by Scott Kupor
But we went public because it was the only viable source of capital available to LoudCloud. We desperately needed the additional funding to continue to run the business. Despite having raised a lot of money to date, we were dangerously low on cash due to the post-2000 dot-com collapse. This was because we had originally targeted our service offerings to other startup companies; they seemed like a natural customer base given that they could benefit from being able to pay LoudCloud to worry about their computing infrastructure while they focused their activities on the internal development of their custom applications.
For us to provide this service, however, we had to procure significant amounts of data center space and a ton of computer equipment. We paid for this infrastructure up front with the idea that we would amortize the payback of these costs as we grew our customer base. That worked for the first year or so until the cascading effects of the air being let out of the dot-com balloon caught up to us. As a result, our dot-com customers started going out of business and naturally had no VCs willing to fund their ongoing operations. We were stuck with a very high fixed cost base of capital infrastructure against a diminishing base of customers—a recipe for significant cash consumption.
And, as noted above, by this time, the VCs had essentially stopped writing checks, so the only other option for us was to raise money from more buyout-oriented investors. Buyout investors are different from VC firms in a few ways. Namely, they tend to invest in companies that are beyond pure startup stage, and they generally make what are called “control” investments. Control means that they often own a majority of the company and control a majority of the seats on the board of directors; this gives them the ability to be the major determiners of the company’s strategy. Buyout capital can often be more expensive than VC because the upside opportunity for these investors is more constrained given the later stage at which they invest. This was the case for us, meaning that the valuation at which they would fund the company was much lower, and thus the amount of ownership we would have to give up was much higher. In addition, the control aspects of the buyout alternatives we had were less palatable than our desire to preserve more degrees of freedom in running the business.
In an odd way, therefore, going public seemed to provide the lowest available cost of capital and the apparent path of least resistance. We originally intended to sell shares to the public at a range of ten to twelve dollars per share. (When companies file to go public, they put what’s known as an “initial filing range” out to the market to signal the price range at which they hope to sell shares to the public. IPOs that are in demand are often oversubscribed, meaning there is more institutional demand to purchase shares than there are shares to sell, and naturally in that case the company will increase the filing range accordingly.) But the stock market continued to deteriorate over the course of our IPO marketing period, and we ultimately sold stock to the public at six dollars per share. This is definitely not your typical IPO story. But, the IPO allowed us to raise sufficient capital to give ourselves a shot at success without having to give up day-to-day control of the business.
“Live to fight another day” is another great startup mantra to always keep front and center in your mind. Of course, as John Maynard Keynes reminded us, this applies to almost every financial endeavor: “The markets can remain irrational longer than you can remain solvent.” Cash is undoubtedly king in the startup world—and in the business world more generally.
But perhaps the most poignant phrasing of this lesson that I ever heard came from the late Bill Campbell. Bill is a Silicon Valley legend (Apple, Intuit, GO Corporation, Google, etc.) and in his later years was referred to as “Coach,” for he spent tireless hours coaching entrepreneurs as they were building their businesses. He was also once a “real” coach of the Columbia University football team, but suffice it to say that his coaching record there paled in comparison to his many business successes over a long career. We were privileged to have Bill on our board at LoudCloud, where he constantly reminded us in very simple terms of the critical role that cash plays in a startup’s life cycle: “It’s not about the money. It’s about the F-ing money.” Enough said.
In 2002, we ultimately sold most of the LoudCloud business to Electronic Data Systems (EDS) and essentially restarted as an enterprise software business named Opsware. In addition to being the new name of the company, Opsware was also the name of the software we had developed to use internally when we were running the LoudCloud business—the name was a contraction of “Operations Software.” Because as LoudCloud we had to manage a whole series of servers, network devices, storage devices, and applications, we developed the Opsware software to reduce the amount of manual labor needed by automating a variety of the technology management tasks. When EDS acquired the LoudCloud business, it licensed the Opsware software but allowed us to retain the core intellectual property. So we did what any enterprising startup would do and created a new business selling the Opsware software to other large-enterprise customers who could benefit from automating their own technology management processes.
And we did all this while still being a publicly listed company, albeit with a nascent business and a market cap that appropriately reflected that (im)maturity. The stock hit a low of thirty-four cents, but we stuck with it for another five years and ultimately built a nice software business at Opsware that Hewlett-Packard purchased in 2007 for $1.65 billion. My partner Ben has written extensively about the transformation of the business in his own book, The Hard Thing about Hard Things, which I highly recommend. (And that’s not just because he’s still my boss!)
Immediately following the sale of Opsware to Hewlett-Packard, many of us had the opportunity to stay on as part of the HP Software business. At the time, HP Software was a roughly $4 billion division within the broader HP mother ship (HP sold everything from printers and ink cartridges to desktops, servers, networking equipment, and storage devices) that had been built on the foundations of HP OpenView, a set of software products that, like Opsware, helped companies manage their IT assets.
