20 VC 030: VC Funds, Angels and IPOs with John Taylor, Head of Research @ NVCA

In today's show I am joined by John Taylor, a nationally recognised authority in the venture capital and entrepreneurial finance sector. Currently, John is Head of Research at the National Venture Capital Association (NVCA). In 2003, he co-founded the NVCA CFO Task Force which focuses on regulation and emerging issues dealing with a diverse range of Some of the many gems of this conversation include: where venture funds actually obtain their funds from, what is the main difference between an angel and a VC, what investors expect from their VCs, how has the IPO market changed since 2000, what do VCs look for in potential investments, how do VCs manage their time, what is the typical workload of a VC, can University students go straight into the VC industry? Items Mentioned in Today's Show: Dave McClure | Lean VC | 500 Startups Andreeson Horowitz

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

• 0:00Harry Stebbings?

  Hello and welcome to episode 30 of the 20 Minute VC with your host, Harry Stebbings. Now today's show is a special show as it's a bit of a milestone here at the 20 Minute VC being the 30th episode. To celebrate this milestone, I'm hugely excited to welcome today's guest, John Taylor. John is Head of Research at the National Venture Capital Association and it's fair to say that John really is a leading figure in the venture capital and entrepreneurial finance industry, having co-founded the NVCA CFO Task Force, which focuses on regulation and emerging issues dealing with company reporting, industry transparency and disclosure. John is also frequently quoted by major newspapers and magazines on the subject of venture

• 0:45Harry Stebbings?

  capital. Recent original reporting and syndication appearances include NPR Morning Edition, APR/NPR Marketplace, CNBC, Wall Street Journal and Bloomberg Radio. But without further ado, let's dive into the interview.

• 1:05Speaker 01

  You have now arrived at your destination.

• 1:08Harry Stebbings?

  John, welcome to the 20 Minute VC. It's an absolute pleasure to have you on the show.

• 1:13Speaker 02

  Thanks, Harry.

• 1:14Harry Stebbings?

  Okay, so let's start at the very beginning then. There's always this perception that VCs have this ton of money and they're very well-financed. But where do venture funds actually obtain their funds from?

• 1:29Speaker 02

  It's, yeah, and of course, in our definition, the bright line between a venture capitalist and an angel is an angel or angel group is an individual or a group of people investing their own money. In the case of VC, the money is third-party money. They're raising it from someone, somewhere typically an institutional investor. And if you go back to the early days of the industry, the 70s, the 80s, the pension funds and the changing of the rules to allow the pension funds to invest, really is what got venture capital off the ground, the so-called prudent man rule and things that enabled pensions to, in a measured and prudent way, get involved.

• 2:12Speaker 02

  A lot of those pension funds now with the shift away from defined benefit plans really aren't the factors they once were. So virtually all of the money raised by venture capital fund comes from, in many cases, family offices, some cases sovereign wealth funds, colleges, universities, other charitable foundations that are out there. And there's still some pension fund money in there. But with the pensions now seeing aging populations, they're generally not in a position to be doing the 10 to 12 to 14 year lockup, which a venture capital fund typically is.

• 2:56Speaker 02

  They can't commit to that level timeframe of the liquidity. So we're seeing some new folks, largely the high net worth individuals, family offices now very much involved in putting money in.

• 3:09Harry Stebbings?

  So these institutional investors, they give their money to VCs. And do they get charged a management fee that's a standard management fee? Is there a standard management fee? Do they have expectations? What are the typical expectations of a VC fund return?

• 3:25Speaker 02

  Sure. Well, typically, an institutional investor would be looking at the whole spectrum of places where they can put their money. And they would have certain expectations on the public markets and then, you know, varying asset classes, whether it be hedge funds or private equity funds or venture funds or whatever. There is an expectation that in return for the additional risk and return for the lack of liquidity, that there is a premium. And lots of times you'll hear institutional investors saying that they want at least 300 to 500 basis points better than what they think they can do in the public markets, which is 3% to 5%. So if they're thinking they can do 6% return in the public markets, and then they're looking

• 4:10Speaker 02

  on a whole from venture for at least 9% to 11% returns. So the 300 to 500 basis points has been a pretty common benchmark. When you look at how venture has done over time, and we have a period of about, you know, fifteen years ago to a period about three, four years ago, where returns were tough for venture, but historically venture capital funds have returned to their investors net about twenty-five to thirty percent. It's been a very, very good performing asset class over the long haul.

• 4:47Harry Stebbings?

