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Hi, I’m Brad Feld, a managing director at the Foundry Group who lives in Boulder, Colorado. I invest in software and Internet companies around the US, run marathons and read a lot.

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When VCs Don’t Bullshit You

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I know many entrepreneurs who feel that VCs have played them, gamed them, deceived them, or bullshitted them. But this doesn’t only happen to entrepreneurs. VCs play this game with VCs all the time.

One of our deeply held beliefs at Foundry Group is that there is no value in bullshitting anyone. We screw up a lot of things, make plenty of mistakes, and often look back and say some version of “oops.” But we never bullshit each other or bullshit anyone we work with.

Seth, Jason, and I had an awesome dinner with one of our LPs last night. In addition to being an incredibly supportive investor in us from the beginning, this LP has become an extremely close friend. He’s someone we trust with anything and listen to carefully whenever he has feedback. And we always enjoy being together – a lot.

As I was walking home after dinner, I thought about the person who had introduced us to this LP. His name will be familiar to plenty of you – it’s Fred Wilson. This LP is also a long time investor in Union Square Ventures and was one of the first people Fred introduced us to when we started raising the first Foundry Group fund in 2007.

In 2014, it’s easy to reflect on what has happened over the last seven years and feel good about it. I’m fortunate to have three amazing partners, an awesome team that I get to work with every day, a hugely supportive set of about 20 LPs, and hundreds of entrepreneurs who we love to work with, and whom I think respect us and appreciate us a great deal.

But is wasn’t always this way. In 2007, when we set out to raise our first Foundry Group fund, early stage tech VC was in the shitter. No one believed that you could make any money as an early stage VC and when we went out to raise our first fund, we heard over and over again that we were on a fools errand. The prior fund that I had co-founded – Mobius Venture Capital – had blown up after having a very successful first fund in 1997. The collapse of the Internet bubble was not kind to us and by 2005 it was clear that our second fund – raised in 1999 – was a disaster, and our third fund – raised in 2000 – was off to a very rocky start.

In early 2006, my partners at Mobius and I decided not to raise another fund. In 2007, several of us (Jason, Ryan, Seth, and I) set out to create a new firm.

I thought I had a lot of VC friends and supporters from the last decade of my life as a VC. I quickly learned that it was easy for these so-called friends to say “I’ll help” and very hard for them to actually follow through.

When we started raising our first Foundry Group fund in 2007, I called many of the VCs I knew and asked them for introductions to their LPs. While some of them said they would help, I only recall three who actually made any serious introductions.

Fred Wilson at Union Square Ventures was by far the most helpful. Fred introduced me to all of his significant institutional LPs. We had been friends for a long time and had worked together on several companies. I had deep respect for Fred and I think he felt the same way about me. There was no hesitation on Fred’s part – he made real introductions, advocated strongly for us, and was unbelievably supportive. Over 33% of our capital ended up being from the same LPs who invested in USV. I will never, ever, ever, forget this. Fred can ask me for help on anything he wants for the rest of his life and I will always be there for him.

The next person on the list of supporters is Scott Maxwell at OpenView Venture Partners. Scott and I were both on the Microsoft VC Advisory Board that Dan’l Lewin organized and ran. While we had never invested together, I felt like Scott was a kindred spirit. We both spoke truth to Microsoft execs, even though they mostly ignored us. I remember a meeting with the Microsoft Mobile 6.0 team as they were pitching us their vision for Microsoft Mobile 6.5. Both Scott and I, on iPhone 1′s or 2′s at the time, told them they were completely and totally fucked. They ignored us. A year or two later they had less than 3% market share on mobile. We had a blast together and as we went out to raise our Foundry 2007 fund, Scott made several introductions which resulted in two wonderful, long term LP relationships.

The last person who was helpful was Jack Tankersley at Meritage. When I moved to Boulder, Jack was one of my early mentors. He was a partner and co-founder of Centennial Funds and he and Steve Halsted basically created the VC industry in Colorado in the early 1980s. Jack was extremely helpful in coaching me on how to create a new firm and made a number of introductions, one of which became an LP. I appreciated the energy he put into this immensely.

