As I was giving some career advice recently to a college class, I realized there was one important piece of advice that I never received, but now preach and try to practice:  as busy as you may be, always carve out the time to take random meetings.  Simply put, it pays on occasion to take meetings with high-quality people, even though you have no idea who the person is that you’re meeting with and why.

I have learned that in the world of VCs and start-ups, those somewhat random meetings with high-quality people can lead to interesting outcomes.  In fact, my career has been shaped by VCs I didn’t know reaching out and having random meetings with me, leading to interesting outcomes.

When I was a student at Harvard Business School, at a time when I didn’t even know what venture capital was, a VC firm called Greylock invited me to a dinner meeting on campus and, later, was kind enough to introduce me to one of their portfolio companies, Internet commerce start-up Open Market. I ended up joining the firm after business school and had the privilege of riding the Internet 1.0 wave as an executive there for five years, through an IPO and many exciting ups and downs.

In the middle of my time at Open Market, I got a random phone call from another VC I didn’t know, David Fialkow from General Catalyst, who wanted to have breakfast with me. I wasn’t looking for a job and didn’t really have any reason to meet with him, but I enjoy meeting interesting people and so took the meeting. Another interesting person was at that breakfast – a great marketing entrepreneur named Michael Bronner. Michael had an idea for a new company:  helping families save money for college by redirecting the billions of dollars they spend on marketing programs into tax-free college savings plans. I thought it was a brilliant idea and immediately agreed to jump on board to help found the company and serve as president and COO. Today, Upromise has over $18 billion in college savings plans under management across 8 million households in America. Sallie Mae purchased the company in 2006.

Three years into my tenure at Upromise, I got a random call from another VC – this time one I knew.  He and another friend were starting a new venture capital firm and wanted me to consider joining them.  I told them I wasn’t interested in becoming a VC – just like I wasn’t originally interested in a job at Open Market or helping Michael Bronner start Upromise – but they were interesting people that I knew and respected, and so took the meeting.  Shortly thereafter, I joined my partners Michael Greeley and Chip Hazard in starting a new venture capital firm, IDG Ventures Boston.

And now I’m the one on the other end of the phone calling up people I don’t know, and who don’t know me, and asking them to take a random meeting that may lead to an interesting outcome.

Everyone is super-busy and over-programmed, so it’s hard to maintain that discipline, but I’ve always been impressed with those that block out the time to take a few random walks and seek out serendipity.

Scott Kirsner is always good for a little controversy.  The Boston Globe reporter wrote an article in today’s business section that talks about the VC blogging phenomenon with a Boston lens.  The article probably won’t win him any popularity contests at the Bay Colony Corporate Center in Waltham, but that probably wasn’t his point.

My partner, Chip Hazard, has been an enterprise IT VC since he joined Greylock in 1994.  He and I have watched with some amusement as everyone and their brother in the VC community has been writing off enterprise IT as a boring industry and reinventing themselves as consumer VCs.  With some coaxing, he agreed to do an update on a guest blog he did a few years ago on the topic.  Here it is:

When Nicholas Carr wrote his now-famous Harvard Business Review article over four years ago, “IT Doesn’t Matter”, the most damning claim to our industry was that IT had become a commodity input – irrelevant as a source for strategic advantage. Many pundits, from Larry Ellison on down, began pontificating on the maturation, consolidation and eventual death of the enterprise software business – at least for companies whose names are not IBM, Microsoft, Oracle, SAP or Symantec.

The general thesis goes something like the following: 1) corporate IT departments are looking to reduce, not increase their number of vendors and are therefore not inclined to work with start-ups; 2) customers no longer are pursuing best of breed strategies, but instead want integrated suites to simplify deployment and operations; 3) the sales and marketing costs of large enterprise software solutions are extremely high and drive a need for significant investments that are beyond the capabilities of many early stage companies; 4) the overall rate of growth of the software industry as a whole has slowed and there are few areas for innovation. Common analogies used by these pundits include the maturation and consolidation of the automobile and railroad industries in the early to mid 1900s. Pretty depressing stuff.

