When we were growing up, my two older sisters would come home after school and immediately turn on the television and watch soap operas all afternoon.  I would sit on the floor playing with marbles, blocks and baseball cards for hours while General Hospital, All in the Family and As The World Turns droned on.  In retrospect, I wish I had paid better attention to these old-fashioned dramas.  It would have prepared me much better for being a VC.

Why would soaps and VCs be a good mix?  Because, at least in my experience, every start-up company is like a soap opera – full of intense drama and intrigue, conflicts and clashes, heroes, villains and beautiful (well, more often brilliant than beautiful) but flawed characters.

Why is there so much drama in start-ups?  If you look at the ingredients in a start-up, it shouldn’t be too much of a surprise.  Start-ups involve hard-charging, ambitious entrepreneurs and VCs who are aggressively trying to create value from nothing.  Strong (often eccentric) personalities and high stakes prevail, with literally millions of dollars at stake and the opportunity to meaningfully change the lives of the principals, for better or worse.  The participants in the drama ride the ups and downs together – sometimes working as a team, sometimes working against each other – under intense time conditions with competitors (and other villains) nipping at their heels.

Thus, with all the money, pride and ego involved, it’s no wonder there is so much drama in start-ups.  I’m always amused when an entrepreneur tells me they want to write a book about all the trials and travails they experienced in their recent start-up; amusing because what to them feels like such a unique, surreal life experience (one might event say, made for TV), is actually such a common one.

Over my 10 years as an entrepreneur and 4 as a VC, I’ve seen the following (I now realize not uncommon) scenes:

• Trust erodes so deeply between a CEO and some of the board members that they each believe everything the other says is an outright lie with a hidden agenda, resulting in completely dysfunctional relationships and requiring a premature sale of the company.
• The board of directors calls in three members of the senior management team and interview them individually to determine whether to fire the founder or the CEO, because both cannot operate in the same company any more.
• Some of the VCs in an under-performing company decide they don’t want to continue investing in the company and state their intention to walk away, causing the remaining VCs and management to scramble. That is, until business begins to show signs of picking up, and then these same VCs defend their position vigorously, resulting in management whiplash and dysfunctional relationships at the board.

Acquisitions.  Follow-on financings.  IPOs.  Missed expectations and quarters.  Hiring and firing.  Ego, pride and lots of money.  All mix together to create a tremendous amount of drama and tension.  Seasoned board members and entrepreneurs know to expect this and stay cool no matter what scene they find themselves acting in.  If only I had paid more attention to the beautiful people blathering on the tube rather than my baseball cards…

I’m probably one of the last people on the planet to watch Al Gore’s “An Inconvenient Truth”, particularly after its performance at the Oscars.  But my wife and I finally did sit down and watch this thought-provoking documentary cum college lecture from our former vice president and Green Cheerleader-in-Chief.

I have to say it was far more impactful than I had thought it would be.  The data presented was overwhelming and impressive.  Recent cover story articles in The Economist and Business Week underscore the importance and responsibility we all have to address this issue.  My wife and I are beginning to adjust how we operate as a family in order to attempt to reduce our carbon emissions.  And it changed my thinking on all the hoopla over venture investments in the alternative energy market.

Like many others, I had dismissed the alternative energy investment efforts as pie-in-the-sky and inconsistent with the fundamental early-stage venture capital equation:  invest small dollars in early-stage technologies that are 1-2 years away from commercialization and 4-6 years from creating enough value to sell to the public or, more likely, another company at a healthy multiple.  At least that’s the equation when practiced successfully!

But most of the alternative energy projects we have reviewed appear to be more “science projects”, 4-6 years away from commercialization, very capital intensive and with uncertain exit potential and candidates.  Further, this category seemed to me to be falling into the trap you see in numerous “hot” sectors – too much capital chasing too few ideas, thereby increasing price competition for the best deals as well as an oversupply of exit candidates for a small number of exit targets, all resulting in depressed return potential.  The numbers bear out these warnings.  Dow Jones VentureOne and E&Y reported last week that VCs invested $1.28 billion into 140 “clean tech” deals in 2006, up from $664 million and 103 companies in 2005.

But having seen Al Gore’s movie (and sitting with a few knowledgeable entrepreneurs in the space), I have changed my view on the sector.  At least in America, it appears that the consumer mood has shifted such that “being green” is now being seen as a positive brand attribute, akin to “organic” or “all natural”.  Thus, it is likely that large industrial companies will begin to make aggressive acquisitions of technology, once they are proven out by aspiring entrepreneurs.  Perhaps the time horizon will still be elongated, but state and national subsidies are becoming more available to supplement equity capital.  When an investor gets in early enough, you never know what might happen when big dollars from multiple sources get thrown at arguably the biggest problem on the planet.

