I'm excited to report that we've started to release the results from our first-ever study on best practices in private equity and venture capital deal origination.  My coauthor Chris Farmer (formerly Vice President, Bessemer Venture Partners) and I published a summary in the current issue of Harvard Business Review. 

Evalueserve, a global research firm and the acquirer of my former company (Circle of Experts), provided supporting research and analytics in the initial phases of this study. We also thank Yujin Chung and Neha Kumar (Wharton 2010), research associates who provided invaluable support, and interns Corentin Roux dit Buisson, Dan Clark, Nitin Gupta, and Nikhil Iyer .

A highlight from the HBR article:

We've found that late-stage tech investors with geographically diverse portfolios are consistently among the best performers and have continued to attract large limited partner commitments, even during the challenging period since 2007. Almost all such players have been able to raise at least as much cash as they could previously. By contrast, the funds with traditional origination programs, focused on local networks, have had difficulty; most haven't raised new capital since late 2005.

Read the whole thing.

For more data from the study, see the slides below:

Download this presentation.

Download this presentation.

So the New York City government has decided it needs a little social media savvy—you now, since that newfangled Twitter thing came out, they feel like they need to be jumping on board with technology as an early adopter.  So, they’ve posted an open position for a Chief Digital Officer (PDF posting). 

The position will:

“help develop forward-thinking policies on social media, digital communications, web 2.0 initiatives and other tools to better serve the public”

and it’s responsible a host of stuff:

“Managing and presenting a consistent and comprehensive new media face for the City of New York; coordinating with City agencies in the promotion of initiatives via new media tools; working with the Department of Information Technology and Telecommunications (DoITT) to improve the design and content of NYC.gov to increase usability and make relevant information more accessible; developing meaningful social media uses to keep residents informed and engaged; leading the development ofdigital project implementation; managing the build of current and future digital assets; managing schedule, scope, quality, requirements and rollout activities for redesign/development and other digital projects; mining new and improved ways to expand current business through relationships and communicating new ideas; overseeing improvement of digital media activities through creation and analysis of dashboards, metrics and appropriate analytics; and managing special digital media projects as assigned.”

Hmm… Lots of building, broadcasting, promotion, releasing info…

…but you know what I don’t see?

Listening.

Yeah, so, that’s kind of the point of all this Web 2.0 stuff.  I’m not sure if you heard, but it’s not about centralized hubs of communication anymore.  It’s about listening.  It’s about taking what you learn from the inbound and enabling and empowering communities around you—small pieces loosely joined.

That’s what’s going to be hard to bring NYC government into “2.0” mode.  Anyone can set up a Twitter account and post their press releases to it, but how many people are actually going to have public conversations there?  Will our lawmakers and city officials be empowered to engage with citizens without having everything run through legal first? 

I took a meeting with a city official once and the first think he said to me was that the contents of the meeting were not to be blogged.  That pretty much imploded my interest in the rest of the meeting—because that signaled that this was not going to be a process where listening accurred, or that there was a real possibilty to affect change with thoughtful input. 

That’s not a technology problem—it’s a culture problem.  How do you change culture?  By crossing “A master's degree from an accredited college in economics, finance, accounting, business or public administration” off of the requirements list and adding “Uses Twitter and Foursquare…  keeps a blog, etc”.  Hopefully, after they find that person, they won’t muzzle them.  If we don’t hear form the CDO on a regular basis through social media channells in an authentic, engaging way, you might as well toss their salary into the Hudson because they’ll never have the freedom to work. 

So before "…multimedia content from NYC Media and other outlets will be integrated into the City's website, mobile devices, video-on-demand and in public spaces…" how about recognizing the following:

This is not a media broadcast position or a project manager job—it’s a community organizer… someone who can create community out of various government agencies to interact with the outside world in an efficient manner as well as to empower communities of constituants online.  Hopefully, we’ll see a lot less recreation of wheels, some autonomy around this position, and a renewed engagement in the community for city officials.

