The Only Thing That Matters (redux)

In 2007 Marc Andreessen wrote a seminal article titled The Only Thing That Matters. One of the best and most oft-quoted ever written in the VC space, the post has had a dramatic impact on my approach to early-stage investing and I’m sure countless other investors would say the same. The article called out much of the hubris (still) prevalent among VCs about how VCs evaluate startups as investments, and directed their attention to — well, the only thing that matters (product/market fit).

It occurred to me that much of the same type of hubris is prevalent among VCs when talking about themselves (ourselves?) — meaning, our own mantras to prospective LPs about what we do and why they should choose to invest their precious dollars with us.

I thought it might be cool, as an experiment, to take Andreessen’s original article about investing in startups, and redirect it towards the topic of investing in VC funds themselves, with the goal of changing as few words as possible, to see if the pattern, cadence and arguments worked. I did this just for myself, for fun, as a type of (serious) parody, I guess.

I copy-pasted his original post below and just highlighted the words and phrases I changed. I mainly substituted “VC fund” for “startup,” “value-add” for “product” and “portfolio” for “market” with a global replace-all and then made the other (minimal) requisite changes. I thought it worked pretty well. Curious to know what you think. (I’d be really curious to know what Marc himself thinks.) So with due respect to Marc Andreessen — without further ado:

The only thing that matters (in VC)

May 4 2016

This post is all about the only thing that matters for a new VC fund.

But first, some theory:

If you look at a broad cross-section of VC funds — say, 30 or 40 or more; enough to screen out the pure flukes and look for patterns — two obvious facts will jump out at you.

First obvious fact: there is an incredibly wide divergence of success — some of those VC funds are insanely successful, some highly successful, many somewhat successful, and quite a few of course outright fail.

Second obvious fact: there is an incredibly wide divergence of caliber and quality for the three core elements of each VC fund — team, value-add, and portfolio selection.

At any given VC fund, the team will range from outstanding to remarkably flawed; the value-add will range from a masterpiece of strategy to barely offered; and the portfolio will range from booming to comatose.

And so you start to wonder — what correlates the most to success — team, value-add, or portfolio? Or, more bluntly, what causes success? And, for those of us who are students of VC fund failure — what’s most dangerous: a bad team, a weak value-add, or a poor portfolio?

Let’s start by defining terms. [BW: Obviously had to change these a little given the change in context, but surprisingly not as much as I expected]

The caliber of a VC fund team can be defined as the suitability of the partners, senior staff, associates, and other key staff relative to the opportunity in front of them.

You look at a VC fund and ask, will this team be able to optimally execute against their opportunity? I focus on effectiveness as opposed to experience, since the history of the VC industry is full of highly successful VC funds that were staffed primarily by people who had never “done anything [BW: sorry couldn’t resist] before”.

The quality of a VC fund’s value-add can be defined as how impressive the value-add is to one portfolio company or founder who actually uses it: How easy is the value-add to use? How practical is it? How fast is it? How relevant is it? How polished is it? How many (or rather, how few) false assumptions about what the real world is really like [BW: :-)] does it have?

The measure of a VC fund’s portfolio selection is the number of up-rounds and exits, and growth rate, of cash returned to LPs.

[…]

Some people have been objecting to my classification as follows: “How great can a value-add be if nobody wants it?” In other words, isn’t the quality of value-add defined by how the portfolio performs?

No. Value-add and portfolio growth are completely different.

Here’s the classic scenario: the world’s best “hands-on VCs” for portfolio companies nobody wants. Just ask any software developer targeting the market for BeOS, Amiga, OS/2, or NeXT applications what the difference is between great effort and big returns.

So:

If you ask LPs or VCs which of team, value-add, or portfolio is most important, many will say team. This is the obvious answer, in part because in the beginning of a VC fund, you know a lot more about the team than you do their value-add, which hasn’t been provided yet, or the portfolio selection, which hasn’t been made yet.

Plus, we’ve all been raised on slogans like “people are our most important asset” — at least in the US, pro-people sentiments permeate our culture, ranging from high school self-esteem programs to the Declaration of Independence’s inalienable rights to life, liberty, and the pursuit of happiness — so the answer that team is the most important feels right.

And who wants to take the position that people don’t matter?

On the other hand, if you ask founders, many will say value-add. This is a value business, VC funds create valuable portfolio companies, customers buy and use the portfolio companies’ products. Sequoia and a16z are the best funds in the industry today because they build the best startups. Without the value-add there is no company. Just try having a great team and no value-add, or a great portfolio and no value-add. What’s wrong with you? Now let me get back to work on creating value.

Personally, I’ll take the third position — I’ll assert that portfolio selection — picking winners — is the most important factor in a VC fund’s success or failure.

Why?

In a great portfolio — a portfolio with lots of real potential unicorns [BW: :-)] — the portfolio pulls value out of the VC fund.

The LPs need to be fulfilled and the LPs will be fulfilled, by the first viable exit that comes along.

The exit doesn’t need to be great; it just has to basically pay back the LPs. And, the LPs don’t care how good the team is, as long as the team can produce that viable exit and return.

In short, LPs are knocking down your door to get the return; the main goal is to actually answer the phone and respond to all the emails from people who want to invest.

And when you have a great portfolio, the team is remarkably easy to upgrade on the fly.

This is the story of Sequoia, Benchmark, and [BW: of course] a16z.

Conversely, in a terrible portfolio, you can have the best value-add in the world and an absolutely killer team, and it doesn’t matter — you’re going to fail.

You’ll break your pick for years trying to find investors who don’t exist for your marvelous fund, and your wonderful team will eventually get demoralized and quit, and your VC fund will die.