There were at least a dozen other VCs who said “I’d be happy to make some introductions for you.” Very few of them did, and the ones that did made introductions to junior people at LPs who quickly blew us off.

My partners and I are forever appreciative of Fred, Scott, and Jack’s help. And, after 90 meetings in the first three months of fundraising, which resulted in 20 immediate rejections and no obvious path to a fund at the end of the first quarter, our appreciation for these three people grew. As we started to have momentum in the second quarter, Fred and Scott really stepped up and advocated for us. By September we were oversubscribed and did our first close with our final close in November. We’ve never looked back.

The wonderful dinner last night with the LP Fred introduced me to reminded me of this. But more importantly, it reminded me of how often VCs bullshit each other and entrepreneurs. And, in the situations where they don’t, how incredibly powerful it is.

Fred, Scott, and Jack – thank you.

My First Known Interview – Age 4

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We’ve all got to start somewhere.

Over the weekend my mom gave me a CD with the recording of my first known live interview. I’ve tossed it up on SoundCloud for your listening pleasure.

This recording was done by KERA, our Dallas-based public radio and TV station when I was four. It was for a video segment on a painting I had done that showed on Channel 13 (our public TV station.) My mom hasn’t been able to find the video so the audio will have to do.

While Amy and I listened to it, we made a bunch of observations over the 15 minute segment.

  • At age 4, I had my dad’s NY accent. Even though we were living in Dallas, my accent hadn’t been neutralized yet.
  • My OCD tendencies were painfully apparent in how I described things, especially the lines and dots.
  • I was very clear that I liked watching cartoons on Saturday – and this was on Friday. Amy was impressed that I knew the days of the week so clearly at this age.
  • I didn’t like to physically fight. I still don’t like to physically fight, but I’m not afraid of battle.
  • My brain was racing. I described it as being like a motorboat. I have no idea where the motorboat metaphor came from.
  • Even at age four, numbers had personalities for me. They still do – I love numbers. Especially prime ones.
  • All the dark colors were my favorite colors, which is still true today.

Thanks mom for digging this up. And for being a great mom.

Amazon’s Scorpion Problem

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I expect most of you know the fable of the scorpion and the frog, but if you don’t, it goes like this (quoted from Wikipedia):

“A scorpion asks a frog to carry him over a river. The frog is afraid of being stung during the trip, but the scorpion argues that if it stung the frog, both would sink and the scorpion would drown. The frog agrees and begins carrying the scorpion, but midway across the river the scorpion does indeed sting the frog, dooming them both. When asked why, the scorpion points out that this is its nature. The fable is used to illustrate the position that no change can be made in the behaviour of the fundamentally vicious.”

Over the weekend, there was some commentary on AWS in fight of its life as customers like Dropbox ponder hybrid clouds and Google pricing. Amazon turned in slightly declining quarter-over-quarter revenue on AWS, although significant year-over-year quarterly growth, as explained in Sign of stress or just business as usual? AWS sales are off slightly.

“Could Amazon Web Services be feeling the heat from new public cloud competitors? Maybe. Maybe not. Second quarter net sales of AWS — or at least the category in which it is embedded– were off about 3 percent sequentially to $1.168 billion from $1.204 billion for the first quarter. But they were up 38 percent from $844 million for the second quarter last year. In the first quarter, growth in this category year over year was 60 percent. So make of that what you will.”

Could Amazon’s nature be catching up with it, or is it just operating in a more competitive market? A set of emails went around from some of the CEOs of our companies talking about this followed by a broader discussion on our Foundry Group EXEC email list. It contained, among other comments:

  1. AWS is not the low price provider.
  2. AWS is not the best product at anything – most of their features are mediocre knock offs of other products.
  3. AWS is unbelievably lousy at support.
  4. Once you are at $200k / month of spend, it’s cheaper and much more effective to build your own infrastructure.

While we are in the middle of a massive secular shift from owned data centers to outsourced data centers and hardware, anyone who remembers the emergence of outsourced data centers, shared web hosting, dedicated web hosting, co-location, and application service providers will recognize many of the dynamics going on. Predictably in the tech industry, what’s old is new again as all the infrastructure players roll out their public clouds and all the scaled companies start exploring ways to move off of AWS (and other cloud services) into much more cost effective configurations.