Two NY start-ups, The Faster Times and True/Slant, were profiled in a NY Times Magazine article about web journalism models. Both are struggling with how to profit from new media.The Faster Times was started by Sam Apple, formerly of Nerve.com. Apple couldn't offer salaries and benefits or flat rate freelance fees, so he promised contributors 75% of revenues from ads placed near articles. Contributors profit from their work, according to the market's assessment of its value.

A second news web site called True/Slant, now has about a million visitors monthly, and works with 300 part-time entrepreneurial contributors. The site, built on a $3 million investment from Fuse Capital and Forbes Media, experiments with the idea that technology can allow the creation of a news organization without editorial hierarchy. Freelancers are paid a pittance compared to traditional news rooms, the magazine said.

New York Times Magazine

Related:

> Gawker Advises Writers "Scandal Sells"

I grabbed this just now on my Facebook home page: a sponsored Link with the Gmail/AOL/MSN logos, and my email address in bold, Thanking me?

I normally would have ignored it, but frankly I was curious. I clicked. The result, however, was insidious:

So now I can see what the plan is- Facebook wants to keep an eye on your Google account to make sure you don't connect to someone by email without also connecting them to Facebook.

It's hard to know what the cumulative effect of constant authorizations, approvals, and stored passwords really is, but I predict one day it sneaks up on you, an accidental overshare or ads that seem to insidiously follow you whenever you want?  A friend who lands on a site they hate, to find out that you praised it before you knew how much it would offend them? 

Or will it be merely the insidious, price-discriminatiung ad where you get to fly to Fort Lauderdale for $389, but your friend flies the same itinerary for $250 with a free checked bag?

Scary? Only sometimes.  But it all started with one click.

By the time of this post is done, Diaspora, the web decentralization play from four NYU/Courant students in New York, will undoubtedly have $100,000 raised on Kickstarter.  Over and above that, it seems like they’re on a clear path towards a million dollars.  Think I’m poking the bear?  I’m dead serious.  You watch.  A week from now, they get to seven digits.  Why?  Because the ire over Facebook’s privacy issues, platform aggression, etc. is real.  If you’re concerned about Facebook, these guys are your heroes. 

So, great…  One day,  you’re a bunch of tech dudes hacking away at a hardcore grad math program and the next day, you hit the proverbial startup lottery and you’re sitting with some major coin in the bank.  Every VC and their mother is banging down your door, the media is all over you, and there are underage groupies lining up outside in Washington Square Park NKOTB-style.  Ok, so maybe not the last one, but still.  Undoubtedly you are completely overwhelmed, distracted, etc.  What the hell do you do now?

If you’re Max, Dan, Raphael, and Ilya, (only two of whom are old enough to drink) here’s my suggested game plan:

1) Start talking—but on your own terms.  You guys are now the startup version of the OJ Simpson white Bronco chase.  All eyes are on you.  The temperature of the media buzz around you is white hot—but it’s fueled by very little information whatsoever about what you’re building, what your intentions are, who you are, etc.  The last thing you want is for people to start making up their own stories—especially that you’ve taken people’s money.  They’ll start to build up their own expectations, and what’s worse is that they’ll repeat them.  Before you know it, the “these guys want to kill Facebook” rumors will start and then you’ll find things from a strategic and competitive dynamic to be suddenly very difficult.   Start blogging and telling the world, in very plain, innocuous, basic terms, what you’re aiming for, what your driving goals are, who you are, etc.  The more fact you throw on this fire, the less you leave room for conjecture and the less interesting the story actually gets.  Take away the story, essentially, by telling it yourselves.  Sure, the buzz is nice for raising money, but it’s going to make things very difficult for you to concentrate and actually get all the work done you want.

2)  Ask advisors that you trust to help you prioritize who you should talk to—and talk to only the ones that usually talk to people at your stage.  Undoubtedly, you have a shit ton of inbound e-mail.  I would just declare e-mail bankruptcy right now and delete all or most of it.  Then, ask the people you know in the startup world who the 10 people you should have a conversation with are.  Get their feedback, but then right away, get to work.  You don’t need a ton of money, so don’t waste your time talking to all the investors who want to talk to you.  In fact, you don’t need their money at all, so talk to the ones you think you can learn something from in terms of how to build a real business, if that’s your goal.  Money is money, but there’s definitely a limited number of people who normally write checks of the kind of size you’d normally take at this stage.  You don’t want someone who is willing to make you guys the exception—so stick with the people who help teams like yours at your stage on a regular basis. 

