of the others. One of themost successful Super Angels recently commented that he hadinvested in over 500 companies fortunately they included

Google.

VC firms fiduciary obligations make them necessarilytenaciously persistent in their backing of their portfoliocompanies. The partners in VC firms serve on the Boards of onlya small number of companies because they are viewed by theirlimited partnership as directly responsible for the success of theirportfolio companies. As importantly, other externalconstituencies of a new venture company see their VC firmpartner/investor as a responsible party standing behind the new

company, increasing that companys credibility withimportant constituencies such as new employees andcustomers. (This credibility factor is why venture firmsplace such value on their reputations). In follow onfinancings, new investors expect the existing VC firms toinvest at least their pro rata, reflecting their responsibility forthe new company while Angels are not held to this standardand normally dont invest in follow on rounds which are higherpriced and involve a lot more capital.

Naturally, there is a wide divergence of capabilities betweenventure firms and between individual Angel investors which anentrepreneur needs to sort through to get the right match/partner for his companys stage of development. Not easy, butthats why they get paid the big bucks.

ANNUAL FUND RAISING DISCIPLINE

With modest variations, most VC backed companies will needto come back to the (equity) well about once a year for their

first several years i.e., until they have reached the scale forescape velocity and are internally cash flow positive. Thisannual fund raising exercise is one of the most importantinstitutionalized disciplines in the Silicon Valley venturemodel. Justifying themselves to capable new 3rd parties withrespect to why the Company still has a raison detre (andvalue), requires management to rethink and adjust theirbusiness (its goals, strategy, management and tactics) to arigorous level. (Is this company really a leader in doingsomething valuable?) The annual fund raising exercise keepsthe whole business development process honest and avoidsthe common human trait of subornly defending ones pastbeliefs and decisions. Woe to the firms who dont bring in new

investors.

STAYING COHERENT

VC by definition needs to fund the new new thing. The mostdangerous mentality to fall into is that of the Maginot Line.In venture firms, this would mean scaling up your internalexpertise (staff) to be the most knowledgeable about previouslysuccessful categories. On the other hand, jumping at everynew thing (which always looks like a greener pasture than whatyour portfolio currently holds and where you now know all theproblems) produces completely incoherent portfolios overtimeand normally poor results. (Portfolio coherence (and teamstability) is essential to the accumulation of IP in a particular

firm). Venture firms need to work assiduously to maintaincoherence because the imperative to pursue the new new thingis constantly straining in the opposite direction.

EPISODIC RETURNS IN VC, I.E. NORMALCY

Returns in VC (especially IT-VC) have always been, and canbe expected to be, episodic concentrated in limited timewindows. If you take out 66 69, 81 83 or 96 to 00,the business looks a lot less interesting. Valuation enthusiasm


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and the underlying technology forces simply ebb and flow. (Seediscussion of cycle causality). What is always impossible tojudge, however, is the underlying supply side i.e. the number ofgood future entrepreneurial opportunities. A reduction here willpermanently lower returns on a secular basis. At this moment asizeable inventory of good companies is being built up inprivate portfolios. We can all take solace by remembering thatthe head of the U.S. Patent Office recommended closing thePatent Office in 1909 because everything that needed to beinvented, had already been invented.

SMALL VC FUNDS VS. LARGER,

GLOBALIZATION AND GROWTH VC FUNDS

Investors argue about which type of VC fund will producesuperior returns. However, as is so frequently the case, theanswer lies in the doing not the theory. With clearunderstanding the task at a first principles level, almost anyconfiguration can be made to work. Firms with larger size and

scale of activities enjoy certain competitive advantages to be avery attractive partner for an entrepreneur. On the other hand,scale can dilute the critical base of always limited investor skills.Among the causes of death for investment firms, only hubrisranks above taking on too much capital.

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