Let’s pick apart the four points above a little bit.

1. AWS is not the low price provider. When AWS came out, it was amazing, partly because you didn’t need to buy any hardware to get going, partly because it had a very fine grade variable pricing approach, and mostly because these two things added up to an extremely low cost for a startup relative to all other options. This is no longer the case as AWS, Microsoft, and Google bash each other over the head on pricing, with Microsoft and Google willing to charge extremely low prices to gain market share. And, more importantly, see point #4 below in a moment. Being low priced is in Amazon’s nature so this will be intensely challenging to them.

2. AWS is not the best product at anything – most of their features are mediocre knock offs of other products. We’ve watched as AWS has aggressively talked to every company we know doing things in the cloud infrastructure and application stack, and then rather than partner eventually roll out low-end versions of competitive products. We used to think of Amazon as a potential acquirer for these companies, or at least a powerful strategic partner. Now we know they are just using the bait of “we want to work more closely with you” as market and product intelligence. Ultimately, when they come out with what they view of as a feature, it’s a low-end, mediocre, and limited version of what these companies do. So, they commoditize elements of the low end of the market, but don’t impact anything that actually scales. In addition, they always end up competing on every front possible, hence the chatter about Dropbox moving away from AWS since AWS has now come out with a competitive product. It appears that it’s just not in Amazon’s nature to collaborate with others.

3. AWS is unbelievably lousy at support. While they’ve gotten better at paid support, including their premium offerings, these support contracts are expensive. Approaches to get around support issues and/or lower long term prices like reserved instances are stop gaps and often a negative benefit for a fast growing company. I’ve had several conversations over the years with friends at Amazon about this and I’ve given up. Support is just not in Amazon’s nature (as anyone who has ever tried to figure out why a package didn’t show up when expected) and when a company running production systems on AWS is having mission critical issues that are linked to AWS, it’s just painful. At low volumes, it doesn’t matter, but at high scale, it matters a huge amount.

4. Once you are at $200k / month of spend, it’s cheaper and much more effective to build your own infrastructure. I’ve now seen this over and over and over again. Once a company hits $200k / month of spend on AWS, the discussion starts about building out your own infrastructure on bare metal in a data center. This ultimately is a cost of capital discussion and I’ve found massive cost of capital leverage to move away from AWS onto bare metal. When you fully load the costs at scale, I’ve seen gross margin moves of over 20 points (or 2000 basis points – say from 65% to 85%). It’s just nuts when you factor in the extremely low cost of capital for hardware today against a fully loaded cost model at scale. Sure, the price declines from point #1 will impact this, but the operational effectiveness, especially given #3, is remarkable.

There are a number of things Amazon, and AWS, could do to address this if they wanted to. While not easy, I think they could do a massive turnaround on #2 and #3, which combined with intelligent pricing and better account management for the companies in #4, could result in meaningful change.

I love Amazon and think they have had amazing impact on our world. Whenever I’ve given them blunt feedback like this, I’ve always intended it to be constructive. I’m doubt it matters at all to their long term strategy whether they agree with, or even listen to, me. But given the chatter over the weekend, it felt like it was time to say this in the hope that it generated a conversation somewhere.

But I worry some of the things they need to be doing to maintain their dominance is just not in their nature. In a lot of ways, it’s suddenly a good time to be Microsoft or Google in the cloud computing wars.

Why The SBIC Doesn’t Work For Venture Capital Anymore

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I woke up to an article in Daily Camera today titled Small Business Administration trying to bring SBIC funds to Colorado.

There are so many things wrong in the article I felt compelled to write about it. This isn’t a knock on the writer (Alicia Wallace) – I like Alicia and think she does a good job. Rather, it’s an example of the difference between signal and noise in any kind of reporting around the VC industry.

I’m an investor in over 40 VC funds around the world (mostly in the US) and three of them are SBIC funds. Each of the SBIC funds were raised in the 2000 – 2002 time period. On paper, only one is in positive return territory as a fund, but the SBIC leverage is a substantial negative factor for the LP investors in that particular fund. And, in the other two, I don’t expect to ever see any of my capital back because of the SBIC leverage. Furthermore, I don’t believe any of the GPs in any SBIC-backed fund would ever take money from the SBIC again.