3) Do the opposite.  Everyone is expecting you guys to be their knight in shining armor against the likes of Facebook.  You’ve clearly got a lot of support to be that, and the temptation may be to do exactly just that—but consider the opposite for a second.  Are you really going to be the next Facebook—or perhaps if what you’re trying to do is to protect the average person and help give them control over their data, how can you do that the most effectively.  Perhaps actually helping Facebook and other networks do to that, and to help them be successful, is your best bet to make the biggest impact.  Helping Facebook isn’t exactly what people want to see you do, but in this firehose of publicity and feedback that you’re getting now, don’t forget to consider *all* the options.

4)  Get your legal and financial ducks in order.  Now that you have money, you’re going to have all sorts of legal and financial responsibility.  Step one, get a bookkeeper who can also just do simple stuff like setup a bank account for you, get a cashflow statement going for you, and get you a corporate credit card to pay for things.  I know an awesome one for you—she works for several local startups and will make your life much easier.  Get a lawyer, too… especially given that you’ll have real IP and that you’ll have to deal with being at a University.  You don’t want to spend a lot on a lawyer, either.  Perhaps a brief meeting with Jonathan Askin would be a good start.  He helps local startups get off the ground, using the resources of his Brooklyn Law class.

5) Get to work.  This week is going to be crazy, awesome, overwhelming, stressful.  It’s unlikely you’ll get to much code, but next week, get back to work.  Focus.  While you might feel like a rockstar today, the task you’ve bit off for yourselves is enormous and building a company is way fucking hard.  Don’t forget that.  Don’t let it all get to your heads.  You have a lot of work to do now, so get to it!

If you need help, feedback, etc…   my e-mail is charlie@firstround.com .   I’ve been on your side of the table and I also teach entrepreneurship at Fordham.  You’re welcome to ask awesome people like Evan Korth, who you know, about me and the folks I work with here at First Round.  Good luck and thanks for helping to drum up the New York startup scene into the spotlight!!

Hiring is hard.  So is dating.  When you’re talking hiring for startups, the two are actually pretty similar—because joining a super early stage startup is essentially like getting married.  You’re building a young team with a small amount of money.  Chances are neither of you has done this before—you’re making the rules as you go along, but you’re all hot and heavy to go at it (at least until the money runs dry, anyway). 

It shouldn’t come as a surprise that you hear similar complaints from people on both sides that there’s “nobody good out there”—either for dating or hiring for tech.  The reality just doesn’t reflect that.  I think the people who complain a lot about that situation don’t realize or want to admit that they’re either a) not putting in much effort or b) not better than the worst alternative.  Not every project or person is worth taking up someone’s time, to be honest.  Some people are just undateable and some projects just don’t interest a tech person.  It’s a game of musical chairs and the person left standing will usually place the blame on the system before looking it the mirror.

Everyday, lots of people fall in love and get married—even in big, unfriendly cities like New York.  They hire hackers, too.  The “trick” is that it just takes some time, the right mindset, and, most of all, a lot of hard work.  You can’t get away without that last one.  It sure seems easier for other couples or other cities, but you’re not seeing a lot of what goes on behind closed doors—literally.

The first thing you need to realize is how much time it takes, for both.  If you want to get married right now, or in the immediate future, you can.  You just go to eHarmony, fork over your cash, and boom, out pops someone self-selected to be looking for marriage.  It’s the same in the tech world.  There are lots of development shops out there who would be more than happy to build the tech for your startup.  Some of them are pretty fantastic, too.  It’s a simple transaction.  You pay them, out comes code.  Simple as that.  Like any hire or any date, though, sometimes things don’t come out so well with dev shops—and a lot of people are looking for something more.

If you actually want a real partnership—for code, love, or both (I’ve dated a number of women who can write code… it’s ridiculously awesome), then you’re going to need to put in a little more effort. 

