"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!

Red Sox Nation is strangely depressed this month of September.  Ever since the "Boston Massacre", where the hated Yankees came to town and swept five games to knock the Sox out of contention, it’s been a time of great disgruntlement and dissatisfaction.

It is a bit jarring to see how quckly fans can turn on this team and ownership group.  After all, these are the same folks that delivered arguably the greatest comeback in sports history, and ended the 86-year drought to win the World Series a mere two seasons ago.  This team has been in the playoffs for three years in a row, yet the fans appear as down on them as the lowly Celtics.

This attitude of Red Sox Nation is very reminiscient of an attitude pervasive in VC and entrepreneurial circles.  I refer to it as the "What Have You Done For Me Lately?" syndrome.

For entrepreneurs, it’s a classic source of frustration.  They close a big deal, deliver a strong quarter, ship a breakthrough product release – and the board smiles and says, "Nice job, but what’s next?  How’s that next quarter look?"   After all, the next quarter is the most important one.  And G-d forbid you navigate a great exit as an entrepreneur.  Before the dust even settles and the wire transfer is cold, everyone around you asks, "what’s next?".

As a VC, I see the same syndrome.  Nice deal, say your partners and the LPs, what’s the next one going to be?  Nice exit – way to go – what else looks good in the portfolio and what does it take to deliver an even better one?  If you can raise a great fund, everyone wants to know when you’re going to "put it to work" and deliver the returns.  After you deliver the returns, everyone wants to know when your next fund is going to be.

If you can’t beat them, don’t even bother trying.  An entrepreneur friend of mine once told me he tries to live by his father’s motto:  "Ever Forward" (although his father probably said, "immer nach vorne").  I can’t think of a more apt motto for entrepreneurs, VCs and Red Sox Nation alike.  It simply doesn’t pay to look back.

“It’s the weirdest thing,” confided an entrepreneur to me the other day.  “Talk about role reversal:  when I was raising my series A, the VCs were so negative and pessimistic that I had to exert every ounce of optimism in me to overcome their objections and convince them to invest.  But now that we closed the round, successfully launched the company and they’re on the inside sitting on my board, they are the over-the-top optimists and I find myself, as the one slogging through the hard details of building the business, I am suddenly the pessimist!”

It is an odd phenomenon I have observed.  VCs love to shoot holes in other people’s projects and plans, particularly during the due diligence phase of evaluating a project where the exercise is to identify all the major risks and scrutinize every one of the entrepreneur’s lofty claims, finding all the points of weakness and using them as rationale to either walk away or beat down price in the deal negotiations.

But once a VC has invested in a company, they suddenly go native.  When speaking about one of their own “babies”, they can often be the biggest promoters on the planet.  At times, they are even more over the top than their entrepreneurs. How many press release or article quotes in financings contain the effusive “this could be a billion dollar company” description from the lead VC?  Or how brilliant the entrepreneur is that they’ve just backed?

You will never hear them confide in a cocktail party conversation that, "this company is a dog"?  Or hear them describe one of their entrepreneurs as simply weak?  Instead, ask any VC how they’re portfolio is doing and you’ll likely get the common refrain:  “Somewhere between strong and very strong”.  They are either being promotional, or they really believe it.  After all, everything looks better from 30,000 feet.

On the other side of the table, the entrepreneur who is slogging through the start-up muck sees all the warts. During the fundraising process, they spend hours upon hours covering up these blemishes. But once the VC is in the tent and on the other side of the table, the entrepreneur exposes everything.  And then the tension can begin, because the entrepreneur is the one on the hot seat dealing with all the problems – sweating out each quarter, each product release, each competitive move.  They can often get frustrated when the VC glosses over the issues and dismisses them with a glib comment at the end of a board meeting – and see you next quarter.  And so, their positions switch – the VC morphs into the optimist and the entrepreneur morphs into the pessimist.  So next time your local VC is raving about their latest portfolio company, before you jump to any conclusions, remind yourself to check in with the entrepreneur – you may get a very different picture.

I’m pleased to provide a “shout out” for my partner, David Aronoff, and his new blog GeekVC  David is far funnier, more colorful and creative than I am, as his blog attests, and I’m thrilled he’s decided to step up and join me in the blogosphere!  My other partner, Chip Hazard, provided a guest blog a while ago on his views on the Enterprise IT market (with a nod to Spam-a-lot, we refer to it as the “Not Dead Yet” investment philosophy).  Now my 4^th partner, Michael Greeley, is the sole “blog virgin” in the partnership.  We’ll see how long that lasts…