  And has that led to institutional investors giving more money to this asset class?

• 4:53Speaker 02

  In many cases, yes, and a lot of them find it particularly attractive right now. And yet, in some cases, a lot of the money's in the hands of very, very large institutions that can no longer put money into a twenty or thirty or forty million dollar venture fund. They just don't have, they just can't divide it up in that small a parcel. So, yes, it's still an attractive place for many of them to invest, and in many cases, it's, you know, fairly large chunks of money and large parts of their allocation that they put in. In terms of the actual arrangements, it varies.

• 5:34Speaker 02

  Each venture fund and its group of investors, as it puts a fund together, negotiates the terms and the conditions and everything. Many funds charge roughly two percent for management fees, and that's the cost of the staff and keeping the doors open and sourcing deals and providing the talent to manage the money. That's not unusual, the two percent. And typically, the VC makes its money, his or her money, on sharing a portion of the capital gains with the investors. And typically, what they call twenty percent carry is what you see a lot.

• 6:18Speaker 02

  Some firms, it's a little bit more, some firms, it's a little bit less. But the idea is that the primary objective of the fund is for the investment made in the company. To to increase dramatically in value and and not only do the investors in the venture fund do well, but so do the venture capitalists themselves. And we should also add also the companies. So you don't see a lot of places in in the economic world where it's sort of a shared objective, shared sense of success, shared shared vision and direction. But but that's absolutely what's happening here. It's all lined up and it's all about buying

• 7:02Speaker 02

  low and selling high with with with the investors, the VCs and the the entrepreneurs and the the team of the entrepreneurs all benefiting.

• 7:12Harry Stebbings?

  And do you see VCs also making angel investments on the side? Is that a common practice in the industry?

• 7:18Speaker 02

  Yeah, it's all over the place. You you have a lot of the original founders of the venture industry now retiring. In in some cases, they're they're leaving the funds that they founded and they're they're they're still passionate about building companies and that's what gets them out of bed. And they're they may not be in a position or have an interest to sign up for another 14 years of of managing the life cycle of funds. So they'll go out and they'll make their own investments. Typically, that comes a little bit later in the career. You know, when a when a younger VC or VC right in sort of the middle of of the career is investing, the the investing is done on the part of

• 8:03Speaker 02

  the fund and not not the individual.

• 8:05Harry Stebbings?

  And why do you think VC funds do have the 10 to 13 year lockup that say mutual funds don't?

• 8:11Speaker 02

  Yeah, I mean, the the bottom line is that the the money typically first goes in, you know, whether it's two people and a dog in a garage or or something coming out of a laboratory.

• 8:26Speaker 02

  You can have in many cases a three to five year initial investment period as as the thing scale, as the thing gets going, maybe as it gets to proof of concept, or as it gets to first sale, or it gets to the point where it finds its business model, things start to scale up. And especially in recent years, the last four or five years with a with a dearth of IPOs, you see companies that have been waiting anxiously for the opportunity to go public, seven, eight, nine, 10 years. And by the time they're able to get out, by the time they're able to go public, that could be 12 years or longer from the

• 9:09Speaker 02

  initial investment. So is some of that a sign of the times, the fact that the IPO markets were tough, you know, three, four years ago? Yeah, I think that's a lot of it. And you look at just in the past, gosh, I mean, the past three years, 2013, 2014, 2015. And the interesting thing is that the majority of the IPOs in each of that period were biotech companies, which historically is only about 20% of the money. But many of these companies have been waiting patiently to go public, and they finally had their opportunity, and out they went. And they weren't huge.

• 9:46Harry Stebbings?

  So why do you think biotech has seen its opportunity where maybe others haven't?

• 9:51Speaker 02

  I think in the case of biotech, it's just been pent up demand. I think it's been, I think the public, you know, these things move in waves, and the public was identifying with companies like Facebook, and some of the, some of the things that maybe consumers use and touch every day. And that's just an easier sell on an IPO. But if you look at, if you go back to in the 1990s, and look at what percentage of the first fundings in the 90s ended up going public, it was 14%. So basically, one in every seven companies that got a dime of venture financing went public. Now, because it takes so long, it's very hard for us to know.

• 10:36Speaker 02

  What the current crop of companies or even the crop of companies eight or 10 years ago, what their outcome will be, but my guess is it's going to be 5%, maybe 6%. It's just a much, much smaller number that are able to get out. So with that, you have the changing expectations on the part of the entrepreneurs taking money, especially if their going in position is that they're going to be a slam dunk to go public when they get to the right point.