And if there does end up being an overall over-investment in alternative energy industries?  Good for the planet.  But bad for our returns.

Within the Boston VC community, there’s a new hot phrase running around when it comes to deal selection strategy.  Four or five firms have recently informed me that they have concluded that a "barbell strategy" is the best approach for them and that they are uniquely positioned to execute it.  No, that’s not a reference to some testosterone-induced competition amongst VCs over who can lift the most weight (answer to that trivia question below).  It refers to the strategy funds take who want to keep a toe in the early-stage waters, while still trying to justify more assets under management through large deals.

The math for this multi-stage strategy is simple and compelling.  The more assets under management, the more fee income the VC earns.  If the goal is to build a large VC fund with, say, over $1 billion under management, it’s hard to write checks smaller than $10-20 million at a time per deal.  The deals that have enough mass to absorb that much capital at a time tend to be later-stage opportunities.

Yet, the historical data shows that the >10x return opportunities lie in the early-stage, Series A deals, where less money is invested at a lower price.  These companies commonly are looking to raise only $4-6 million at a time, often split between two firms.  Thus, VCs have a conundrum – whether to stay focused on early stage, where it’s harder to put big money to work (and therefore earn big fees), or focus on later stage deals, where it’s harder to generate 10x returns.

When faced with a hard decision such as this, some firms look in the mirror and make the tough decision…to do both.  They invest dollars at the early stage in small chunks hoping to get a >10x return, and then at the later stage in large chunks, hoping to get 3-5x.  Partners within these firms may either specialize in one stage or the other, as the skills can be quite different, or play on both sides of the barbell.

Either way, it’s a risky strategy that many Limited Partners are complaining about.  Their beef?  Generally speaking, they prefer to have funds be focused on one stage or another, one market sector or another, even one geography or another.  They prefer to make the allocation decisions across funds representing different focus areas as opposed to allowing the VCs roam across boundaries, often resulting in mediocrity across the board.

The frustration that VC managers have is palatable when they learn that their business simply doesn’t scale the way hedge funds do (see my "Circle of Envy" post).  So perhaps VCs shouldn’t bother trying.  Stick to your knitting, whatever it is you’re best at, and leave the portfolio allocation to the limiteds.

Oh – and the answer to the above trivia question?  The strongest VC in Boston is without a doubt Rich d’Amore of Northbridge.  Load up the barbells and watch him work:  he can bench over 350 pounds.  I defy anyone to outperform that benchmark!

"I’ve been in the venture business over 10 years and still haven’t received a carry check," complained a VC buddy to me the other day.  I was so stunned by this comment that I decided to conduct an informal survey and discovered that many of the 30 and 40 something VCs who have been in the business 6-10 years find themselves in a similar predicament.  Now I admit that a VC whining about lack of carry may sound tiresome to an entrepreneur, but it’s a phenomenon worthy of some consideration nonetheless, as how VCs get paid underline their motivation – and has been a driver for much of the VC personnel movement in the last few years.

Some context is required to understand the "inside baseball" concept of carry, or carried interest.  The carried interest is the percentage of profits that a fund earns as a performance incentive – it’s a concept that applies to venture firms, buyout funds, real estate and hedge funds alike, among others.  The typical carried interest ranges from 20-25%, although some firms are able to get as high as 30%.

For example, if a $200M fund that has a 20% carry returns 3x, or $600M, it would generate $80M in carry for its general partners – a handsome sum to earn over the ten year fund life.  But here’s the rub:  the carry is often paid out after the original capital has been returned.  And if the capital isn’t returned, there is no carry.  Further, some funds have inflation-adjustments or minimal return hurdles.  So a fund that returns only 5% per year over 10 years, or $326M for a $200M fund, may get no carry.

Now let’s examine what has happened to folks who have been in the business for the last 10 years.  Let’s say you joined a VC fund as a principal sometime in 1996-1998 when VCs were rapidly expanding and hiring young investment professionals like crazy.  The funds that began during that period had spectacular performance (one fund I know returned 15x on a $100m 1997 fund, yielding an extraordinary $280M in carry for its 4 general partners!).  Unfortunately, as a principal, you didn’t get any of the carry, you were simply paid a salary while the senior general partners took the carry.