So I’m speaking from at least a little experience – albeit indirectly – with the SBIC, as I’ve never been a GP in a fund that had SBIC leverage.

The article starts off saying that “Matthew Varilek has traveled across the state, proselytizing the potential benefits of the Small Business Investment Company Program.” As a partner in one of the most visible VC firms in Colorado and an LP in many of the Colorado VC firms, I’ve never heard from Matthew or anyone from the SBIC. Matthew, if you really want to have a deep discussion about why the SBIC program isn’t effective for VC funds anymore, feel free to give me a shout. I’d be happy to meet with you.

Next, there is the wonderful PR quote about the SBIC that says “Since the program’s inception, SBIC “success stories” include the funding of companies such as Apple, Costco and FedEx when they were burgeoning small businesses.” The SBIC was instrumental in the creation of the venture capital business. The Small Business Investment Act of 1958 helped catalyze many of the VC firms created in the early 1960s. When I first heard about VC firms in the late 1980s, and my first company (Feld Technologies) started writing portfolio management software for some Boston-based VC firms, many of them had funds with SBIC leverage, although even by the late 1980s this was changing and many of them had shifted away from the SBIC. If you want to see a fun quote on it, read A History of Silicon Valley which quotes:

“ …many venture capital pioneers think the SBIC program did little to advance the art and practice of venture investing. The booming IPO market proved the model of investing in new companies, as some SBICs cash out at attractive levels. SBICs did give a boost to early venture firms, and some like Franklin “Pitch” Johnson, profiled below, thought the new law made the US “see that there was a problem and that [venture investing] was a way to do something… it formed the seed of the idea and a cadre of people like us.” Bill Draper, the first West Coast venture capitalist, has been more blunt: “[Without it] I never would have gotten into venture capital. . . it made the difference between not being able to do it, not having the money.” Many believe SBICs filled a void from 1958 to the early 1970s, by which point the partnership-based venture firms took off. The US government, however, lost most of the $2 billion it put into SBIC firms.”

So, while Apple, Costco, and FedEx benefited, the PR would be more credible if the SBIC was trumpeting iconic companies created after 1990 or even 2000, especially where the lead investors (rather than follow on investors) had SBIC capital.

Peter Adams, head of Rockies Venture Club, is quoted a few times. I like and respect Peter, so this isn’t aimed at him, but rather at the clear lack of understanding of the capital dynamics around VC funds.

“It looks really great on the surface,” said Peter Adams, executive director of the Rockies Venture Club, a nonprofit aimed at connecting investors and entrepreneurs. “Then when you dig into it, there were some problems.” Adams, who has been involved in many of the meetings with the SBA and members of the investment community, said the greatest concerns voiced by investors and venture capitalists involved management team qualifications, investment track records and the addition of debt to the equation. No. 1 for us is they want a management team with multiple people that have track records in venture capital and have worked together as a team before,” he said. “I can see where they’re going with it, but the VC industry in Colorado has been fairly decimated through the economic downturn.”

Peter is right about the context, but has two fundamental things wrong here. First, the VC industry in Colorado wasn’t decimated through the economic downtown. It was decimated because of lack of performance between 2001 and 2009, just like much of the rest of the VC industry around the US. There’s nothing special about Colorado in this mix, and it has nothing to do with the economic downtown. This dynamic has been reported thousands of times so I don’t need to go through it again, but we don’t have to look back very far to hear the drum beat from the media, LPs, and everyone else about how “VC is dead.” And if you’re curious, it wasn’t too long ago that Silicon Valley was also dying.

The other problem here is the need of the SBIC to invest in “a management team with multiple people that have track records in venture capital and have worked together as a team before.” Any VC firm that fits this qualification is unlikely to have difficulty raising money in today’s environment, and subsequently has no need for the SBIC leverage. And, more importantly, the only firms that will look for SBIC leverage are one’s that don’t have this, which is a classic adverse selection problem.

Then there’s this:

The recession also then plays into requirements that the management team members have been involved in a meaningful number of successful exits during a four- to six-year period. “From 2008 to 2013, that was not a good time for exits,” Adams said.

