We have been tracking the interesting discussion about Advisory Capitalists. Several have weighed in – many with real market weight such as Stowe Boyd, Jeff Jarvis and Umair Haque. We generally follow what these guys have to say and value their perspective so their discussion on this topic is noteworthy.
I am neither an AC or VC although I have rubbed shoulders with many in both categories. As an investment banker for seven years on both coasts, I probably fancied myself somewhat of an AC and a provider of late stage capital. I was convinced I was adding value to my clients – not only in providing capital – but also strategic expertise. It wasn’t until I left investment banking to work at a start-up that I realized how far I was from understanding what it takes to run a company. I was flying at 30,000 feet, but company entrepreneurs were taking bullets at ground zero.
Venture capitalists generally look with disdain at investment bankers since investment bankers are merely agents and do not have skin in the game. That is true. Having capital at risk aligns the interests of both VC and entrepreneur. However, most of the capital a VC invests is funded by limited partners. So a VC also plays the agent role, forging a bridge between company and limited partner capital.
Jarvis passed along VC Fred Wilson’s view. Fred points out how an AC does not put anything at risk and therefore doesn’t feel it in the gut like an entrepreneur and a VC does.
He qualifies that the “best” VCs feel it in the gut. I can agree but I can’t say there is much data to support the following statement.
VCs are joined at the hip with their limited partners and will often cut and run on an entrepreneur, hardly being “there for the entrepreneur when they need it most.”
That is capitalism.
Most entrepreneurs and innovators are passionate about their business. Sure greed plays a role for an entrepreneur but for many entrepreneurs they are also driven to create, change lifestyle or define new models, industries or products. VCs or their limited partners rarely share these passions. And why should they? Their motivation is defined purely by greed and when the forecast for home-run returns looks bleak, the capital and the expertise of a VC is withdrawn as he runs for cover or focuses on a deal that looks better. I am not saying it should be any different, I am just saying let’s face it.
Stowe’s model makes sense, precisely because the reward opportunity for an AC (with no capital at risk) is not so much an attempt to match reward with risk but compensate for contribution and value creation. An AC under Stowe’s plan would receive 10% of what a typical VC would receive for a first round investment. A VC is compensated for taking risk by receiving a substantial equity stake. An AC is compensated for contributing value by receiving a much smaller equity stake. However, the AC equity stake proposed by Stowe’s model is much higher than equity offered to
Capitalism (and Stowe) require that a longer-term commitment and more regular strategic involvement will require a greater ROI for the AC. Agreed. Let the market determine that. It sounds like Stowe is testing it.
I believe that the AC fills a niche in the marketplace for start-ups. As Jeff points out, “capital is a commodity.” How VCs try and differentiate from their competition is through providing “advice, connections, and expertise.” This will become more important in the future. That will be difficult for VCs that have limited partners that require deal flow and thus naturally restrict the resources a VC can commit to nurturing existing investments. Limited partners will continue to demand that a VC aggressively find places to deploy their capital. More capital, means more deals and less time with each investment. And the supply of available capital just keeps growing.
On the demand for capital side, as Stowe, Jeff and Umar point out, many Web 2.0 companies need less capital but still could benefit from “advice, connections, and expertise.” One could argue that an AC may provide substantially more valuable “advice, connections, and expertise” than many VCs.
The demise of the VC? Hardly. Fred articulates it well.
I am with you Fred. The business of investing capital in start-ups won’t go away just as traditional media won’t completely go away. But perhaps some unbundling of the traditional VC value will occur.
So how can an AC get skin in the game? How can an AC align risk and reward with an entrepreneur? It is economically unrealistic to think this will occur as it does with a VC. But the reward structure proposed by Stowe is economically realistic. My question is will an AC be willing to accept vesting of her equity stake on performance measures like unique visitors, conversion rates, revenues or some other metrics? If so, there will be a place for the AC among start-ups that need less capital but want and need “advice, connections, and expertise.” VCs without AC-quality expertise will be left with an over-supply of capital and perhaps be required to become more flexible on terms. Sounds like good news for start-ups now matter how you look at it.
I am neither an AC or VC although I have rubbed shoulders with many in both categories. As an investment banker for seven years on both coasts, I probably fancied myself somewhat of an AC and a provider of late stage capital. I was convinced I was adding value to my clients – not only in providing capital – but also strategic expertise. It wasn’t until I left investment banking to work at a start-up that I realized how far I was from understanding what it takes to run a company. I was flying at 30,000 feet, but company entrepreneurs were taking bullets at ground zero.