But in 2000-2002, after a brief apprenticeship period, you "made it" and became a general partner.  The problem?  Fund sizes swelled to $600M – $1B during that period, the market crashed, and very few of those funds returned capital, never mind posted large enough gains to generate significant carry.  The senior partners siphoned off the excess management fees, leaving the junior partners with comfortable, but not exhorbitant, salaries and no carry.

The new funds that were raised in the "post-crash" era of 2003-2006 have promise, but because of elongated exit time frames, and the fact that many limited partners negotiated tighter terms on the timing of carry distributions, general partners may have to wait until 2008-2010 to receive their first carry checks.

The net result?  It’s not as uncommon as you think for fairly senior general partners, with 10 years of experience, to have never received a carry check.  And if they’re only working for salary, then another VC fund that offers them a bigger salary can poach them away.  An old VC hand once quipped to me that VC was a "get rich slow" business.  For partners who have been hanging around for a while waiting for their golden moment, this must sound painfully true.

Hope everyone is enjoying their holidays.  As food for thought, as I did last year, I submit a few predictions, looking ahead to 2007:

1) NYC:  Imbalance No More.  There is a huge VC-entrepreneur imbalance when comparing New York City to its little parochial cousin, Boston.  Although the population difference is a stunning 14x (8.2m NYC residents as compared to 0.6m Boston residents – and NYC is growing while Boston is shrinking!), there are far more venture capitalists in Boston than NYC and, illogically, many more VC dollars get poured into MA than NY.  This imbalance can’t last.  Although NYC VC firms have to compete for talent with far more hedge funds, private equity shops and investment banks than their Boston brethren, 2007 is the year where the NYC VCs and start-ups begin to flourish and make their mark as a credible, top 3 (on its way to #2?) VC-entrepreneur market cluster.

2) Vietnam as the Next Frontier.  After watching the country’s economic development over the last few years through the lens of our nascent fund, IDG Ventures Vietnam, I received a call the other day that served as the catalyst for this prediction.  A Harvard professor wanted my help connecting to our team there as part of her leading a trip to Vietnam with tens of top-tier limited partners to scout out the investment opportunities.  The combined funds under management of this group is in the tens of billions of dollars.  Vietnam is a fascinating country – it has a population of nearly 100 million people, one-third of the United States, and an average GDP per person of $3,000 (as compared to $42,000 for the United States) growing at 8-10% per annum – the second fastest economy in Asia after China.  With its entry into the World Trade Organization (WTO) in November 2006, Vietnam is well-positioned in 2007 and beyond to become the next China or India – a low-cost center for Western and Asian businesses to manufacture and build.

3. Laptops No More – The Mobile Phone Dominates.  At some point in everyone’s life, you realize that you are an old fogey.  For my 30-something peers who grew up, like I did, with the personal computer and laptop, that point in time is 2007.  This is the year that the mobile phone will be declared the absolute dominant computation and personal device for the next generation.  Today’s teenagers are using their phones to text, chat, Skype, IM and decidely not sitting at desktop computers.  Ringtones and wallpapers are cute (and, yes, now a multi-billion dollar business), but we ain’t seen nothing yet when it comes to the range of future applications, content, community on mobile.  With the number of mobile phones now over 2 billion, the advent of video over mobile networks, Wi-Max and dual-mode phones coming into play, municipal wireless networks being built and devices getting more powerful thanks to Moore’s Law and nanotechnology, these cute devices are becoming truly ubiquitous, powerful computation tools.

That’s all for now.  See you in 2007!

Today marks the end of "CyberWeek":  the week after Thanksgiving Week, when everyone is supposed to be glued to their computers, frenetically pressing "BUY".  Last Monday, or CyberMonday, was the much celebrated coming out party for Internet retail, as promoted by shop.org.  As someone who was involved in the very earliest Internet commerce sites and fought the e-commerce wars during my 5 years at Open Market (1995-2000), I was pretty blase about the whole affair.  I figured it would be roughly flat or perhaps slightly better than last year.  With housing prices crashing, the stock market stalling, Iraq in civil war (Matt Lauer said it was ok to say this, honest), how much incremental e-commerce would we really see?

Boy was I wrong.

Online shopping activity on CyberMonday was explosive.  Reports showed a 26% gain in sales from the same day in 2005 and a 40x overall increase in online shopping as compared to Black Friday (the Friday after Thanksgiving).  Consumers are expected to spend an average of $800 online and nearly 50% plan to make at least one holiday purchase online, up from 36% a few years ago.  In total, an estimated 61 million people will shop from work this holiday season, 10 million more than last year.  One of my portfolio companies, Mall Networks, powered the CyberMonday.com website and gleefully reported explosive traffic numbers this week.

