One of Silicon Valley's Original Venture Capitalists Provides a Fresh Perspective on the Current Venture Capital Climate

Friday, December 19, 2003

John, vctaskforce., http://www.vctaskforce.com/pr_Oct_25_2003.html#8

Better Business Management & Planning Practices

One of Silicon Valley's Original Venture Capitalists Provides a Fresh Perspective on the Current Venture Capital Climate

MENLO PARK, Calif., Oct. 25, 2003 - VC Task Force features the interview of an individual who is regarded as a luminary in the venture capital community. This month, we are pleased to present an interview with Franklin "Pitch" Johnson, a founding partner of one of Silicon Valley's first venture capital firms, Asset Management Company (www.assetman.com). Pitch is a graduate of Stanford University and the Harvard Business School, and was one of the pioneers of venture capital investing in the early 1960s. He is a true visionary who has been front and center in the launching of several investment funds and in the funding of several successful companies. John "Monte" Montgomery conducted the interview on behalf of VC Task Force. Monte, who recently formed The Montgomery Law Group (www.montgomerylawgroup.com), has distinguished himself as a corporate and securities attorney for the venture capital community and has cultivated relationships within the VC community over a period of almost twenty years. The following is a transcript of their interview, providing a fresh perspective on the current venture capital climate.



John "Monte" Montgomery, The Montgomery Law Group
Franklin "Pitch" Johnson, Asset Managment Company


JM: How does the current economic down cycle compare to similar down cycles in the past?

PJ: This downturn is not so different from the other ones. It's not worse than the previous down cycles; it's just contrasted to a big up-cycle. But there are two or three things that are different. One thing is that there is an awful lot of money sitting uninvested that is committed to venture funds, something like $75 billion.

With that kind of money around, there are still deals being done, maybe $16 billion this year. That's not too tiny. Only 10 years ago, a year of 2 to 3 billion was a big size. Is it down? I don't think so. It's a big business now. Roughly speaking, the amount of money going into venture capital was in the 10's of millions in the 60's and 100's of millions in the 70's and in the billions in the 80's and 10's of billions in the 90's. There is plenty of money available for the deals that people want to do. This is not a down period when compared to every other down period.

My own guiding philosophy is to keep doing deals. Some of the great companies that will be in existence, profitable and growing in 5 years from now, will be started now.


JM: Does this current period create any special opportunities for professional investors?

PJ: I don't think of venture capitalists as investors. I have to disagree with the question. Venture capitalists are people who build companies. They certainly have to make investments, but more important is the work that they do around the companies once they are in them. I have a third factor that I throw in for fun and that is because entrepreneurs are committed and zeal driven people, venture capitalists have to share some of that enthusiasm, drive and desire.

But the opportunities now are nothing new. We just have to figure out how we can build a company that will grow in sales and profitability over the next five to seven years, not over 6 months and then go public. Our job is and has been to build companies with money and talent. That has not changed. It's only a matter of finding some combination of technology and managers that can build a company. So there is nothing special going on now. There are all sorts of companies, even Internet related services and controls and protocols, which are going to be terrific companies. They will get their funding by having good people; a good plan and a good way of believing its going to get big; not because of the magic of some name and the mere fact they are in business.

There is actually a whole generation of young venture capitalists who were not active during the boom times and so they are growing up and they have not seen the easy money. Only their older brothers have, and they think things are down.


JM: Speaking of down, a lot of the ancillary industries that work in the venture capital community such as investment banking and law have right sized in the last couple of years. Will there be a shake out in the venture capital industry? What will the business look like in 3 to 5 years?

PJ: It is not something that will shrink down a lot and become a side issue. Venture Capital creates the new businesses that challenge the old businesses and create new jobs. A study at MIT twenty years ago showed that all the net new jobs are created by companies less than ten years old. I am sure this data would still hold up. So, I think venture capital will stay large. There will be a temporary adjustment as the $75 billion sitting out there is invested. We don't have to raise a lot of new funds while we use up that supply.

The average fund size will shrink and so will the number of people in the business. There are about 8000 people in the business. I think that will probably shrink down to 6000. This is absolute guesswork. It will shrink some but not by half. In order to say that, you have to believe our economy will continue to grow. Money managers will continue to finance venture capital because it has been a successful investment.

From the point of view of money managers, they are investors. They invest in venture funds and that is an investment but the venture funds themselves use that money and their teams to build companies and that will shrink a little but not a lot in my opinion.


JM: As the business matures, where do you think the financial reporting standards are going to end up? Will there be a uniform reporting standard as the industry matures?

PJ: People investing in public funds will be required to disclose the results of their investments. I think that is inevitable. Venture funds who do not want to take money from people who manage public monies, obviously can choose not to do that. That will be resolved in favor of disclosure. And I think in the end venture funds will not be so troubled about disclosure as long as the disclosure is about overall performance, not about the performance of individual portfolio companies. For competitive reasons, disclosure shouldn't be down to the individual company level; private companies don't want their financial information disclosed to competitors.


JM: What effect will outsourcing technology jobs to India and other countries have on the next wave of technology?

