Академический Документы
Профессиональный Документы
Культура Документы
December 6, 2007
entrepreneurial company from the CEO’s perspective, I am struck by the number of lessons that I
learned that are also relevant for a future venture capitalist. As I contemplate a job next year
investing in private technology companies, I have tried to summarize these key lessons on both
venture deal evaluation and board management to serve me as a guide throughout my career.
Similar to an entrepreneur, a venture investor should focus primarily on two attributes: a) the
authenticity of the idea; and b) the total available (and serviceable) market. However, in contrast
to an entrepreneur, the venture capitalist should also assess the motivations of the management
and look for teams who are willing to take high-risk, high-return strategies. An analysis of these
• Authenticity: As we studied the various cases, there was a clear pattern in that the
the problem or a natural capability to solve it) were noticeably more successful than non-
authentic businesses. In McAfee, for example, John McAfee is ideally positioned to establish
his company because of his understanding of viruses and his experience operating electronic
bulletin board systems. When he reads an article about a rumored computer virus, he
immediately understands the implications and how he could distribute software to prevent
1
Formation of New Ventures – Final Jules Maltz
December 6, 2007
these viruses. Similarly, Vinod Kholsa’s idea for Sun Microsystems grew out of his
realization that Daisy was spending 80% of its resources building computer hardware
because nothing existed in the market. Recognizing this need for standard workstation
often struggled to clearly address the market need. While David Roberts and Brian Axe had
some prior general business knowledge, they launched Zaplet based only on a personal bad
experience scheduling a vacation (rather than a true understanding of the email coordination
positioned or capable to address the opportunity, the company struggled to find its product
market fit.
• Market Size: In addition to authenticity, venture investors should also look for businesses
with large current, or future, available and serviceable markets. While an authentic
entrepreneur (the “jockey”) is core to the success of a company, there is no substitute for a
product uniquely positioned to address a large market (the “horse”). McAfee, for example,
recognized that every PC would ultimately need virus protection software. His distribution
strategy of using the bulletin board systems allowed him to take a large share in the
serviceable market of network-enabled PCs, and eventually grow into the total available
market of all computers. The venture investors backing XenSource also focused on the
market opportunity in virtualization. While XenSource was clearly behind VMware in its
share of the serviceable market, only 5% of all severs were virtualized, creating a large
“green field” opportunity for the company. Furthermore, Sequoia Capital, in its fund XI
offering memorandum, explicitly states that it focuses on markets that are, or have the
2
Formation of New Ventures – Final Jules Maltz
December 6, 2007
potential to grow to, over $500M. By consistently backing companies that are addressing
large markets, venture investors can avoid mediocre outcomes, and, hopefully, achieve
premium returns.
• Attract High-Risk, High-Return Entrepreneurs: Finally, venture investors should attract risk-
loving entrepreneurs who are willing to take large gambles to achieve massive returns. As
Andy Rachleff illustrated through the “coin flipping exercise” (i.e. at what dollar amount
would you stop flipping a coin if you had a 50% chance of making 10x your money and a
50% chance of losing it all) the typical entrepreneur is significantly more risk averse in
betting his/her company than the average venture investor (since the investor has a
diversified portfolio). To encourage the venture fund’s potential for high-return outcomes,
investors should look for entrepreneurs who have an unusual tolerance for risk. Vinod
Kholsa demonstrated this quality when he left Daisy, which had already achieved some
success, to start Sun Microsystems. Kholsa’s goal in founding Sun was “to take on IBM and
DEC,” the two largest mainframe players, and beat them in their primary businesses.
entrepreneurs who demonstrate this risk-loving quality are immigrants. Leaving one’s home
country demonstrates that an individual is willing to take a large risk for a high return.
In addition to analyzing the company formation process, the class also focused on the
dynamics surrounding a private company’s Board of Directors. While many of the cases centered
on dealing with the Board from the management’s perspective, there were several lessons in how
a good venture director should work with the CEO. Specifically, a venture investor should
3
Formation of New Ventures – Final Jules Maltz
December 6, 2007
remember that the Board relationship with the CEO: a) starts with the term sheet; b) should be
challenging, yet supportive; and c) may come into conflict with the interests of the venture fund.
• Relationship Starts With The Term Sheet: While a venture investor typically does not join a
company’s Board of Directors until after his or her fund has made an investment, the
investor’s relationship with the CEO starts well before the first Board meeting. For many
directors, the CEO’s conduct during the term sheet negotiation process serves as a good
indication of the CEO’s future behavior in dealing with the Board. In Hotmail, for example,
Sabeer Bhatia used the threat of a fictitious angel financing to convince Steve Jurvetson to
pay an unusually high price in the initial financing round. Although the company ended up
with a successful outcome, Bhatia’s behavior in negotiating the term sheet created a lack of
trust between both parties. This mistrust continued after Jurvetson joined the Board and into
the future financing rounds, placing the company in unnecessary risk. In contrast, John
McAfee’s conduct in working together with Jeff Chambers from TA Associates to structure a
fair deal fostered a more productive relationship between the two parties that ultimately
resulted in a better managed company. In addition to analyzing the CEO’s behavior during
the financing, venture investors should also behave in a way that encourages trust with the
entrepreneur. By placing the “gun in the entrepreneur’s hand” and letting the entrepreneur
determine what terms are fair, a venture investor can create a strong bond with the CEO and
• Challenge and Support the CEO: Once the investment has been made, a venture capitalist’s
primary role as a director is to serve as a “sounding board” to the CEO. As the article
“Forming and Working with the Board” mentions, the best Board directors give
“independent, informed advice to management and challenge the CEO, rather than acting as
4
Formation of New Ventures – Final Jules Maltz
December 6, 2007
a rubber stamp.” Because a venture investor has often backed numerous companies, he or
she can provide guidance that can help the CEO navigate through a difficult situation. At the
same time, however, venture directors must be careful not to “direct” the activities of the
company. For example, in Zaplet, Vinod Kholsa, as a Kleiner Perkins director, drove the
company to create five disparate business units. While this was, in part, due to the frothy
and the ultimate demise of the business. Instead of directing management, Board members
should empower the CEO, who needs to be responsible for the actions of the company (and
the eventual outcomes). This system allows the Board to effectively evaluate the
performance of the CEO and assess whether future management changes are necessary.
• Recognize and Manage Potential Conflicts of Interest: Finally, it’s important that an investor
recognize and address his or her dual role as a fiduciary of the company and as a partner of a
venture fund. Because of this dual role, there may be potential conflict of interests when an
investor might prefer to push for a higher-risk, higher-return outcome, even though it is not
in the company’s best interest. For example, in the Conectics case, Kleiner Perkins may have
preferred that the company restart a Phase III trial for Relaxin, rather than focus on the safer
dermatology business. A director should avoid these conflicts by always voting in the best
interest of the company as a Board director (even if this conflicts with how the investor’s
firm is voting as a shareholder). Additionally, a venture director should abstain from votes
where there is a clear conflict of interest and/or seek to involve independent directors to