Here are a few tips I learned from being out there in the market to hire developers, struggling at first, but then eventually learning how to successfully acquire talent in the end. 

#1  Maintain a great professional reputation.  If you’re a developer, you undoubted pinged a dozen times a day for your services.  If you’re not spending all day reading blogs, Twitter, and Techcrunch, you might not know who these people or startups are—so you’re probably going to forward them on to a few folks that you think seem to know everyone.  What are they going to say about you?  The more people that either a) know nothing about you or b) think perhaps you might not be such a great person to work for the more trouble you’ll have hiring.  You might be a great person once someone takes the time to get to know you, but people just don’t have the time for that.  Also, most people just don’t have time for a company with any kind of black mark on it.  Building good relationships with the right people, playing nice in the sandbox, that’s just like minimum to be able to hire—because it reflects on the kind of partner you’ll be.

#2 Work on a technically interesting project.  People knock developers who work on big Wall St. projects, but what they fail to realize is that many of them, because of their size and scale, are actually technically pretty interesting.  (Actually, I think the bigger wasted talent suck is Madison Avenue—because, really, does Diet Coke really need another flashy microsite that no one will care about after this “viral” campaign?)  In fact, I’ve seen lots of devs—especially the best ones—bend over backwards to work on cool stuff, taking way less pay, salary, etc.  I mean, they spend all sorts of pro-bono hours contributing to open source projects, right?  If you can’t get any of them to work on your startup for free, maybe it’s not that you can’t pay enough.

#3 Build up relationships beforehand.  When I hired Hilary Mason, I had an unfair advantage.  No, it wasn’t how good my angel investors were or how much I could afford to pay her.  It was more simple than that.  I knew her.  We weren’t best buds, but we knew each other enough that we were following each other’s progress on different things and building up a little repoire.  That goes a long way—and makes a big difference when compared to starting from scratch.  Entrepreneurs really underestimate how much it takes to motivate someone to change jobs.  You may think it’s easier to get people to do that in the Valley but there are other things at work.  For example, because the community is smaller and more tight knit, there’s an increased chance that you know someone at the company you’re moving to—or that it already has a good community reputation.  When someone jumps in NYC, it isn’t always obvious whether or not your startup has any trajectory, and sometimes people don’t know you even if you’re successful—so it’s a bigger jump.  So, if you just drop into the tech community out of nowhere, with a new startup, don’t expect everyone to jump on board right away.

#4 Look under every rock.  There are so many more hackers in NYC than just the ones who go to the NY Tech Meetup or who hangout on community listservs, etc.  When I went hiring, I went through hundreds of contacts on LinkedIn one by one, and wrote side e-mails to over a hundred.  “Is this person good?  Would you hire them, etc?”  It’s largely a function of how many people you put into the top of the funnel.  Have you interviewed 50 developers yet?  If not, then I don’t see how you can say there aren’t enough good hackers here.  You certainly wouldn’t give up on finding love if you hadn’t met 50 single people of the opposite sex over the course of your lifetime, right?  So many entrepreneurs have a myopic perspective—they feel like they’ve met everyone and gone after everyone who is “out there” when they probably haven’t met even 5% of the people coming online for a job search over the next three months.  They’re often too quick to judge a book by their cover, too.  Just because someone hasn’t worked at a startup before, or doesn’t know much about equity options doesn’t mean they aren’t startup hacker material.

#5 Spread the search outside of your city, even if you want to hire here.  NYC is an awesome place that people want to live in.  If you restrict your target to the 5 boroughs, you’re bound to miss out on people just waiting for the chance to jump to the Big Apple.  Trust me, they’re out there.  Find the right people who believe in your idea and convince them to come here.  If you can’t do that… not sure how you’ll ever drive your company to $10 million in revs.  That doesn’t even mean pulling people out of the Valley.  Tried RPI, Cornell, Boston, or DC yet?  Regional is a minimum area for an important search.