PJ: The other version of that question is - what's going to happen to Silicon Valley?

I think we will not see manufacturing as a major part of Silicon Valley. What happened over many years in Silicon Valley is that, companies started here, did their engineering here, had their headquarters here, they had their marketing people here and they had their manufacturing here. What we are seeing and will continue to see is that people will do their manufacturing elsewhere, not just in other countries. We see plenty in Oregon and Nevada. Las Vegas is a growing entrepreneurial town; its not all gambling. There are businesses down there. I know people moving there because of business opportunities. The state also has a favorable tax climate and lower cost of living, which will be able to attract manufacturing jobs. Also, India, Eastern Europe and other places will also attract manufacturing jobs.

To answer your question, I think the main hands-on engineering will take place in Silicon Valley at the headquarters of startups, because the entrepreneurs are here.

But big companies will have engineering jobs all over the place. You will see them taking advantage of doing training and the cost of doing engineering in other countries. But young companies will keep their engineering closer to home where the entrepreneurial group is and where they have a few engineers and get their product on the marketplace. That's where Silicon valley will be a headquarters kind of a place, with the entrepreneurs here, the new management here, most of the engineers here, marketing here and the manufacturing not so often here.


JM: What advice would you have for an entrepreneurial team starting a company today?

PJ: Go after a large market that exists or can be created. Don't go to some market that isn't worth the effort. Try to build companies with revenues in the many 10's of millions in a few years time and then have some technology to serve that market which gives you an advantage over other people.


JM: A lot of people believe that we have just seen the first wave of the internet. Do you think the second wave will be bigger than the first wave?

PJ: It will be more stable than the promotional activities of the late 90's. You will see some ups and downs, but I think you will see steady use of the Internet being used for many different businesses. Right now, email is a big deal, websites are a big deal, doing business with suppliers and customers is a big deal. The Internet is the backbone for a lot of communications and just about all computers and computer networks. There will be one world where all computers are tied together with plenty of firewalls. But it will be routine for one computer to do something and talk to another computer somewhere else and share the computing power with high-speed Internet connections.

So I don't think its going to go to a whole new level. I think it is going to continue to develop for many years in more and more important ways and there will be plenty of opportunities for people to anticipate where it might go and where it might go soon enough to build a business around it.

Look at spam. I get so much spam. It takes me 4 to 5 minutes every day and I go over it fast. I am sure I delete people who are trying to reach me. I can't sit and open a hundred emails. I look at it and skip over all the ones that I don't want to read and block them out and then come to the ones that I would like to read and I end up with 10 or 12 that I want to see. I don't want to spend 10 or 20 minutes a day opening up email. That's with high speed Internet and if I am out and there is no high speed Internet at a hotel, it takes a long time to just erase the junk. There has to be a solution to spam. There's got to be a solution to intrusions, into your privacy and into your systems.

If spam isn't controlled, email can't be the great killer app of all times.


JM: What advice would you give to a group raising a venture capital fund today?

PJ: I would give advice that I am not following! I would have a specialized fund because the people who invest money, they want to say "I have these bio tech funds, I've got these wireless funds, I've got this IT fund." They want to pick sector groups for their own portfolio management.

The big money is managed professionally by people who have been very conscious of their portfolios and will want specialized funds. So I would get some terrific talent together in a very specialized field including somebody who has been in the venture capital business and someone who has been an operating person. At least some of the people have to have a track record in venture capital for big time investors to feel comfortable.


JM: One final question. What are the attributes and characteristics of the team you look for in a potential portfolio company?

PJ: We look for ease of communication among them, some evidence of trust, mutual respect, willingness to listen to the next guy. We look for team characteristics at the same time we need somebody who looks like a leader, who is accepted by the rest as a leader.

You will also need a functional team with the skills we discussed and marketing and engineering, manufacturing and finance at some point. Being in business a long time helps.

A good team will organize themselves so that everyone gets a chance to have a say so in the meeting. You want to meet the whole team. Not everyone in the company but the top people. Use your instinct about whether they are communicating well or not. You can tell. It is one of the risks. Risks often come true when you are under pressure.

The most important of all, do you have a sense of whether they are trustworthy people? Are they honest, open, decent people that will communicate with you and you with them? Because, when you get going, you have to trust each other, the venture capitalist has to be devoted to the success of the company without going overboard by what is good for his own firm. As a director of the company, you represent the shareholders. Are these people you can trust and are these people you can work with? The balance between helping someone and not being too intrusive is a tough one.

You look for a good team and look for people you would really like to be with. People you respect and trust and who trust you.

The important key to our business is that our job is building companies. That implies a lot of other things - about people, markets, about what venture capitalists role is, and we shouldn't be going single-mindedly and directly after making money. If you build great companies then you will create value for your investors and for yourselves. When people pursue money directly they don't build great companies, because they are not focusing on building.


For More Information, Contact:

June Riley
VC Task Force
650-968-1304
rj@vctaskforce.com

Richard Wood
Sand Hill Partners
650-631-0123
partners@sandhillroad.com

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