there are only about 400 active firms. And half of those have done four projects or fewer. That’s probably the right number [of firms].
Entrepreneurs are an incredibly smart and perceptive group, and they know how to avoid firms that they think won’t raise capital. Probably the easiest proxy for them to figure that out is whether the firms have been active recently. In each of the recessions that we’ve invested through, what we’ve seen is an automatic flight to quality. During a bubble, there are so many people who are interested in funding each entrepreneur that the capital becomes in some ways a commodity. But during times of constrained economics, your best entrepreneurs will very quickly make decisions as far as what name-brands they want to work with.
X: You said earlier that at CRV you don’t feel pressure to “put money to work.” Can you explain that phrase?
JA: Sometimes you will hear large venture capital or private equity funds say, “Look, because we have a billion-dollar fund it doesn’t make sense for us to get involved in a project where we can’t invest a minimum amount of money.” $20 million, $30 million is oftentimes what you hear. That’s something known in the industry as putting money to work. They’d look at a new project and if it only needs $4 million, ever, they’d say that’s too small. We didn’t want to be in a position to ever have to say that. The right amount of capital might be $2.5 million, or $5 million.
X: So you’re saying that the reason the firm gave all that money back to the LPs in 2001 was that it didn’t want a fund so large that it couldn’t invest just a few million dollars.
JA: It’s certainly one of them. We didn’t want to look at projects and have to say, “That’s too small for us.” We’ve done years of homework on this issue of what is the right size, and we think it’s exactly where we have it now. We went out with the objective this time around to raise $300 million. We took just a little bit more, and we stopped it.
X: Some angel investing groups would argue that even a $300 million fund is too large—they’d say that it precludes you from funding companies that are good bets but might only need $1 million or $2 million.
JA: In our world of disruptive technologies, that is somewhat rare. It’s not as though we plucked this number, $4 or $5 million, out of thin air. We’ve done a lot of homework on that. We do see some companies on the West Coast, especially in the Internet space, that only require a small amount of capital, maybe ever, and that’s great, and we do have the ability to play in those projects. We have a program called QuickStart where the checks are much smaller—usually $250,000—and that might be all they ever get, and that is fine with us. But by and large, in the space where we historically invest, you can’t really build a high technology company for a couple million dollars.
X: A glass-half-empty way of characterizing what you’re saying might be that there really aren’t that many good ideas out there, that entrepreneurs should scale back their expectations about finding funding, and maybe even that we shouldn’t count on venture-funded innovation to help with economic recovery.
JA: I’m not saying entrepreneurs should scale back their expectations. I’m saying that a key part of economic recovery is disruptive innovation. If you look over the twentieth century and what happened in the postwar period [you see that] semiconductors and the aircraft industry and just a few other key innovations were huge drivers. My point is that there is a finite number of these drivers, and because of that there should be a finite amount of capital investing in them. You cannot invest 10 times the capital into 10 times the number of startups and hope for 10 times the results. If there is one true entrepreneurial breakthrough and one true management team in a given sector, then maybe that is all there should be.
The problem in the last 15 years has been that the signal-to-noise ratio has gotten out of whack. Having 10 startups in one space isn’t good for anyone; it’s not good for the nine that don’t survive or for the one that thrives, because it’s dealing with competition from companies who are ultimately going to go out of business. So our point is that maybe there are two or three that should be funded, not 10. The way to do that is to control the capital going into the industry.
X: How do you control the flow of capital in a free market?
JA: This business doesn’t run like a cabal. We don’t call each other and say, “let’s only invest in three startups in this area.” I think every firm will make its own decisions. Ultimately, the providers of capital for our industry [the limited partners] are a very important constituency right now, because they, I believe, understand very clearly that smaller is better. When we meet teams, we try to back the very best and the ones with the proven results. LPs are making similar decisions.