One of the major themes of the evolution of the private equity industry for the past decade has been the growth of internal groups focused on enhancing the value of portfolio companies. Twenty years ago, the great majority of the people working in private equity came out of investment banking, i.e., a deal background. Today, it is far more common for a private equity fund to employ people with an operational/consulting skill set, e.g., Bob Nardelli at Cerberus. I predict we’ll see the same phenomenon among venture capital funds. The latest example: Union Square Ventures announced that they are hiring for a newly created position as General Manager of the Union Square Ventures Network.

Within private equity, these groups are often called "portfolio operations", sometimes "portfolio resources groups", or what Riverside Company calls its Toolkit. At larger funds, "operations" may be distinguished from governance, talent selection, pre-investment involvement, or even strategy, partly because "operations" is a term that management may infer to mean backseat driving.

By definition, these groups focus on improving the operations of the existing portfolio, not on diligencing potential deals or on deal structuring. Just a few of the many major private equity funds that have well-developed private equity operations groups: 3i (Business Leaders Network); Cerberus; Irving Place Capital; Bain Capital; TPG; General Atlantic; and Welsh, Carson, Anderson & Stowe.

A Bain study found that "as much as 80% of private equity returns [going forward] will come from real performance improvement, rather than [ ] financial structuring." According to a 2006 KPMG study of 100 private equity exits (below), 48% of the value-add during private equity ownership came through organic revenue growth, as opposed to capital structure changes and multiple arbitrage.

Source of Gains in Private Equity-Backed Companies

I see six major reasons why limited partners now expect that private equity funds will have a formal operating strategy, minimally an operating partner and/or a formal portfolio resources group. I should mention my thinking throughout this blog post and especially in the list of factors below is shaped by a number of presentations I’ve seen by Jon Weber, who has run portfolio resources groups at three major private equity funds.

1) Global economic crisis. Particularly in 2008-09, most portfolio companies required operating changes to survive. In most cases, the existing management teams were hired for their ability to grow revenues, not their ability to restructure. The funds had to supplement and/or replace the existing teams.

2) Commoditization of financial engineering. The classic question Michael Jensen asked is: if leveraging is so wonderful, why don’t companies do it themselves instead of waiting for an LBO fund to buy them out? Since Jensen first began researching this area, larger companies increasingly chose to lever themselves, and there has been a massive boom in the private equity industry—thousands of funds all of whom can offer leverage. It has become much harder for a private equity fund to make high returns simply by borrowing some money and taking advantage of the interest tax shield.

3) Investors seek differentiation. Building a formal portfolio resources group has been a way that private equity investors can differentiate themselves and ease the capital-raising process.

4) Maturing private equity industry. According to the Parthenon Group, the larger size and greater complexity of funds has led to greater role specialization. As one investor said to me, "We’ve moved from the ‘great man’ to the ‘great team’ model."

5) Risk mitigation. The deal team tends to have a strong incentive to do a deal, and then move on to the next deal. An operational perspective adds a counter-balance to the deal team.

6) Strategy driven. Certain strategies — deep value investing, turnarounds, mid-market focus, and industry-specialized funds — require a hands-on approach.

I remember speaking at a Capital Roundtable Private Equity Portfolio Operations conference back in June 2008, and I was struck at the number of attendees who commented publicly on how they felt like "second-class citizens" at their funds, both in status and in compensation. However, when I spoke at the IIR PE Ops conference in October 2009, in the midst of cleanup from the economic crisis, the mood of the operating professionals was much more buoyant (despite the challenges they faced in their portfolio.) On a relative basis, they knew that their professional contribution had become much more apparent at their firms.

We have not yet seen a similar boom in portfolio resources teams in the venture capital industry, but it’s coming. I recently had a conversation with Chris Farmer about this, which sharpened my thinking considerably (he is the coauthor of my forthcoming study on "Best Practices in PE/VC Deal Origination"). According to the NVCA and PWC Moneytree, the average VC round has doubled in the last 12 years with the growth of the industry (from $4m to $8m). At the same time, the cost of starting a company and proving concept with a new product has declined dramatically in many sectors.