In the last six years, many venture capitalists are submitting their own vote on this debate with their feet, as the percent of funding dollars to software companies has declined from 25% of all venture disbursements in 2001 to 19% in the first half of 2007. Anecdotally, when you walk the halls of VCs around Sand Hill Road and Route 128, you hear a similar refrain: “We’re diversifying away from software… we are experimenting with consumer-driven business models… we like Web 2.0/new media plays”.

So where does that leave a talented entrepreneur (or VC, for that matter) with deep experience in this now passé field? While challenges remain, we submit that there remain numerous glimmers of hope in the enterprise software market – and certainly the recent reopening of the IPO market and the more robust M&A environment has brought some of these to light. If you look at some of these recent successes, themes and strategies emerge that entrepreneurs can adopt to drive the creation of successful companies:

• Innovate to drive efficiency. For many times over the last decade, enterprise software companies positioned themselves as automating certain functional departments of corporations. First it was manufacturing, then financials, supply chain, sales, marketing etc. If this is your view of the enterprise software environment, then by and large Larry Ellison is right – there is little room for new categories and innovation. That said, if you spend time with the average CIO, you will hear a different story. In today’s “post-bubble” environment, CIOs have seen their staff and capital budgets cut back, but the demands on their organizations from business executives have continued to increase as companies seek to have a more flexible and cost-effective IT organization to support their business plans. CIOs have gotten their much sought-after “seat at the table”, but with that seat comes the pressure of accountability to deliver bottom-line results. Compounding this challenge of doing more with less is the sheer magnitude of the accumulated applications and technologies that have been deployed by enterprises over the last 20 years. The number of lines of code, disparate pieces of software, and points of integration has exploded exponentially. As a result, there remains a robust opportunity for focused vendors to drive innovative technology into enterprises to drive efficiency in IT operations. The bar, however, is quite high. If you can’t drive a 5 to 10 times reduction in key metrics, the status quo will prevail. A recent success story is Bladelogic, which went public in July of 2007 and trades at 13 times trailing twelve moths revenue, primarily due to the company’s success in automating data center operations, a key means to drive efficiency in IT operations. Opsware, which HP just agreed to acquire for $1.65 billion, is another example and also demonstrates there is a relatively healthy M&A market, as these innovative companies fill key product gaps for large acquirers, such as IBM, Microsoft, Oracle, HP and EMC, as well as mid-sized public companies such as BMC, CA and Symantec.
• Wrap your software in commodity hardware. One of the complaints you will often hear from IT departments about working with a new vendor is the challenge of integrating their solution into their already complex environments. The mundane, manual tasks of requisitioning and provisioning the necessary hardware to run, or even pilot, the shiny new piece of software slows the path to adoption. As a result, a number of innovative software companies don’t appear at first blush to be software companies at all. Instead they sell pre-provisioned, plug and run, hardware appliances. Companies that adopt this model are not only able to leverage Moore’s law to drive performance, but also can ship their customers a unit that can be slotted into a rack and up and running in hours, not days. This allows customers to trial the solution and see the benefits immediately, mitigating the long sales cycles that plague many traditional enterprise solutions. Further, the appliance approach tends to lead to easier adoption by channels that are better suited to selling hardware than complex software. This appliance strategy was seen initially in the security software industry, but has since spread to other areas such as storage back up solutions from companies such as Data Domain, which recently went public and currently commands a $1.4 billion market capitalization on trailing twelve months revenue of $76 million.
• Dominate a niche. Start-ups are often caught in a quandary. To raise money and hire the best people, they need to convince VCs, employees and other supporters of the company of a big vision and the opportunity to capture a billion dollar market. To do so, however, they run the risk of going too broad, too quickly and losing the laser focused approach that allows young start-ups to win against large, incumbent vendors. A better strategy is to instead think about climbing a staircase. You know you want to reach the next floor, but you don’t do that by trying to jump up 13 stairs all at once. Ask yourself, “What can I uniquely do today for a customer that solves a real problem and also provides a link to doing more things for those customers in the future?” In today’s age of rapid development, componentized software and offshore resources, software code is relatively easy and cheap to write, and is no longer the “barrier to entry” and source of competitive advantage it was ten or twenty years ago. Instead, what matters to customers (and potential acquirers) is the deep, domain-specific knowledge instantiated in that software. For an early stage company to build this knowledge, they need to be incredibly focused in a given domain and make sure they have people on their team who understand a customer’s business better than the customer does themselves. Unica, a recently public $80 million in revenue marketing automation company in Boston is a good example of this. When they first got going, they had the best data mining tools for marketing analysts on the planet. Not a huge market, but one that valued innovation and provided a logical steppingstone to campaign management, lead generation, planning and the other marketing tools that the company sells today.
• Explore SaaS (software-as-a-service). If the key barrier to success for early stage enterprise software companies is excessive sales and marketing costs, adopting a software-as-a-service model may be the right approach. This is more than just selling your software on a subscription versus perpetual license basis. Instead, SaaS is all about making it easy for customers to understand, try and, ultimately, gain value from your software. In 5 minutes and for no up front cost, I can become a user of Salesforce.com. Within the 30 day trial period, I can self-qualify and decide if it is the right solution for me and worth the on-going subscription cost. Most importantly, I can potentially do this without consuming a single dollar of their sales and marketing spend. None of the airplane trips, four-legged sales calls, custom demos, proofs of concept or lengthy contract negotiations that lead to the 6 to 12 month sales cycle that costs a traditional software firm 75% of their new license revenue in a given quarter.
• Consider Open Source. Open-Source is not about free software, but rather products that have seen, or have the potential to see, widespread grassroots customer adoption. A passionate end-user community has the benefit of driving a development cycle that quickly surfaces key product requirements and needed bug fixes. Further, the grassroots adoption of the product provides a ready installed base of early adopters who will promote the product across their enterprise, purchase professional services and acquire more feature rich versions of the product. Like SaaS, this is a way to mitigate high sales and marketing costs. When My SQL looks for customers for the enterprise version of their open-source database, they have to look no further than the estimated 11 million active installations of their software or the 750,000 plus people that subscribe to their email newsletter. RedHat’s version of Linux, Jboss’s version of the application server and Sugar CRM are three other well-known open source success stories, but other opportunities abound.