Over the years, HP Software had acquired a number of other software businesses in the broader IT management space, and thus the product line, employees, and customer base were very diverse and geographically dispersed. I had the opportunity to manage the integration of the Opsware team into HP Software and then to run the roughly $1 billion global software support business. With 1,500 employees scattered across every major global market, I logged more airline miles in that job than I have ever done in my professional lifetime to date. But it was a fun and exciting opportunity to manage a team at scale, as jobs and learning experiences of that kind can be hard to come by in the earlier-stage startup world.
Change Is Afoot in Silicon Valley
Following the 2007 sale of Opsware to HP, Marc and Ben began investing in earnest as angel investors. Angels are traditionally individuals who invest in very-early-stage startups (generally known as “seed-stage companies”). In Silicon Valley in 2007, the angel community was pretty small, and there were not many institutional seed funds, meaning professional investors who raised money from traditional institutional investors to invest in seed-stage companies. Rather, angel investing was dominated largely by a loose collection of individuals who were writing checks out of their personal accounts. Interestingly, Marc and Ben made their angel investments through an entity known as HA Angel Fund (Horowitz Andreessen Angel Fund), a reversal of the now-well-known brand name for their venture fund.
Marc and Ben started investing at an exciting time when change was afoot in Silicon Valley. To understand this change, you have to understand a bit of the history of the VC industry.
As we’ll dive into deeper in subsequent chapters, the Silicon Valley VC business started in earnest in the 1970s and was characterized for most of the next thirty-odd years by a relatively small number of very successful firms that controlled access to startup capital. In simple terms, capital was the scarce re
source, and that resource was “owned” by the then-existing VC firms, many of which are still very successful and active players in the current VC marketplace. Thus those who wanted access to that capital—the entrepreneurs—needed to effectively compete for that capital. The balance of power, therefore, as between the VC firms and entrepreneurs, was squarely in favor of the former.
Beginning in the early 2000s, though, there were a few significant transformations in the startup ecosystem that would change things in the entrepreneurs’ favor.
First, the amount of capital required to start a company began to decline; this continues in earnest even today. Not only did the absolute cost of servers, networking, storage, data center space, and applications begin to fall, but the procurement method evolved from up-front purchasing to much cheaper “renting” with the advent of what is known as cloud computing. As a startup, these changes are very significant, as they mean that the amount of money you need to raise from VCs to get started is much less than in the past.
Y Combinator Cracks Open the “Black Box”
The second material transformation in the startup ecosystem was the advent of an incubator known as Y Combinator (or YC for short). Started in 2005 by Paul Graham and Jessica Livingston, YC basically created startup school. Cohorts of entrepreneurs joined a “YC batch,” working in an open office space together and going through a series of tutorials and mentorship sessions over a three-month period to see what might come out the other end. Over the past thirteen years, YC has turned out nearly 1,600 promising startups, including some very well-known success stories such as Airbnb, Coinbase, Instacart, Dropbox, and Stripe.
But that’s not the most significant impact that YC has had on the VC ecosystem. Rather, the import of YC, I believe, is that it has educated a whole range of entrepreneurs on the process of starting a company, of which raising capital from VCs is an integral part. That is, YC cracked open the “black box” that was the VC industry, illuminating to entrepreneurs the process of startup company formation and capital raising.
In addition, YC created true communities of entrepreneurs among which they could share their knowledge and views both on company building and on their experiences working with VC firms. Prior to this time, the entrepreneurial community was more dispersed, and therefore knowledge sharing between members of the community was decidedly limited. But with knowledge comes power, thus the second material driver of the changing balance of power between entrepreneurs and VCs.
Something More
And that takes us to the founding of Andreessen Horowitz, started in 2009 by Marc Andreessen and Ben Horowitz. What Marc and Ben saw was this fundamental shift in the landscape that would no longer make access to capital alone a sufficient differentiator for VC firms. Rather, in their view, VCs would need to provide something more than simply capital, for that was becoming a commodity, and instead, in this post-2005 era of VC, firms would need to compete for the right to fund entrepreneurs by providing something more.
What that “something more” would be was informed by their thinking around the nature of technology startup ventures. That is, tech startups are basically innovative product or service companies. In most cases, tech startups represent an amalgamation of engineers who identify some innovative way to solve an existing problem or create a new market by introducing a product or service that consumers didn’t even know could exist. This affinity between the identification of the problem to be solved and the development of the product or service that in fact solves the problem is a key component of successful tech startups. No doubt that effective sales and marketing, capital deployment, and team building, among others, are also crucial ingredients to success, but fundamentally tech startups need to “fit” a market problem to a compelling market solution to have a shot at success.