• 11:06Harry Stebbings?

  Switching sides of the table slightly now, what do you think VCs look for when investing?

• 11:12Speaker 02

  Well, yeah, I think it's all on the upside. And it used to be that VCs and companies would match up geographically and you would go down the street to the venture capitalist down the street who is geographically close by. It's much more complex now and it's much, much more sector specific. And not sector specific, but sub-sub-subsector specific. And there's less dependence these days on geography and more on specifically what the company will do. And so you even see some of the West Coast coastal firms making investments elsewhere.

• 11:55Speaker 02

  Maybe a university or government lab or something has an intriguing encryption or some kind of e-commerce technology. In some cases, that firm, say the coastal firm, would make the investment directly. Other cases, they'd be looking for someone on the ground that could actually get involved in it. So what is the upside? How does this play with my Rolodex and who I can bring into the company? How does this play with other portfolio companies that we have and where we think the internet is going and so forth? All of these are questions that are being asked and perhaps geography a little bit less.

• 12:41Speaker 02

  You also have VCs frankly having to meter their most important and most scarce asset and that's time. And we did, we've done a study now, we did it back right after the bubble and we've revisited it once or twice with Dow Jones, looking to see what this, what a typical workload, a board level workload is of a venture capitalist. And the number comes back six and it was true during and after the bubble, it's been true since, that a venture capitalist with six board seats has a very full workload. So, a lot of entrepreneurs go out, they look for money and you have a VC of, you know,

• 13:23Speaker 02

  one or two people investing a hundred million dollar fund and they actually think, okay, they're only looking for a million or two million, they have a leg up, but in fact, a venture capitalist is saying, okay, I basically have six shots to get this right. I, I, you know, there's six, I can only sit on six boards. How do I, you know, how do I make sure I'm picking the winner? So, so that's clearly what's going on in the minds of the VCs.

• 13:48Harry Stebbings?

  And can I ask, do you think a VC can really be a VC and a fully fledged active VC if they do engage in a lean VC method like Dave McClure's 500 startups where they don't take board seats?

• 14:03Speaker 02

  Well, yeah, the short answer is they're, they're different models and typically a, a round of financing will involve a VC taking a board seat. Now, a lot of the rounds are syndicated and, and at some point, the value added to the VC is the VC's expertise and rolodex and experience, connections, everything else. So I don't see how you can get completely away from that, but, but there are firms out there that, that provide different levels of service, different levels of engagement. Andreessen Horowitz, for example, comes to mind, there are some other firms, including back in Boston and the East Coast, where they actually have a, a, a deep, I'll call

• 14:47Speaker 02

  it a bench or a resource pool that's brought to bear on the companies. And that's part of the services provided by the venture capitalist as, as part of the, part of the investment and, and part of ensuring that whatever span of control, however many board seats a VC can take, that that company has the, the best fighting chance of being successful.

• 15:08Harry Stebbings?

  So if you were to select one service which is the most important value add that a VC can bring to a startup, what would you say it would be?

• 15:16Speaker 02

  Gosh, it's tough. I mean, I think the short answer is people. You have many one- and two-person companies that's gotten funding, but I can't think, maybe with the exception of Enron, a one- or two-person company that's gone public. And at some point during that journey, whether it's getting from ten people to a hundred to a thousand, that company needs to be filled with talent. And someone, an entrepreneur, may not know where all of that talent lies, whereas a VC probably has a history of working with other startups, but even more important, companies that are just now maturing, where you have, I'm thinking

• 16:01Speaker 02

  now, Google, Facebook, and so forth, where maybe you have talent that's ready to come out and try their hand in a different environment.

• 16:11Harry Stebbings?

  And talking of VCs with experience, have we seen a rise or a decline, do we think, in VCs coming straight out of business schools and entering into the venture capital industry?

• 16:22Speaker 02

  Tough question to answer, because many of the top business schools are now requiring that their people have four or five years of relevant or domain work experience. I think it varies hugely. You don't see a lot of folks going in directly from VC, you don't see a lot of folks coming out of business schools, even the top business schools, going directly into a VC firm to become a VC. If they had prior experience, if they had, say, you know, before joining, before going to business school, they had a middle manager role at an Amgen or something, something like that would obviously be different than

• 17:03Speaker 02

  someone just coming out. But the experience and the rolodex are going to drive that decision. I think also you have to look at where venture is. And over the past Four or five years, we've seen a reduction in the number of firms, a slight reduction in the amount of capital available, but a significant 30% reduction in the number of firms out there, which says that a lot of the capitals being concentrated by larger firms and in many cases experienced hands. So unfortunately, the help wanted section of VC Weekly, if there were to be such a thing, would not be terribly robust at the moment.