Enterprise software entrepreneurship and investing is certainly not for the faint of heart, but when pursued with some combination of the strategies above, we believe interesting opportunities remain for innovative companies to make their mark in the world and have a positive impact. Contrary to the claims of many, it is still possible to build these companies in a relatively capital efficient manner. Sticking to some of the examples cited above, it is illuminating to note that Bladelogic raised $29 million of venture capital before its IPO, Data Domain $41 million, Unica $11 million, Red Hat $16 million and Jboss (pre-acquisition) $10 million. Only Salesforce.com raised a lot of capital – $64 million – although almost 75% of that came in their last round when one would assume there was evidence the model was beginning to work.

In the end, we believe the analogy to the automotive industry is flawed. The manufacture and distribution of cars is fundamentally different from the software industry. In auto industry, there are tremendous benefits of scale, the underlying platform (tires, chassis, internal combustion engine, frame and skin) has remained the same for decades, and there is little room for small players to access end-users. Software, on the other hand, is a digital good and an information business. Innovation is limited only by the creativity of the author. Small teams can be extraordinarily productive – often times more so than larger teams and organizations. The underlying platform and architecture has changed several times in the last 30 years, and there is no physical product to distribute, thus end-users can be accessed much more directly. Is there a benefit to the incumbency and distribution might of IBM, Oracle or EMC? Absolutely. Does that mean there is no place for creativity, innovation and entrepreneurship in this industry? Absolutely not.

There’s a new VC-entrepreneur newsletter that has been getting a lot of attention lately called TheFunded.com.  The Wall Street Journal had a profile of it last week and I find more and more entrepreneurs and VCs talking about it.

The concept is quite simple.  It’s a bit like what TripAdvisor is to travelers – entrepreneurs go online and report on their impressions of working with this VC or that one and the reviews are broadly posted to the community.Why is this gossip column cum feedback site so popular?  With a nod to Aretha Franklin, I think it simply comes down to one word.  RESPECT.  Entrepreneurs want to be treated with respect.  As the holders of the money and, often, power, VCs are often labeled as arrogant know-it-alls – one of the most consistent criticisms you hear in the industry and see from the posts.  TheFunded.com provides an open counter-balance, requiring VCs to be on their best behavior, else they are “called to carpet” in a semi-public forum by entrepreneurs.  Can anyone say:  VC accountability?

