Nov 2

Tim O'Reilly

Tim O'Reilly

What VCs Learned from Odeo and YouTube

I sent around the Radar back-channel a pointer to Techrunch's coverage of the new Charles River Ventures quickstart program, which abandons traditional early stage venture investing in favor of bridge loans at a discount to a later venture round, if any.

I'm all for small-scale seed investing, but as an angel, I've never been a big fan of this "discount from venture" approach, as it seems to devalue the risk that the early investor is taking. But more than that, it's an admission of ignorance -- a statement that "I don't know what this is worth, so I'll wait for someone else to figure that out." It always seemed to me to be the approach of new and unsophisticated angels. So in some ways, for a venture fund to take that approach seems a bit backwards.

Bryce Roberts ended up saying something very similar in email:

This move is not about what's right for the entrepreneur, it's about Odeo and YouTube.

I spent some time on Sand Hill road last week and the refrain from every VC I met was the same- this is a hits business and we just don't know who the winners are going to be any more. The old formula was one that they were all comfortable with - get a proven team in a hot market and you've got a winner. Then Odeo happened (CRV was the primary backer). Rockstar team, smoking hot market, all-star angels -- and it didn't deliver the hyper growth traditional VCs need for their return profile. YouTube on the other had was a couple of junior guys from PayPal moving into a saturated market which had never really panned out. $1.65B later, the VCs are scratching their heads as to how this could happen. Looking out across recent wins, you don't see all-star proven teams. You see scrappy entrepreneurs long on ideas and enthusiasm, but short on actual management experience like those at Facebook, Digg, Flickr, etc.

So what's a VC firm to do- spray and pray? If the odds of getting into a hit deal are akin to hitting it big in Vegas, it's about making a lot of bets. This program aims to make 50 loans in two years between two partners. Those two partners would historically make 2 investments per year, period.

The heart of the venture business is being able to separate signal from noise, rolling up your sleeves and working with the entrepreneur to build something successful. Is there any coincidence that Yahoo, Google, YouTube and so many of these "hits" have come from a handful of firms? Certainly timing and luck play a huge part in our business, but minimizing it to a seat at a roulette table is a shame...

Part of the problem is that the VC funds are so large, they just can't put enough money to work in the smaller investments that are appropriate in today's agile development environment. The right answer isn't to broadcast lots of bets. It's to create a smaller fund, where the amounts to be invested match up to the needs of the entrepreneur, but the traditional VC values of careful selection and added value still count.

And for what it's worth, it seems to me that there are sectors (think energy) where lots of capital may need to be deployed.

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Comments: 13

  James C [11.02.06 08:13 AM]

What you're looking for already exists here:

Seems like a pretty decent idea, haven't tried it myself, but the idea itself is sound.

  Julian Bond [11.02.06 09:11 AM]

Maybe it's time for the business incubator to re-appear. "Incubator 2.0"?? Or we just stand back and look at what is actually required for the first 12 months of a web startup and keep the VC for the second round of growth. Damn, this whole deal feels more and more like the music biz.

Or for VC to get out of the software business and back into areas that require big capital. Which is what you're saying in the last sentence.

  Tim O'Reilly [11.02.06 09:33 AM]

James C -- I almost mentioned Y-Combinator in the post, but decided against it. They are actually even earlier in the chain than a small early stage VC. The amounts they provide are tiny, so they are really more of an incubator.

But if you look at the CRV description, they are talking about initial investments of $500K or so. That's a sweet spot number for a small VC with small amounts of capital to deploy, a spray-and-pray number for a big one.

  anon [11.02.06 10:36 AM]

I'm not so sure YouTube v. Odeo is such a great example. Evan is perhaps a rockstar but Pyra was a very slow growth, non-blockbuster. Let's be honest, Podcasting is hardly a smoking hot category. YouTube, on the other hand, was the first out of the gate for what is was doing, was started by the guy who created PayPal's original site (and has Jim Clark as a father-in-law, btw), and two original engineers, all three of whom had gone through basically the identical lifespan (scrappy startup in semi-crowded market, parasites on to massive host and monetizes for $1+b).

VCs want everyone to think it's a hit business so they don't look so bad.