With this kind of growth, it’s no wonder there are many companies pursuing "E-Commerce 2.0" strategies.  Nearly 12 years later, I’m pleased to see that this time, it’s real.

Like many Americans (and few Kazakhs), I saw the Borat movie this Turkey Day weekend.  In addition to being at times hilarious, shocking and offensive, it struck me that there were a few good lessons for entrepreneurs in Sacha Cohen’s irony-laced film.

Take risks, without fear.

When one watches the Borat character approaching strangers on NYC subways, attempting to plant "hello" kisses on them, it is thrilling and fascinating.  One frets that Cohen will end up battered and hospitalized by some irate, affronted resident of Gotham.  It is this aggressive risk-taking, fearless approach that makes the charater so engrossing.  It is impossible for the viewer to predict what is going to happen, but you know it will be voyeuristically entertaining.  Entrepreneurs who take bold risks without fear of personal repercussions are similarly fascinating.  They engender the admiration of those around them, who are similarly enthralled by the unpredictability of the outcome and their absence of timidity.

Audacious, yet credible.

This boldness leads to the next attribute that is so striking about Borat.  He is audacious, yet somehow credible.  How else can one explain his ability to lure congressmen, college frat boys, racist cowboys and stuffy socialites on film, only to make complete fools of themselves?  If he were too over-the-top, their BS meters would be firing.  Somehow, he is credible enough to pull off the charade.  Entrepreneurs have similar challenges – they need to be bold enough to inspire, yet credible enough to not lose anyone along the entrepreneurial journey.  Striking this fine balance is an accomplishment that only the most talented entrepreneurs are able to pull off gracefully.

Never stop selling.

We never catch Sacha Cohen on screen out of character.  He is always selling Borat.  No matter what surprises and twists and turns come his way (e.g, walking into a weatherman delivering the daily report), he is always able to remain in character.  Similarly, talented entrepreneurs are always selling.  They are always able to convince customers, partners and employees to follow them despite the odds, despite the twists and turns.  Staying "in character" throughout the many obstacles that challenge an entrepreneur is a valuable attribute that Borat, and others, appreciate.

The final lesson:  have fun with it.  The entrepreneurial journey is a long one with many twists and turns.  A little humor goes a long way.  Just ask Borat.  And if he were to ever want to start IDG Ventures Kazakhstan?  My prediction:  Great Success!

I confess, I’m one of the few Boston VCs who danced a jig over last night’s election results, where the Dems swept the nation and Deval Patrick made history as the state’s first African-American governor.  In fact, I was probably one of the very few VCs who was at the Hynes Convention Center that evening (flying in from a very long day in NYC) to see all the speeches and celebrate the victory.

I just hope Deval governs from the middle, as promised in some of his recent interviews.  I attended one of the business council meetings before the election and there was a whiff of populism that would make any VC, even very liberal ones, tremble.  We can all agree that Clean Technology is a promising investment area, but should the state government be spending large subsidy dollars when VCs are pouring money into this field?  And why is cleantech a better place for state subsidy dollars than nanotech, stem cell research, wireless, RFID and other promising technologies?  Some in the audience argued that the "capital gap" between angels and VCs required government intervention.  But most practioners know this is an absurd idea in an industry that has too much capital chasing too few ideas and a tremendous oversupply of local capital – in a relatively small economy, MA has the 2nd largest concentration of VCs and consistently attracts the 2nd largest amount of VC capital.

The government needs to be very careful not to try to pick winners and losers.  VCs have a hard enough time figuring out what hot industry and hot companies are worthy of investment – would the MA state government be any better?  I hope Governor Patrick truly focuses his formidable firepower and overwhelming popular mandate on addressing the key issues state government is uniquely capable of addressing, such as:  (1) more affordable housing; (2) more affordable health care for consumers and businesses; (3) a strong public education system, K-12 as well as the state’s higher education infrastructure.  If Governor Patrick moves the needle in these important areas, the local economy will really hum.

I had the pleasure of seeing my second investment as a VC come to fruition when 3M acquired Brontes for $95M (huge congrats to the entrepreneurs, who were two HBS students I met on campus in early 2003 and an MIT professor).  The process reminded me of the role and importance of bankers and brokers, a topic that many entrepreneurs often ask me about.

It’s actually very amusing to solicit VC views on bankers and brokers.  "Hate ’em coming in, tolerate ’em coming out" is the refrain you’ll often hear.  In other words, VCs don’t like dealing with bankers and brokers when representing companies who are raising money, but like working with them when they are selling their companies.  Why the dichotomy?