Huh, what? At Foundry Group, our significant exits (at least 10x capital returned) since we raised our first fund in 2007 include AdMeld, Zynga, MakerBot, and Gnip. We’ve had plenty of other exits, but these are the big ones. One of those companies, Gnip, is Boulder-based and another from our older funds (Rally Software) also generated a greater than 10x return for us. Techstars (which we helped start) have also had a steady stream of significant exits, including local Boulder companies like Filtrbox, GoodApril, and SocialThing. And then you’ve got plenty of Boulder / Denver monsters on paper – some in our portfolio (like SendGrid and Sympoz) and others like Zayo, Ping, Logrhythm, and Datalogix. Finally, if you look across the country, the exits have been awesome the past three years.

It keeps going. There’s talk about the “angel cliff” (e.g. we need funds to invest between angels and VCs – nope, been there – remember “gap capital” – not so effective) and the SBA rules and regulations (which I believe are toxic and inhibiting to a successful VC fund.)

One of the other problem is SBA and SBIC’s behavior in governance of the fund. The paperwork is silly and the overhead is non-trivial. The control over distributions and negative incentives to hold or distribute capital often generates bad decisions when companies go public. And at least one close friend who is a partner in an SBIC fund has now found a new LP to buy out the SBIC so they could actually invest capital in their winners, rather than be limited by the SBIC’s constraints on the amount of capital you can invest in any particular company.

The SBIC could be a powerful force for good in the venture capital industry. But it has to approach things very different and based on my experience with the SBA over the past decade, I don’t see it happening unless there is real leadership somewhere in coordination with leaders in the VC industry. I’m certainly willing to help, if only someone bothered to reach out to me.

UPDATE: It turns out my partner Seth Levine had met with Matthew a while ago. Seth said “Your blog was right on and much of the type of thing I related to Matt and some senior guys he brought in. The gist of my conversation with them was pushing them to consider a different model – that the current one basically led to lowest common denominator GPs and sub-optimal returns. Plus the SBIC leverage could be crushing. I don’t think they have a ton of flexibility around this but they at least listened to the feedback. I’m going to see a bunch of them in a few weeks – I agreed to help judge a business plan competition they were hosting. Like you I’m not a huge fan of the program as it has existed but I give the new guys some credit for both reaching out and trying to be proactive about thinking through this.”

UPDATE 2: Matthew Varilek reached out to me and we are setting up a time to talk.

Use Your Competitors’ Products All The Time

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I was sitting with the founders of a company we’ve funded the other day talking about their competition. I love this product and I use it every day. It doesn’t yet have widespread adoption, but it as extremely actively used by the early adopters.

This company has several competitors – long time incumbents with somewhat stale, but useful products, and several new competitors, including well-funded and noisy ones. I use several of these products regularly in different situations and have encouraged the founders to use them also.

During our conversation, we started off by talking about pricing and go-to-market strategies. As part of this, we were talking through a strategy to change the current game being played in the market, both from a product and pricing perspective. We had clarity on the product side (we have several fundamental architectural differences that enable a powerfully different approach at scale) but thrashed for a while on the pricing perspective.

I realized I wasn’t very clear on the pricing strategies of the competitors so we went through them on-line. While this was sort of useful, our knowledge of their products, how they work, and what the current limitations of them are was more enlightening. Ultimately the product differentiation drove the pricing differentiation discussion, which resulted in our hypothesis about how to change the game which we are now testing.

If we hadn’t all be active users of these competitors products, we would have had a stupid conversation. While we have limited visibility into the competitors’ product roadmaps, we know how hard it will be for them to change several dimensions of their products. Sure, we should assume they can and will do this, but as we enter the market in a serious way, I think we can carve out a unique and very significant position for ourselves by leading with the product differentiation and supporting it with a pricing strategy that undermines theirs. In the absence of the product information we have from our experience using their products, we wouldn’t have been able to tie these two constructs together, and our resulting approach would be weak.

My general approach to competition is to “obsess about their products while completely ignoring the company.” If you can identify competitors, use their products continually, if only to have that knowledge when the moment comes that you have the conversation about how you are going to change the game.

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