Exec meets Allen Morgan of the $2.4 billion Mayfield Fund to talk about the fraught world of technology start-ups and his ten commandments.
Written by John O’Hanlon
If you are setting up a new business, for heaven’s sake don’t mortgage your house or get a loan from the bank, I heard that doyen of European VCs Hermann Hauser say the other day. At least talk to an investor who is prepared to share the risk with you. It may be hard to get these guys to commit but once they have their money is in there for whatever period you have agreed: a bank will get cold feet the day you run into any kind of setback or deviation from your business plan and ask for its money back, and he has the scars to prove it.
Not many individuals have published ten commandments. Not having the internet at his disposal, God did the best thing he could at the time, but it’s fortunate that tablets of stone are no longer required because, on his blog, Allen Morgan frequently adds afterthoughts to the decalogue he issued in 2005 as a guide for entrepreneurs pitching to VCs.
Still, his precepts retain lapidary brevity. A lot of his suggestions relate to time. With a caseload as long as your arm, he is a very busy man. Be on time is his second commandment; get to the point – fast is his fifth, so I felt honored to be the recipient of his full attention.
There at the start
Allen is a Managing Director of Mayfield Fund, at 40 years Silicon Valley’s oldest venture capital company, and of course a major player, with more than $2.4 billion under management. Among the notable notches on its bedpost are Compaq, Silicon Graphics, 3COM, Amgen, Genentech and Millennium Pharmaceuticals. Since it was founded by the ‘dean of venture capitalists’, Tommy Davis, in 1969, Mayfield has invested in 500 companies and has taken more than 100 of them public.
Allen Morgan takes a particular interest in enterprise software applications and infrastructure, “particularly innovative solutions that enhance knowledge-worker productivity, as well as on start-ups in the area of consumer internet services, interactive entertainment, online advertising and new media.” Allen’s notable investments include Jotspot (acquired by Google), PlanetOut, Serious Magic (acquired by Adobe) and Varsity Group.
Before joining Mayfield in 1999, Allen was a partner with two major Silicon Valley law firms, Latham & Watkins and Wilson Sonsini Goodrich & Rosati, but the move into venture capital was fairly seamless he told me. “People become venture capitalists in a lot of different ways. In fact as an industry it’s a very idiosyncratic market. My background is that I was a corporate lawyer in Palo Alto California for about 20 years representing software entrepreneurs. In the course of a nearly 20 year career, one finds that one tends to be as much of a business to them. Most of my clients were early internet companies doing online entertainment, educational software or things in the media.”
Mayfield likes to be in there at the start. The risks are greater but so are the rewards, and in any case the VC that gets it right at the seed stage needs to stick by its investment as the company grows. “We have incubated 15 percent of the companies we have invested in. However we do a lot of series A and B financing, and occasionally will do even later stage financing when circumstances make it attractive.” As a rule of thumb, he says, seed financing is usually at a level between $500,000 and $1 million, series A between $5 and $7 million.
Striking out
The American way, as embodied in Silicon Valley, epitomizes risk. Success is celebrated, failure regarded as a mere setback on the road to success. In this kind of an atmosphere, how do you hold onto any of the old virtues associated with finance – prudence, farsightedness, probity? Well, Mayfield is owned by its partners. They are the guys who take the hit if they put their money behind a dud. “Our business historically has seen between 80 and 90 percent of its returns generated by five to ten percent of its investments,” he says. In baseball terms, that means trying to hit a grand slam home run by swinging for the fences every time they step to the plate, but most often striking out.
As a cautious gambler, I suggest it would be better to play safe and hit more singles and doubles – there’s less danger of strike outs that way. “The reason is perhaps not obvious,” says Allen. “Early-stage VC’s don’t use the home-run every time strategy just because they like high-stakes gambling, much as they might enjoy high-stakes gambling outside of work. They operate this way because in early-stage investing it is damn near impossible to tell with any consistency which startups will succeed and which will fail. One strikes out just as often hitting for a single as for a home-run, so one is actually better off trying to hit a grand-slam every time!”
Despite the inherent unpredictability of early stage investment, businesses like Mayfield survive because its home runs are frequent enough to make up for all of the strikeouts. But that has changed in the last few years as the American NASDAQ capital market-type liquidity exit has become much tougher due to government regulations, mainly Sarbanes-Oxley, he thinks.
AIMing high
Allen is an unequivocal opponent of Sarbanes-Oxley. “I think it is the biggest problem we face. It was legislated in great haste, and with little thought: it has done very little good but plenty of harm. For small companies in particular it probably stretches out between two and four years the time between the formation of the company and the time of than it can sell its shares on the public market. One of the major disadvantages it has caused is that now entrepreneurs are much more anxious to sell their company much earlier in its history, or for less money, partly because of that artificial extension, partly because if you actually do go public, you face quite a miserable life with a great deal more liability.”
The Federal Government’s reaction to Enron, WorldCom and other scandals has dramatically increased the costs of being a public company, he says. As far as I know all of the convictions of the 2000-2001 fraudsters were won under laws that pre-dated Sarbanes-Oxley and related laws and regulations. The pre-existing laws worked fine; we just needed to enforce them.”
Thanks to the ineffable senators more American companies are looking overseas to float, particularly on London’s midsize company-friendly Alternative Investment Market. UK investors receive tax benefits by holding long-term, discouraging the volatility typical on NASAQ. AIM welcomes $100 million and smaller companies, but you wouldn’t list a company on NASDAQ with a market capitalization of less than $500 million.
Nonetheless it’s not really a viable alternative in his opinion. “AIM is really more of an organized marketplace for large private investors, so going public on AIM is really just another way of raising capital for your company. It’s not really a liquidity event. If I were an investor in a Silicon Valley company that has raised say $30,000,000 and wants to raise a further $20,000,000, if you raise that money on AIM, as a current investor there’s no way for me to sell my shares. Indeed I am contractually required to hold onto my shares for a significant period of time: after that I then have to find a willing buyer for my shares and that is done entirely through brokers since there is no efficient market place in assets for me to find someone to buy my shares. So to call it a liquidity event is a misnomer.”
As Allen and I were talking, the full effects of the sub-prime crisis were unfolding, though he doesn’t seem to think it’s causing many tremors in the tech markets. “I think it has had very little effect. Most of our financing takes place via equity sales and most of the financial institutions that have taken big writedowns because of subprime lending are not involved in the financing of venture capital companies and are not even involved in the formation of venture capital funds.”
Venture capital is protected because it invests in high growth markets so a general slowdown has less effect than on larger mainstream corporations. That said, a full scale recession will not leave Silicon Valley untouched: in any case some of the companies in the portfolio will be operating in consumer marketplaces exposed to the credit crunch and will grow more slowly as a result. Time to swing for the fence again – just make sure you invest in good glasses.