Venture capitalists generally look with disdain at investment bankers since investment bankers are merely agents and do not have skin in the game. That is true. Having capital at risk aligns the interests of both VC and entrepreneur. However, most of the capital a VC invests is funded by limited partners. So a VC also plays the agent role, forging a bridge between company and limited partner capital.
Jarvis passed along VC Fred Wilson’s view. Fred points out how an AC does not put anything at risk and therefore doesn’t feel it in the gut like an entrepreneur and a VC does.
“Unless you have capital at risk or some other form of “skin in the game” like sweat equity, you cannot and will not feel the thrill of victory and agony of defeat that binds the VCs and entrepreneurs in startups.”
He qualifies that the “best” VCs feel it in the gut. I can agree but I can’t say there is much data to support the following statement.
“they [VCs] are there for the entrepreneur when they need it most, joined at the hip with the risk/reward belt.”
VCs are joined at the hip with their limited partners and will often cut and run on an entrepreneur, hardly being “there for the entrepreneur when they need it most.”
That is capitalism.
Most entrepreneurs and innovators are passionate about their business. Sure greed plays a role for an entrepreneur but for many entrepreneurs they are also driven to create, change lifestyle or define new models, industries or products. VCs or their limited partners rarely share these passions. And why should they? Their motivation is defined purely by greed and when the forecast for home-run returns looks bleak, the capital and the expertise of a VC is withdrawn as he runs for cover or focuses on a deal that looks better. I am not saying it should be any different, I am just saying let’s face it.
Stowe’s model makes sense, precisely because the reward opportunity for an AC (with no capital at risk) is not so much an attempt to match reward with risk but compensate for contribution and value creation. An AC under Stowe’s plan would receive 10% of what a typical VC would receive for a first round investment. A VC is compensated for taking risk by receiving a substantial equity stake. An AC is compensated for contributing value by receiving a much smaller equity stake. However, the AC equity stake proposed by Stowe’s model is much higher than equity offered to
“the Madame Tussaud wax dummies that most companies populate their advisory boards with. …..in-name-only advisory board members.”
Capitalism (and Stowe) require that a longer-term commitment and more regular strategic involvement will require a greater ROI for the AC. Agreed. Let the market determine that. It sounds like Stowe is testing it.
I believe that the AC fills a niche in the marketplace for start-ups. As Jeff points out, “capital is a commodity.” How VCs try and differentiate from their competition is through providing “advice, connections, and expertise.” This will become more important in the future. That will be difficult for VCs that have limited partners that require deal flow and thus naturally restrict the resources a VC can commit to nurturing existing investments. Limited partners will continue to demand that a VC aggressively find places to deploy their capital. More capital, means more deals and less time with each investment. And the supply of available capital just keeps growing.
On the demand for capital side, as Stowe, Jeff and Umar point out, many Web 2.0 companies need less capital but still could benefit from “advice, connections, and expertise.” One could argue that an AC may provide substantially more valuable “advice, connections, and expertise” than many VCs.
The demise of the VC? Hardly. Fred articulates it well.
“advisors have a growing role in the startup equation for many of the reasons that he [Stowe] articulates. But I think it isn't possible to completely replace the role of the VC”
I am with you Fred. The business of investing capital in start-ups won’t go away just as traditional media won’t completely go away. But perhaps some unbundling of the traditional VC value will occur.
So how can an AC get skin in the game? How can an AC align risk and reward with an entrepreneur? It is economically unrealistic to think this will occur as it does with a VC. But the reward structure proposed by Stowe is economically realistic. My question is will an AC be willing to accept vesting of her equity stake on performance measures like unique visitors, conversion rates, revenues or some other metrics? If so, there will be a place for the AC among start-ups that need less capital but want and need “advice, connections, and expertise.” VCs without AC-quality expertise will be left with an over-supply of capital and perhaps be required to become more flexible on terms. Sounds like good news for start-ups now matter how you look at it.
» Advisory Capitalists - My Two Bits from MidMarketMaven
A discussion is raging on the web among bloggers who have an opinion about Advisory Capitalists. First, let me tell you what I think is meant by this new term. I believe it is intended to represent a group of... [Read More]
Tracked on: March 2, 2006 10:57 PM | Permalink to Trackback