Why are VCs often arrogant?  Is that what they teach us at VC breeding schools?  I think some of it is just the nature of the business.  As I mentioned in my post “Dr. Seuss and The Land of No”, VCs have the job of saying “no” hundreds of times for every “yes” that they fund.  To be efficient, they are trained to say “no” quickly and not waste time on projects they simply don’t like or don’t believe in.  Whether you believe in a project or not is such a subjective standard, that it can always be open for debate and argument.  But VCs can’t afford to have debates and arguments about projects they don’t like, they must quickly, unemotionally move on to the next one.

Entrepreneurs, on the other hand, are emotionally attached to their projects and wired to believe that what they are working on is the absolute best thing going on – after all, they chose to work on it at the expense of every other new start-up or job they could have pursued.  Thus, it is hard for them to contain their natural enthusiasm over why what they’re doing absolutely deserves to get funded.  And nothing is more frustrating for a “walk through walls” entrepreneur than to be dismissed by a VC, no matter how graciously. 

Many VCs find it particularly hard to provide the follow-up “no” (should I call?  Leave a voice mail?  Send an email?  How to make it more personalized?  But if I spend all day explaining to entrepreneurs why I’m saying “no”, I’ll never have the time to get to “yes”).  On the other hand, entrepreneurs take particular offense if the follow-up “no” is curt and impersonal.  It’s a bit of a joke on both sides of the fence.  “Dear X, thank you for your time, but we are not going to pursue the investment opportunity at this time.  Best of luck and keep in touch.  When you are worth billions, we will post you on our ‘missed deals’ website”.

All joking aside, the tension between the two world views of the skeptical VCs and the optimistic entrepreneurs is inevitable.  You see this tension playing out in board rooms and pitch meetings every day.  To be clear, though, it’s a healthy tension.  If it weren’t for the walk-through-walls optimistic entrepreneurs, companies would never get started.  And if it weren’t for the cynical, blasé VCs, a lot of precious capital would be inefficiently wasted on tilting at windmills. 

The trick, therefore, is for VCs to simply treat entrepreneurs with R-E-S-P-E-C-T.  That’s all entrepreneurs are askin’ for.  Just because a VC may not like the idea, or even the person hawking the idea, doesn’t mean they shouldn’t treat them with decency and respect.  On the flip side, the entrepreneurs should remember that it’s the VCs job to sift through hundreds of opportunities and spend time only on very few.  If it’s not a good fit for them, move on.  That’s why TheFunded has struck a chord.

If you at all follow the start-up industry, you have heard the taxing news.  Congress wants to raise taxes on VCs and private equity executives.  Blackstone’s IPO and the perceived excessive economics reaped by the firm’s principals appears to have been the impetus for the new legislation proposed by representatives Charles Rangel (D-NY) and Barney Frank (D-MA).  As a side note, it is ironic that the sponsoring representatives are from two of the three states (California being the obvious third) whose local economies benefit the most from the private equity industry.  Talk about putting national (albeit populist) politics ahead of local interests!

At any rate, the economic impact involved is quite considerable.  Currently, we VCs get taxed at the long-term capital gains rate – that is, 15% – for our carried interest of 20-30% in a fund.  The new legislation would result in taxing the carry as ordinary income, typically 35%.

Just a reminder, the "carry" in a fund is the portion of the gain that the VC reaps as part of their compensation.  That is, if a $200 million fund returns 2x, or $400 million, a "20% carry" on the $200m gain is $40 million, which goes to the VC managers of the fund.  A 10x performance on a $200 million fund would yield $360 million in carry ($2 billion in returns, $1.8 billion in gains x 20% carry).  The tax difference for these two funds would be 20% points in incremental taxes paid by the principals, or $8 million and $72 million, respectively.

Some entrepreneurs have asked me to justify why VCs should get the capital gains treatment in the first place and I confess to being hard-pressed.  On the one hand, we do put capital to work and it is truly risk capital.  On the other hand, the capital we put to work is either other people’s money (our LPs) or our own money (our “co-invest”), which under any circumstances would be treated as capital gains – that’s not a part of the debate.  The carried interest is a more complicated portion to analyze because the carry isn’t really capital at risk – it’s a share of profits, not unlike what a sales VP or a stock broker might get in commissions, which are taxed at ordinary income rates. 

