This is the first in a weekly series of interviews with venture capitalists. We chose True Ventures to kick off the series because it closed a Series A deal for Syncplicity in the dark days of October 2008, earning it a spot on our A-Team. When it closed a second Series A with Loopfuse in February 2009, it joined a very small contingent of VCs that have done two Series A deals since the financial meltdown.
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True Ventures is a VC startup. It is small, scrappy, and willing to take on the big guys and question the status quo. You can listen below to the whole 24-minute interview with Phil Black (Partner) or just read the abstract here. If you plan on meeting with True Ventures (or indeed pitch to any VC), listening to the whole interview may be a good investment. Most of his points are well known; what is different is how True Ventures is acting on them.
The Changing VC Model
Question: As the VC model changes — more singles, less out-of-the-park home runs — does that mean earlier profitability and that VCs must fund all the way to profitability?
Phil pointed out that 85% to 90% of exits are trade sales, which has always been the case, and that the majority of companies exit between a range of $25 and $75 million. The outliers get all the press, but the bell curve is pretty standard. Exiting between $25 and $75 million is decent as long as you have not invested $40 million to do it. So the right formula is to invest less money in more capital-efficient ventures. Doing this is possible because of the lower costs of startups today, as a result of better platforms, outsourcing, and a capital-efficient mindset and management toolkit.
As Phil put it, “It is possible that the VC model is geared towards the big, big wins, and that’s not the mainstream of what most entrepreneurs want today”. He stressed that entrepreneurs need to find a VC that will enable them to “raise the amount that he or she wants to raise based on the needs of their business, not on what the VC’s needs are”.
Question: What is the exit for a smaller but profitable venture?
Phil described two different types of exit valuations:
- Type A, based on a financial metric, such as a multiple of revenue or profit, where the acquisition can be accretive to earnings.
- Type B, based on the price at which the acquirer “does not want to lose the company” for some strategic reason. Current profit is neither necessary nor a primary consideration in this type of valuation.
Type B valuations are higher, but buyers are scarcer, whereas Type A valuations always attract plenty of buyers. So it depends on your appetite for risk, which makes the answer to our next question interesting.
Question: For a long time, there has been a difference in risk tolerance between the entrepreneur, who has only a few shots at success, and the VC, which has many shots. The entrepreneur probably has had to borrow money to get Series A funding, while the VC typically has less of its own money at stake. So the VC may have a higher appetite for risk than the entrepreneur. Do you see this changing, and how?
True Ventures has clearly thought about this carefully. As Phil put it, “Alignment of interest is critical.” The VC does not want an early strong performer to exit too soon just because the entrepreneur needs some cash and security. The really big returns still come from the outliers and not the middle of the bell curve. But for the entrepreneur who has struggled for years and is not financially secure, a “few million dollars” is life-changing.
When an entrepreneur is faced with an opportunity to exit, the decision is often between certainty (an acquisition offer) and uncertainty (the possibility of building a bigger business over time and getting more money later). Phil said that True Ventures’ aim is to offer both certainty and the opportunity to build a bigger business over time.
“We have countered every acquisition offer with a term sheet for that entrepreneur, so that they have a firm alternative,” said Phil, adding, “By no means is it a requirement that they take it.”
Scale First, Monetize Later
We also asked Phil for his opinion of “scale first, monetize later” ventures such as Twitter. He pointed out that that model was “all the rage 10 years ago and had disastrous effects for a lot of the companies,” but that the model is okay as long as you “have some kind of framework with which you are going to monetize.”
He quoted Toni Schneider, a Partner at True Ventures and CEO of Automaticc, “You have to be able to exercise that muscle.” Getting revenue early will lead you to more revenue opportunities, and you will get better at it.
The example of forgoing early revenue that everybody cites nowadays is of Google resisting the temptation to put advertising on its home page. The lesson from that is not to delay revenue, but rather to choose the optimal revenue model for your business.
Talking Their Book
VCs have to hustle like the rest of us, and we want to give them a chance to promote one or two of their portfolio companies at the end of our interviews. The two that Phil chose to highlight are:
- TextDigger: feed your site into TextDigger and it will highlight the words you should be using to better promote your business online.
- LoopFuse: marketing automation using open source, from a team that includes both former JBoss and BEA executives.
Listen to the Interview
Download the MP3.