This is the story of [BW: a bunch of funds that I won’t name, use your imagination].

In honor of Andy Rachleff, formerly of Benchmark Capital, who crystallized this formulation for Marc Andreessen in his original post, let me present Wiener’s Revision of Rachleff’s Law of Startup Success As Applied to VC Funds:

The #1 fund-killer is lack of portfolio quality.

I’ll put it this way:

When a great team meets a lousy portfolio, portfolio wins.

When a lousy team meets a great portfolio, portfolio wins.

When a great team meets a great portfolio, something special happens.

You can obviously screw up a great portfolio — and that has been done, and not infrequently — but assuming the team is baseline competent and the value-add is fundamentally acceptable, a great portfolio will tend to equal success and a poor portfolio will tend to equal failure. Picking the right portfolio companies matters most.

And neither a stellar team nor a fantastic value-add will redeem a bad portfolio.

OK, so what?

Well, first question: Since team is the thing you have the most control over at the start, and everyone wants to have a great team, what does a great team actually get you?

Hopefully a great team gets you at least an OK value-add, and ideally a great value-add.

However, I can name you a bunch of examples of great teams that totally screwed up their funds. Great funds are really, really hard to build.

Hopefully a great team also gets you a great portfolio — but I can also name you lots of examples of great teams that executed brilliantly against terrible portfolios and failed. Portfolios that suck don’t care how smart you are.

In my experience, the most frequent case of great team paired with bad value-add and/or terrible portfolio is the second- or third-time VC whose first fund was a huge success. People get cocky, and slip up. There is one high-profile, highly successful VC right now who is burning through something like $XXX million in LP funding in his latest VC fund and has practically nothing to show for it except for some great press clippings and a couple of co-investors — because there is virtually no quality company in the portfolio he is building.

Conversely, I can name you any number of weak teams whose VC funds were highly successful due to explosively large markets for their portfolio companies.

Finally, to paraphrase Tim Shephard: “A great team is a team that will always beat a mediocre team, given the same portfolio and value-add.”

Second question: Can’t great value-adds sometimes create huge new portfolio companies?

Absolutely.

This is a best case scenario, though.

a16z is the most recent fund to have done it — a16z’s Bus Dev / Value-Add team was so profoundly transformative out of the gate that it catalyzed a whole new movement toward team collaboration, which turns out to be a monster market for its portfolio company, Slack. [BW: OK I went out on a limb there to hold Andreessen’s metaphor intact so I used one of his companies]

And of course, in this scenario, it also doesn’t really matter how good your team is, as long as the team is good enough to develop the value-add to the baseline level of quality the portfolio company requires and get it fundamentally to market.

Understand I’m not saying that you should shoot low in terms of quality of team, or that a16z’s team was not incredibly strong — it was, and is. I’m saying, bring a product as transformative as Slack’s to market and you’re going to succeed, full stop.

Short of that, I wouldn’t count on your value-add creating a new portfolio company success from scratch.

Third question: as a VC fund partner, what should I do about all this?

Let’s introduce Wiener’s Adaptation of Rachleff’s Corollary of Startup Success:

The only thing that matters is getting to portfolio/return fit.

Portfolio/return fit means being in a good portfolio with returns that can satisfy the LPs.

You can always feel when portfolio/return fit isn’t happening. The investors aren’t quite getting value out of the fund, word of mouth isn’t spreading, Fund II isn’t taking shape that fast, press reviews are kind of “blah”, the capital raise cycle takes too long, and lots of institutionals never close.

And you can always feel portfolio/return fit when it’s happening. The investors are investing in the fund just as fast as you can pre-market it — or “personal brand” is growing just as fast as you can add more Snapchat followers. Money from investors is piling up in your fund checking account. You’re hiring associates and EIRs as fast as you can. Reporters are calling because they’ve heard about your hot new thing and they want to talk to you about it. You start getting VC of the Year awards at the Crunchies. Endowment fund CIOs are staking out your house. You could eat free for a year at Buck’s.

Lots of VC funds fail before portfolio/return fit ever happens.

My contention, in fact, is that they fail because they never get to portfolio/return fit.

Carried a step further, I believe that the life of any VC fund can be divided into two parts: before portfolio/return fit (call this “BPRF”) and after portfolio/return fit (“APRF”).

When you are BPRF, focus obsessively on getting to portfolio/return fit.

Do whatever is required to get to portfolio/return fit. Including changing out people, rewriting your investment criteria, moving into a different market, telling founders no when you don’t want to, telling founders yes when you don’t want to, cutting someone in on dilutive GP share — whatever is required.

When you get right down to it, you can ignore almost everything else.

I’m not suggesting that you do ignore everything else — just that judging from what I’ve seen in successful VC funds, you can.

Whenever you see a successful VC fund, you see one that has reached portfolio/return fit — and usually along the way screwed up all kinds of other things, from channel model to pipeline development strategy to marketing plan to press relations to compensation policies to the CEO sleeping with the venture capitalist [BW: that was in Andreessen’s original, I promise]. And the VC fund is still successful.

Conversely, you see a surprising number of really well-run VC funds that have all aspects of operations completely buttoned down, HR policies in place, great PR, thoroughly thought-through hubris, great interviews, outstanding catered food, 100" monitors in the conference room, top tier VCs kibitzing with them on twitter — heading straight off a cliff due to not ever finding portfolio/return fit.

Ironically, once a VC fund is successful, and you ask the partners what made it successful, they will usually cite all kinds of things that had nothing to do with it. People are terrible at understanding causation. But in almost every case, the cause was actually portfolio/return fit.

Because, really, what else could it possibly be?

@BeninJLM. Rare Medium posts, hopefully well done.

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