Some such as Marc Andreessen argue that costs have dropped as much as 100x over the last couple of decades since the current venture capital model was created. As a result, many innovative venture capitalists and entrepreneurs are creating new fund models from Andreessen-Horowitz to Betaworks to Founders Collective and Floodgate. Fred Wilson wrote, "The venture capital asset class does not scale . . . . I think ‘back to the future’ is the answer to most of the venture capital asset class problems. Less capital in the asset class, smaller fund sizes, smaller partnerships, smaller deals, and smaller exits. The math works as long as you don’t put too many zeros on the end of the numbers you are working with."

A corollary of Fred’s point is that the small number of portfolio companies which do hit hypergrowth need more support. Chris and I think that one logical new model is: seed a large number of companies with quite modest amounts of capital. Then, double down with follow-on rounds on those concepts that do take off. For those companies that experience rapid growth, it makes sense for a fund to bring extra support, since those companies can’t hire good people fast enough to do everything they need to do. In addition, a portfolio resources group can share learnings across the portfolio. This is much easier in venture than in private equity, because VC funds are much more likely to specialize in tightly defined industries. In addition, the portfolio companies are smaller and so it’s easier for a VC to shape their growth according to the fund’s beliefs in best practices.

In the case of companies that do not reach hyper growth, the companies will have raised modest amounts of capital and can be sold for much smaller amounts while still resulting in a win for entrepreneur and VC alike. Of course, failing to provide a follow-on investment is a signal that can hurt the company, but that has always been a part of the business and we are confident that models will evolve to minimize the negative effects.

Here are some models of VCs Chris and I identified which are building out portfolio resources groups:

- Andreesen Horowitz has said very explicitly that their model is to be able to invest at a wide range of capital levels in the 10-20 companies per year which have true potential to scale. They have built out a small value augmentation group: Ronny Conway (point person on business development for the portfolio) and several recruiters (1 for college-level talent, and 1 for experienced talent).

- Insight has the "Insight Onsite team" which is particularly focused on sales, SEO, and SEM.

- Accel has a Venture Development group and firms like Oak Investment Partners and Bessemer have Operating Partners to lend added support to companies. Charles River Ventures had a similar approach during the bubble.

- Bessemer also has a Designer in residence (showing the increasing importance of design for internet companies, e.g., Mint.com).

- Highland Capital Partners, Union Square, and numerous others have "Thought Summits" with noteable guest speakers. These events usually are organized by portfolio functional role, e.g., a portfolio CTO summit, portfolio CEO summit, etc.

- As I mentioned above, Union Square Ventures announced that they are hiring a General Manager of their portfolio.

- There has been a boom in accelerators: Boostphase (Atlanta, GA); Bootup Labs (Vancouver, BC); Capitalfactory.com (Austin, TX); Charles River Ventures QuickStart (Boston, MA); DreamIT Ventures (Philadelphia, PA); Iaccelerator.org (Bangalore, India); Launchboxdigital.com (Washington, DC); Nextstart.org (Greenville, SC); seedcamp (London, UK); Shotputventures.com (Atlanta, GA); SeedStart (New York); Summer @ Highland (Lexington, MA and Menlo Park, CA); Techstars.org (Boston (MA), Boulder, CO, and Seattle, WA; The Difference Engine(Sunderland, UK); Y Combinator (Mountain View, CA); and Y Europe (Vienna, Austria). For more information on how to build a replica of Y Combinator, read Jed Christiansen. For a comparative listing and more background, see Readwriteweb and Dan Veltri. TechStars recently released very positive data on the success of their incubated companies.

This approach differs from the incubator and acceletor trend (e.g., cmgi, antFactory) of a decade ago. That model was often criticized for selection bias: the less-competent entrepreneurs found the incubators more attractive. In addition, too much of the core competency of the company was driven by the incubator instead of in the company itself, creating ambiguity in attribution of value between the two entities. The new model looks more like the VC as consigliere instead of a bacteria splitting off new progeny.

I’ve had a front-row seat to this phenomenon, since I’ve done a lot of work in the past with portfolio resources groups at some of the major private equity funds. I’ve presented in the past on "Finding New Deals and Improving Portfolio Company Valuations by Working with Operating Executives," which covers some of the structural options private equity funds have in working with their portfolio.