Who Is Behind The Money?

You often hear successful entrepreneurs, or those who have received venture money or are in the process of receiving it, brag about the "smart money" behind the names of the venture partners who have just signed their term sheet. You often hear about companies that a particular venture firm has backed before, or about the boards that the firm's partners sit on. In fact, the criteria above should be only a partial determinant of an entrepreneur's decision to select a venture partner.

It is interesting that entrepreneurs rarely ask prospective venture firms who is "behind" their money. After all, if one believes that money is only part of the decision to align oneself with a venture firm (the other parts being contacts, the venture partner's experience, etc.), would it not be important to know - or at least consider - the origin of the "venture money?"

Current trends
Venture firms typically raise their capital from institutions (e.g. pension funds, endowments, etc.). These sources have hundreds of millions of dollars to "play with" and venture has been the ideal and, until recently, a "risk-free" investment vehicle. CalPERS (California Public Retirement System) has been a source of capital for many of today's most notable venture funds and investment banks, including Kleiner Perkins, Benchmark, and most notably, Thomas Weisel Partners, a merchant bank that received $100 million from CalPERS for a 10% ownership stake in its fund.

Recently, however, a new question has arisen: Who do venture firms target for their fund raising? According to a recent Industry Standard article, venture firms are targeting high net worth individuals more aggressively than pension funds and other institutional investors. Is this true? And if it is true, what - if anything - does this mean to the entrepreneur?

Differentiation
Venture Economics, a firm that tracks investments in venture firms, indicates that institutional money is still the largest source of capital for today's most successful venture funds. No one individual has the capacity, or the capability, to invest as much as institutions do. Nevertheless, there is a reason why venture firms are sourcing money from individuals - marketing. More than ever before, today's venture firms need to differentiate themselves from competitors since money is not really looked upon as the only determinate of value (see last week's article). Therefore, venture firms look to their backers and to other involved parties to provide the kind of marketing "buzz" that their portfolio companies are known for.

~Michael Jordan, perhaps the greatest basketball player of our time, is an investor in Chicago's Divine Interventures. I find it difficult to believe that Divine was short on cash and needed to tap into Chicago's sports scene to raise capital. Jordan, however, adds something more than just his capital to Divine's prospectus. He adds the "buzz" that today's media craves, and in so doing, attracts entrepreneurs to Divine's brand. Why is this so important? The answer is "deal-flow."

In today's venture economy, being the first on the deal is perhaps the greatest accomplishment of any venture partner. Ten years ago, venture partners would be able to "relax" on golf courses and let the deals come to them. Today, this is no longer the case. John Doerr of Kleiner, who has been known to jump on an airplane to meet entrepreneurs across the country, exemplifies today's venture capitalist. Venture capitalists need to be proactive in sourcing deals, whether that entails attending conferences, speaking at events, or seeking cash from well-known superstars.

There are angels outside of ESPN
Although there are a number of sports stars who have been investors in venture funds (or have formed their own funds), there is also "smart money" from individuals who reside in today's top funds. Kleiner, for example, has always allowed certain individuals to be part of its venture funds. These individuals are mostly top managers of their current or past portfolio companies. Bill Joy, a co-founder of Sun Microsystems, and others like him, add not only their names, but also their expertise to such ventures. It is often said that talent attracts talent; and this is exactly what individuals like Mr. Joy attract. Mr. Joy and many others like him attract entrepreneurs with fresh ideas and technologies. They often receive business plans months before venture firms do; and it is often their guidance that leads first-time entrepreneurs to a Sand Hill Road address.

~Because individual investors provide only a small portion of a venture fund's capital and because they are usually experts in a particular area that the venture firm targets, entrepreneurs should not be concerned about one or more individual investors in a venture fund. They should, however, know who has backed prospective venture firms in order to assess the quality of the management team. Lastly, a word of advice: The next time you have a meeting with a venture firm to pitch your deal, think about the individuals or firms that the venture partners in front of you have pitched.