  Alex [11.02.06 01:49 PM]

You are wrong about the numbers. CRV has an active investing team of 8 people, not 2. This is not just a west coast play for them. 50 loans over 2 years = 25 a year / 8 people = 3 a year per person, at the maximum. Very manageable and not to be construed as a spray and pray. (as Dan Primack from Private Equity Week pointed out in his newsletter today).

  Amit [11.03.06 02:40 AM]

I think numbers aside, the quote about "scrappy entrepreneurs" struck me. There's enough proof that even mild ignorance of consumer psyche has always landed well-meaning VC's with bad investments.

I've always believed that simple ideas that solve a problem, in an admirably scrappy way makes something human and accessible, rather than sterile. From that foundation, one can explain YouTube, and a host of other successes - MySpace being the most obvious example of scrappy. Who and what "runs" these companies is not particularly important. I feel happy that Charles River held up their hands and conceded that they cannot do any assessment that would make any sense. They've resorted to some of the oldest forms of lending and if the fundamental goal of a VC is to make money from money - they succeed. Sounds like they cover the bases they can't predict, even if they understand them.

  misschickie [11.03.06 10:34 AM]

Thanks for this! Being "scrappy entrepreneurs" ourselves, this is music to our ears. Some great insight into what VC's are looking for.

  Gerald Joseph [11.03.06 11:42 AM]

You make a compelling point about energy. Even waste management, water filtration, and clean air technologies could use a boost of VC funding and acumen. Historically, when VCs make a public ideological commitment to a sector, entrepreneurs, proven and unproven, step their game up and a new cycle of innovation soon ensues.

But, regarding Charles River Ventures, the point we all collectively don't want to deal with is:
If there is going to be innovation or reform in the operational approaches of VCs, then their must be innovation or reform in the historic closed door relationships between VCs and LPs. VCs don't have as much wiggle room to reform as many seem to think...

Charles River Ventures' approach is particularly confusing because they have not explained how they will handle the administration costs and logistics of closing and managing so many deals in such a short timeframe. They're just working with too much capital, which necessitates the closing of way too many deals.

Moreover, Startups don't come ready to fit a cookie cutter mold. One size fits all approaches rarely work.

If they want to make this thing work, they will have to reevaluate their administrative structure. Maybe they could include strategic partners such as entrepreneurs-in-residence, technologists-in-residence, traditional early stage VCs, and angel investors to do a lot of the ground zero grunt work. Also, they might want to eliminate the Series A option from the deal. They should just make it a sure bet Series A commitment and show everybody that they mean business.

  bryce [11.03.06 01:10 PM]

Alex- the original article noted the program will be managed by CRV's two west coast partners- Bill Tai and George Zachary. This would make sense considering the program's objective of being a "quick" run and gun type of investment style- much easier to reach a decision with 2 rather than 7. Messaging changed on day 2. Time will tell how the distribution of deals per partner plays out.

Anon- if you remember way back to when Odeo announced their funding (Aug '05) podcasting was very hot. Two of the best, Sequoia and KP, had just backed PodShow and many others were jumping in with deals like Savage Beast. As you note, YouTube was the first to make video compelling. This would suggest you too recognize that video on the web was not a very sexy place to make an investment at that time.

In any event, the larger point is that as an investor, you may be better off looking at sectors that are not yet hot for the next big thing.

  Susan Wu [11.04.06 10:20 PM]

Hi Tim & Bryce:

I read this post about our announcement with great interest and it struck me that you have certain impressions about us and our QuickStart program that may stem from the fact that the two of us (groups, firms) don't know each other that well. So I wanted to take the opportunity to help clarify our position and try to illuminate where we're coming from.

1. We aren't abandoning our traditional early stage model.

-To characterize this as a 'learning from Odeo' is unfortunate and incomplete, because this program arose from genuine, organic interest from entrepreneurs we've been working with for awhile. People have been asking for seed stage convertible notes from us. 4 out of 5 of our most recent projects were seed stage convertible notes. 3 of these are in consumer services, the other is a semiconductor IP company. We formalized a program around activities we were already engaged in, so that these entrepreneurs would have a much more streamlined way to interact with us. Furthermore, we enjoy very early stage investing and want to spend time on these projects.

The thinking was, "Let's not force all seed stage projects who fit a certain profile to go through a process that makes more sense for a traditional venture investment. Let's put in a place a standard term sheet / deal structure so that we don't have to reinvent the wheel every time we finance a project like this."