The industry is obviously aghast at the proposition of paying more in taxes.  The complaints are at both the micro (“you’re going to double my taxes!”) and macro level (“private equity and VC are fundamentally making American business more competitive and critical elements to the economy; increasing their collective tax payments will be deleterious to US growth and global competitive position.”).  Many VCs rightfully argue that the carry can’t be looked at in isolation – it is a single component of a range of components of private equity compensation that the general partners choose to allocate more of their dollars towards as compared to management fees exactly because of the favorable tax treatment.  If that were to change, they would simply raise management fees or increase the carry rate.  Increasing the taxes on VCs and private equity and having these costs passed through to the limited partners in the form of higher fees or carried interest payments will, in turn, lower the asset class returns for American private equity funds and result in capital shifting away from this asset class into other vehicles, likely private equity funds outside the US.

How will all this impact entrepreneurs?  Probably very little in practice.  On the margin, if it pushes a few private equity executives out of the business, the impact will be negligible given the current situation of "too much money chasing too few quality deals".  My observation is that entrepreneurs roll their eyes when they hear their VC friends whining about the topic, and probably rightfully so.

I guess in the end, I personally find myself in the unusual position of being a bit wishy-washy on the topic.  On the one hand, it is galling that Steve Schwarzman’s butler pays a higher tax rate than he does.  On the other hand, raising taxes on such a critical part of corporate America that is so intricately linked to our capital markets, industrial competitiveness and technology innovation clearly isn’t going to help our global competitive advantage.  In practice, my VC friends cynically tell me the whole debate is moot.  If Congress passes the contemplated law, an army of lawyers and accountants will begin advising us on intricate loopholes to structurally avoid the whole thing!

I’m participating in a panel this weekend at the TiE conference on the challenge in Massachusetts of building the next "billion dollar company". It’s an interesting and timely topic, to say the least.

We seem to have an inferiority complex in Massachusetts on many dimensions beyond the historical trials and tribulations of our beloved Red Sox.  We stand in the shadow of New York City as a financial center, despite having a few strong private equity firms and hedge funds located in the Bay State, such as Bain Capital, Highfields and The Baupost Group. And we are a distance second to California in attracting job-creating venture capital, with $13 billion invested into 1,495 start-ups based in "The Golden State" as compared to $3 billion in 380 Massachusetts start-ups in 2006.  It’s not too shabby to be in second place to New York and California, considering we are only America’s 13th largest state as measured by population, but who wants to settle for second place?  With our mix of world-class academic institutions, hospitals, venture capital and technical talent, one would think we would have the potential to generate even more industrial horsepower. Our performance in creating industrial leaders is particularly discouraging, as we have produced a mere 10 of the country’s Fortune 500 companies that call Massachusetts their home state. Why haven’t we been able to create more billion dollar companies as opposed to numerous minnows that get gobbled up by the bigger fish out of state?

To analyze the situation, it is helpful to look at a few historical case studies of successful companies that have indeed broken out.  Two oft-cited role models who have "made it" are EMC and Boston Scientific. 

EMC is arguably the kingpin of the Massachusetts information technology scene.  Founded in 1979, the company has achieved enormous success in the information storage market, with a market capitalization of $33 billion, 2006 revenue of over $11 billion and 26,500 employees.  Boston Scientific holds a similarly exalted position in the medical technology market.  Also founded in 1979, the company’s success in medical devices has led to its growth to a market capitalization of $24 billion, 2006 revenue of $8 billion and 28,600 employees.

What do these two homegrown industrial titans have in common?  One interesting observation:  EMC and Boston Scientific were not classically venture-backed companies.  In both cases, the founders controlled the company through the IPO and had the fortitude to persevere throughout the early lean, start-up years without succumbing to the temptation to sell too early.  Patience in both companies on the part of investors and the entrepreneurs was a virtue.  EMC had its IPO in 1986 and hit $1 billion in sales in 1994, 7 and 15 years after its founding, respectively.  Boston Scientific had its IPO in 1992 and hit $1 billion in sales in 1995, 13 and 16 years after its founding, respectively.  In a nod to Jim Collins’ book "Good to Great", where he cites the importance of steady, consistent leadership, it is worth noting that the two founding leaders, Richard Egan and John Abele, were in their positions for 13 and 17 years, respectively. Another common attribute is that once they had achieved a strong position in their initial core market, both companies made bold acquisitions to maintain leadership and market supremacy:  EMC in the case of Data General and then numerous software companies, such as VMWare; Boston Scientific in the case of Guidant and numerous smaller device companies. In other words, the two companies did not rest on their laurels but instead took risks and aggressively sought to broaden their reach.