Simply put, VCs believe that if a company needs a banker or broker to represent them to raise VC financing, then they’re probaby not worth pursuing.  VCs are required to be snobs by nature.  They have to select one business in a thousand to invest in.  That means they are looking for 999 ways to say no (see related post, Dr. Seuss and The Land of No).  If an entrepreneur needs a broker to find VC money, then VCs automatically think "mediocre".  After all, the super-successful, serial entrepreneurs know all the VCs in town and would be aghast at the thought of hiring a broker.  Sounds unfair, but it’s the way it is.

It’s even more unfair when you put the shoe on the other foot.  Once a VC is an investor in a company, when it comes time to harvest the company for exit, they are often quick to hire investment bankers.  If this appears somewhat hypocritical, you’re right.  For the same truth should hold on "the way in" – talented CEOs know to build relationships with the possible acquirers in advance of approaching them or, better yet, prompt them to proactively approach you as a result of a business partnership.  The reason many boards and VCs turn to bankers is that they know how to run a professional process that will yield the best outcome for the shareholders (i.e., maximize the share price in the sale).  Practically speaking, the bankers run these processes all the time.  Entrepreneurs only sell their companies, if they’re lucky, every five years.  There is also some benefit to creating separation between the CEO of the target and CEO of the acquirer – allowing for good cop/bad cop positioning, back-channel communications, and other negotiation techniques that can yield better outcomes.

All that said, I think the jury is often out on whether entrepreneurs should hire bankers on the way out – it depends very much on the particular situation and the individual entrepreneur.  And unless they want to be perceived as a "knave", like the old nursery rhyme, entrepreneurs should be very wary of hiring them on the way in.

Entrepreneurs in the market for venture capital dread Mondays.  Why?  Because it is the day of the all-deciding, all-encompassing Monday Morning Partners Meeting.  For all their differences, every VC firm seems to have the same rhythm – no matter how many different directions everyone is heading during the week, they all sit and meet as a group on Monday and make the big decisions:  who gets the money and who doesn’t, who gets the job offer and who doesn’t, who gets the term sheet under what terms and who gets the terse email or voice mail that says, simply, "we’ve decided to pass on the opportunity."

When entrepreneurs are invited to attended Monday morning partners meetings, they are instructed to pound through their 30-40 PowerPoint slides in 45 minutes, field tens of questions from all sides, shake hands and be escorted out for the next party.  It can have a little bit of a Hollywood pitch meeting flavor – at the end, the VCs excuse the team, have a brief discussion, and, when the deliberations are complete, give a simple thumbs up or thumbs down.  Robert Altman would feel right at home.

After four years of sitting in on the inside of Monday morning partners meetings, I’ve observed a few interesting dynamics.  First, unless the firm is run by a single managing general partner who makes the ultimate decision, all decisions are typically made as unanimous, consensus-driven.  This means anyone can veto a deal if they don’t react well to it.  Entrepreneurs thus need to be careful to think through how to sell an entire partnership on their opportunity, not just the sponsoring partner.  Get to know each of the decision-makers before the meeting and draw out their hot-buttons.  Don’t be afraid to ask for direct meetings with a subgroup of the partners to try to win them over.  It’s better to head into the Monday Morning Meeting with multiple, knowledgeable advocates, not just one.

Another observation I have is that the key diligence issues on each deal typically get boiled down to a rational set of "top 3" issues. Entrepreneurs should ask their sponsoring partner exactly what these key issues are heading into the partners meeting, what their personal stance is, and if there’s any additional information or analysis that can help influence the meeting.  If you get your 45-60 minutes of fame, focus the time on the areas your sponsoring partner guides you to focus on – don’t provide a long, drawn-out dissertation on the grand theory of the technical aspects of your product.  Instead a focused dissection of the key issues and risks and how you’ll overcome them.   

Finally, the timing of the callback coming out of the Monday partners meeting is often a clue as to how likely you are to get to a "yes".  Partners typically file out at the end of the meeting and immediately place the phone calls for the top priority projects that are moving forward – a sense of momentum is established and the last few diligence items get identified and checked off.  The projects that are to be turned down or put on the backburner fall lower down on the VC call back list.  Therefore, it can be Wednesday or Thursday before the entrepreneurs receive the "gentle pass".  If you get the call back late in the week, it is fair to question whether the interest is sincere or whether the partner is stringing you along in order to simply "hang around the rim" (that’s VC jargon for avoiding turning something down because you’re afraid of missing it if others jump on board, but at the same time not being gutsy enough to push it aggresively forward).

Above all, pick something important to do all day Monday and Tuesday.  There’s nothing worse than waiting around for the phone to ring!