-Ultimately, we are neutral as to whether or not we should do seed debt or equity. We feel that the final decision is up to the entrepreneur. We'll gladly participate in a seed equity round if that's what the entrepreneur deems best for his/her needs. We want to work with folks like OATV - I have a tremendous amount of respect for you guys. What we're trying to do with this program is create some efficiency, transparency, and choices for the entrepreneur.

-Also, the fund we are currently investing out of is a $250 million fund. It's a good size for doing both very early, seed stage projects as well as larger clean tech projects such as Celunol. It's also a fund size that somewhat reduces our incentive to be solely focused on driving massive hits, although of course, we are happy to have hits. I don't think being hits only focused is a good long term strategy in this business.

2. This doesn't feel like a 'spray and pray' approach to me - in terms of how I hear people internally speak about these seed projects. We're doing these seed projects out of both coasts, averaging about 1-3 projects per year per investing professional. We're still doing a decent amount of diligence and research into the seed projects we are investing in.

Btw, Bryce - yes, the west coast team is driving this program in terms of setting up the workflow, infrastructure, and processes, but our entire investing team is involved in making seed investments. Perhaps there was some confusion in messaging, but I assure you that nothing has changed internally. The last 4 seed investments we made were led by multiple people.

Having spent most of my life working hands on with developers in hardcore 'alpha geek' environments, I completely understand that most innovation doesn't necessarily happen with 'rockstar teams' and 'all-star angels'. In fact, most of my time is spent in the field, doing first hand research, hanging out with developers, going to user group meetings.

The reason why I'm excited about this new program is that I'm actively looking at virtual world, gaming, and next gen online socialization technologies. There's some amount of title risk associated with these projects, because implicit in the design of the product are all of the creator's assumptions about user behavior, emotional connection, and the sociological relationship between multiple users/groups. This investment size allows me to more palatably bear the risk of working with a couple of groups to develop a prototype and see how these assumptions manifest into the product/business. At the end of the day, I feel like I've personally failed if none of my seed investments flourish into viable Series A (B, etc) opportunities.

Thanks for reading my long post. I just wanted to share my perspective and try convince you that we are actually being a lot more thoughtful about this process than you seem to think we are. :)


  Dave McClure [11.06.06 12:27 PM]

i have less data on why Odeo didn't hit a home run (although i think Evan and his team are probably quite talented geeks too), but a lot of the reason why YouTube did so well wasn't just based on Jawed, Chad, & Steve... but also because the engineering team over at YouTube had worked together closely at PayPal, and were a rock solid team that iterated very quickly.

Jawed deserves credit for creating a great initial application, and Chad & Steve (& Roelof) for guiding the growth of the product and the company thereafter... however the engineering team over there has been a little bit overlooked for their contributions. they kicked butt, and the product features and viral sharing components were updated on almost a weekly basis.

one thing that strikes me about VCs and their diligence on startup teams -- they do a lot of homework on the founders (or at least the business-focused founders), but not nearly enough on the engineering team (and the technically-focused founders).

in hindsight, sometimes it's not such a great surprise to see great results if you really do know the engineering talent.

- dave mcclure

  Rune Ecklon [11.08.06 04:12 PM]

I am happy to see that the underdogs or lesser teams (on paper) manage to prove their worth by just doing it. In the end doing or not doing is what separates winners from losers.

  brandt cannici [11.22.06 12:28 PM]

I think your blog entry is entirely missing the point. As a "scrappy" what we want to do is focus on building a great product. Scouting out the VC and angel field is a time consuming process that keeps us from getting work done. But more importantly, the last thing I want to do is negotiate with a VC that I barely at this stage on a lot of details and the value of the company when there are still so many unknowns.

A convertible debt investment allows us to push back valuation until a time when we have formed a solid working relationship and many of the strategic details have become clearer. What CV Quickstart says to me is “We like your idea and we want to support you. If we work together I know we can create value. We can measure that value after we have worked together to create it.”

Additionally, a straightforward offer like Quickstart helps entrepreneurs feel secure in working with CV. I am always wondering, “Am I getting the same deal as the guy who went to Stanford with one of the partners?" I think this is particularly for entrepreneurs outside of Califonia who probably don not have the same connections as those inside.

I think this product is a great addition to the startup equity market and I believe that you will find it to be popular with the entrepreneurs, if not the VC market. And in the end, that is what is important.

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