Thus, to increase the odds of ultimately building a widely successful and valuable company, Marc and Ben had a thesis that founders should ultimately be product/engineering types and that there should be a tight coupling between the product visionary and the individual responsible for driving the company’s strategy and resource allocation decisions. Those latter responsibilities are typically the province of the CEO. Therefore, Marc and Ben had a predilection for backing CEOs who were also the source of the company’s product vision.
But, while technical founding CEOs might be great at product development, they might often lack the rest of the skills and relationships required to be all-around great CEOs—technical recruiting, executive recruiting, PR and marketing, sales and business development, corporate development, and regulatory affairs, among others.
As a result, the “something more” that Marc and Ben decided to build Andreessen Horowitz around was a network of people and institutions that could improve the prospects for founding product CEOs to become world-class CEOs. And I was lucky enough to become employee number one as we launched the firm in June 2009.
Over the past ten years, we’ve gone from $300 million in funds under management and a three-person team to managing more than $7 billion in funds and roughly 150 employees. Most of our employees focus on that “something more,” spending their days building relationships with people and institutions that can help improve the likelihood of our founder CEOs building enduring and valuable companies.
An Ode to Entrepreneurs
We’ve been fortunate enough to invest in many great companies, some of which are household names today—Airbnb, Pinterest, Instacart, Oculus, Slack, GitHub—and many that we hope will become household names in the future. And we’ve learned a lot, sometimes by making the right decisions but also by making mistakes as we’ve built the business. We believe in being innovative and experimenting in our own business. In fact, we consistently tell our team to “make new mistakes,” which we hope translates into taking informed risks, iterating on product and service offerings, and learning from previous mistakes to avoid treading down the same dead-end path. Throughout the course of this book, we’ll spend more time on many of the lessons learned.
Most importantly, we believe deeply in the sanctity of the entrepreneurial process and work hard every day to respect the very difficult journey that aspiring entrepreneurs walk on their hopeful path to success. We know that the odds of success for most entrepreneurial endeavors are small and that the ones that make it do so due to a unique combination of vision, inspiration, grit, and a healthy dose of luck.
It is their stories, and those of LoudCloud, Opsware, and Andreessen Horowitz, that are in many ways the story of this book.
Startups thrive (or die) based on the availability of capital from VCs, particularly at the formative stages of their lives when the business itself is in growth mode and can’t support itself through operating cash flow. And VC, like all types of capital, is a great form of financing where the needs and desires of the entrepreneur and the VC are aligned; there is a mutual pact the two organizations enter into with an agreed-upon set of objectives they hope to accomplish together. Money from public, institutional investors can also be an important part of the financing equation as a startup gets to a later point of maturity and can then satisfy the demands for predictable earnings growth that such investors require.
In a similar vein, when interests diverge between entrepreneurs and VCs, the world is not a very fun place to be.
As I’ve already mentioned, the best way to set up a successful marriage between entrepreneurs and VCs is to level the playing field and make sure everyone understands how VC works. So now it’s time to roll up our sleeves and dig in.
CHAPTER 2
So Really, What Is Venture Capital?
Let’s start at the beginning—what is venture capital and when is it an appropriate form of financing for a new company?
Most people think of venture capital as a source of financing for technology startups. That’s certainly true. VC money has funded many very interesting technology startups, including Facebook, Cisco, Apple, Amazon, G
oogle, Netflix, Twitter, Intel, and LinkedIn, to name just a few. In fact, if you look at the five largest market capitalization companies today (though this could well be out of date by the time you read this book!)—Apple, Microsoft, Facebook, Google, Amazon—all of them were funded by venture capital. Not too bad for an industry that, as we will see, is a pretty tiny part of the overall world of finance.
But not all venture-funded companies are technology companies. Among the very successful nontechnology businesses that were also funded by VCs are Staples, Home Depot, Starbucks, and Blue Bottle Coffee.
So what, then, is really the purpose behind venture capital, and how best should we think about the scope of companies for which VC might be the most relevant source of financing?
Is VC Funding Right for Your Startup?
We’ll get into this a lot more in later chapters of this book, but one way to think about VC is that it is a source of funding for companies (whether technology based or not) that are not otherwise good candidates to get funding from other, more traditional financial institutions.
There are other institutions that are in fact the source of “start-up” capital for most new businesses; they’re called banks. Small-business loans, particularly among community-based banks, have for a long time been the lifeblood of new company formation. This is why, among the many problems caused by the global financial crisis of 2008, job growth and new company formation stalled out—banks were simply unwilling (or in some cases, didn’t have the deposit base) to extend loans to new businesses. It’s also part of the reason why we saw the growth of alternative lending platforms (such as LendingClub) in the post–financial crisis years; they were in part filling a hole in small-business financing created by the exit of traditional bank lenders from this space.