What are some of the inhibitors to replicating these two local success stories?  Beyond the lessons cited above, we would also observe that there are subtle differences in the way Massachusetts entrepreneurs and investors approach company-building as compared to our peer elsewhere.  Massachusetts entrepreneurs and investors prefer to push for early exits, exhibiting a predilection for taking their chips off the table early.  To be clear, none of us are beyond reproach here.  Beyond cultural conservatism, another driver of this behavior is the shallow pool of local senior management talent.  When Massachusetts boards consider selling or holding on, one of the key questions they ask themselves is, "Does my current management team have the horsepower to take the company to $1 billion in sales?".  In the absence of having numerous strong training grounds for executives to learn how to run operating units greater than $100 million, the answer is too often no.  You can’t swing a dead cat in Silicon Valley without hitting a high-tech executive with experience at an operating scale of greater than $100 million, but in Massachusetts there is a depressing dearth of such talent.

With the quality of our talent pool and the caliber of our business and political leadership, it’s not all doom and gloom. With home-grown powerhouses like Genzyme and Biogen leading the way, our position as a biotechnology cluster appears to have strengthened recently and we are increasingly attracting out-of-state employers who want to tap into the world-class scientific talent residing here. There are early signs of hope that we are well-positioned to lead in the nascent but potentially robust Green industry, with companies like Evergreen Solar and EnerNOC leading the way. And one of our most promising information technology "up-and-comers", Akamai, appears poised to achieve the magic $1 billion in sales in the next two to three years, dominating the Web content distribution market.

I am thus hopeful that we are on a stronger path in Massachusetts than ever before, so long as we have the continued leadership of the business, financial and political community to show the way.

I just finished reading The Wisdom of Crowds by James Surowiecki, an excellent book that provides insights into consumer behavior as well as the venture capital investment process.

The book’s thesis is a simple one:  a crowd of well-informed, independently minded individuals will make better decisions than any one individual, no matter how smart or experienced.  The book support this thesis (not in a rigorous academic fashion, but in the breezy, conversational manner that you would expect from a New Yorker columnist) by examining a range of case studies that range from the frivolous (predicting the weight of a pig at a county fair) to the profound (the tragic explosion of the Challenger space shuttle).  In example after example, the book nicely weaves a compelling argument that "mob rule" may not be such a bad thing.  The author attempts to make connection from this observable human behavior to derive thoughtful insights into decision-making and capital markets.

In my own observations of consumer-based start-ups and their surge in the last few years, it strikes me that "the wisdom of crowds" is one of the more important factors in driving the success of Web 1.0 and Web 2.0 start-ups.  The Internet has enabled the efficient congregation of crowds of individuals from around the world and the rapid, low-cost aggregation of their input, allowing this "crowd power" to select the most interesting products to buy (eBay), videos to watch (YouTube), search results to view (Google) and knowledge to absorb (Wikipedia).  Arguably, the Web 1.0 and 2.0 phenomenon has largely been built on the theory behind the wisdom of crowds.

And, as usual, the book caused me to reflect on the venture capital process as well.  If you believe in the book’s thesis – that no one person can be as smart as a group of informed, indepedent-minded people – then the way to make the best investment decisions is to construct a democratic investment process rather than a hierarchical one.  That is, collect aroud the table a group of experienced investment professionals with diverse backgrounds and perspectives and don’t allow any one individual’s power status to sway the discussion.  Instead, allow robust group group discussions and debates to ultimately yield better investment decisions; better even than any one smart individual might achieve operating alone.

Interestingly, in my experience, this is the construct of most good venture capital firms.  It would be an interesting study of VC firms’ performance over time to determine whether firms that have democratic, open decision-making processes perform better on average than those that have more hierarchical, autocratic decision-making.  Understanding this dynamic within a VC firm is critical for entrepreneurs pitching to and working with VCs – an area in which I find surprisingly few entrepreneurs really probe deeply.  They should.

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!