• 17:45Harry Stebbings?

  And how do VCs compete against each other in the very kind of hot rounds, say of your Snapchats and Ubers? How do they really attain that position in the funding round?

• 17:55Speaker 02

  Well, I think it goes back to the question of talent, who they can bring in as the company grows. Certainly, there's the deal terms themselves, the actual valuations and the dollars involved and so forth. Each of these rounds now is getting, there's a changing dynamic largely in Silicon Valley, but we're seeing it elsewhere with some of these headliners. And that is that the VCs themselves are coming to the table with roughly the same amount of money they have the past few years. But we're seeing the total amount invested, the total size of these rounds, expanding by 40, 50%.

• 18:39Speaker 02

  The total amount of venture-led rounds, the dollars has gone up dramatically. And so in many of these, you have corporate venture capital groups that have become very active, but even more so with some of these headliner later rounds, you're seeing mutual funds, you're seeing hedge funds, you're seeing private equity players that are not traditionally engaging with these startups and with these pre-IPO companies. So it's a changing dynamic. And so an entrepreneur looking to see which VC to work with in the later rounds would probably be looking at the Rolodex and the experience and the working relationship between

• 19:22Speaker 02

  those VCs and some of these third parties that could be brought to bear if. For example, as as we've seen recently, instead of going public, a company decides to take a very, very, very large round of financing, uh, still as a private company.

• 19:37Harry Stebbings?

  And did prior investors in in these very popular rounds, do they get pro rata conditions or do they do they not get any priority?

• 19:47Speaker 02

  All of this is negotiated round by round and and lots of times there is some kind of participation, but but especially if you're talking about a very small, uh, early-stage fund that was involved early on, sometimes it's very difficult for them to come back later on with the with the with the amount of capital that that's needed. So so there's a dilution effect and I I'm not sure how you get around that. The short answer is I think it really depends upon the terms and, uh, to the extent that those early investors are are coming back into the later rounds, some may say, okay, look, you know, we we're coming back in here, we know we need to put more money in, we

• 20:31Speaker 02

  may not be able to make our share, but if this whole journey works the way we think it's going to, we'll still come out in good shape. And, you know, that's something that that an entrepreneur looking for money should think about, whether it's whether it's a first institutional money or whether they're going for a state grant or whether they're looking to kickstart something or go to an incubator or an accelerator for help early on. I I think the question they have to ask is, what does the whole journey look like? Am I going to need ten million dollars to get to where I'm going? Am I going to need a need a hundred million? Um, you know, if if you look at Uber, which, uh, uh, second quarter of of twenty fourteen,

• 21:12Speaker 02

  they got a one point two billion dollar round and we're all sitting there getting the Money Tree survey ready to go and we're saying, wait a minute, one point two billion is larger than most venture funds. Uh, now, how can this be a venture round? And we looked at it and it was a venture round. And, uh, then, as if that wasn't enough, they went back, they did it in the fourth quarter for one point two million, then they came back in first quarter of this year and did another million. So, you know, we're looking at 3.4, I'm sorry, billion is what I should be saying. So 1.2 billion, 1.2 billion, 1.0 billion. So, you know, all of a sudden, you know, we're, we're, we're, you know, well over $3 billion into this one company. And, uh, you know, the, the, the numbers are mind boggling, but, but somebody somewhere

• 21:56Speaker 02

  was thinking a year ago, two years ago, three years ago, okay, this is how much money it's going to take us to get there, to get to our final destination. And at what point do we hop over from being private to being public? And, you know, is, is it a better thing for us to be staying private longer? And, you know, I think these are all, uh, questions that, that the entrepreneurs need to be asking, certainly the VCs are.

• 22:22Harry Stebbings?

  Well, John, thank you so much for coming on the show, and that is something I would love to touch on in the future with you, the entrepreneur's journey, but I can't thank you enough for giving up your time.

• 22:31Speaker 02

  Harry, it's a pleasure. Good talking with you.

• 22:34Harry Stebbings?

  Now, for all the resources and figures mentioned in today's show, do head on over to our blog at www dot the 20 minute VC dot com. And I would highly recommend you go and check out the NVCA website at www dot NVCA dot org. Thank you so much for listening, and we look forward to seeing you in the next episode.