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Why a VC is A Great Seed Investment Partner May 17, 2010

Posted by Lawrence Lenihan in Uncategorized.
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Later this morning, we are going to announce FirstMark’s seed investment program, FirstSteps.  Although we are making the announcement now, we recently closed on our 10th investment in this program which we started last year.  Since we started FirstMark in 1996, we have had a long history of creating companies from scratch and investing in them from an early stage.  In 2000, we started Outlooksoft in our basement and sold it to SAP for several hundred million dollars.  In our most recent fund,  we were the founders of Dovetail (a next-generation insurance platform) and EagleEye (comprehensive data and analytics solution for the insurance industry) and made seed-stage investments in Clickable, LiveGamer and WePlay.  All of these companies are now growing and maturing companies and several have progressed through one or more rounds of institutional funding.

You can read all about the FirstSteps initiative in the press release at http://www.firstmarkcap.com/node/1131, but the purpose of my post is to provide some insight into the answers for two critical questions: 1) why should a VC be doing seed stage investments and 2) why invest in New York City?

We’ve all read some good posts about the pros and cons of VC’s as seed investors versus traditional angels.  Let’s be clear where we are going to come out on this: a great angel is a great partner to have.  But a great VC is a great partner to have too!  We complement what an angel investor can bring to the table in terms of skills and expertise.  At times we might be more knowledgeable about the market, at others we might have a different and complementary perspective.  In addition, a great VC has seen literally thousands of companies and can apply incredibly valuable insight drawn from this vast experience to help an entrepreneur avoid potential (lethal) pitfalls and seize unique opportunities as they present themselves.  What works?  What doesn’t?  Who is a great strategic partner? Who will sink your company in support requirements? What kind of skillset do we need for our go-to-market strategy?  Where should we recruit the best head of marketing?  We have seen these questions play out hundreds of times in our company.  Believe it or not, history does tend to repeat itself and recognizing the patterns of success and failure is a key attribute of a great VC.   A great angel will have great relationships.  A great VC will have great institutional relationships.  Moreover, in addition to having a big chunk of our personal wealth on the line in our funds, we do this for a living day in, day out. We have a fiduciary obligation to our investors to do everything we can to make an entrepreneur successful, and that is a strong commitment.

If you’re successful, we’ll be there for you down the line too.  If you pick the right VC, you’ll have someone there beside you to provide funding for you as you build your company.  We won’t try or demand to take all the follow-on round – that’s not what we do.  In fact, we have begun telling our companies recently that, like an angel, we won’t lead the follow-on round of funding for the company, but we will commit to being a follow-on investor in an institutional round of funding.  We will typically look to guarantee a minimum percentage of the follow-on round, but we won’t put ourselves in the position of negotiating price and terms from a position of control.  That is not our style and it is not fair to the entrepreneur.  This is the best of both worlds for the entrepreneur: he knows he has a partner to support him in the next round of funding, not fight him and he has that long term funding commitment if he can continue to execute and build value in his company.

The relationship between entrepreneurs and investors is delicate at anytime, but especially so at this stage.  Picking the right partner is one of the most important decisions that you will ever make as an entrepreneur.  You need to know what you are getting when you pick your partner.  We feel so strongly about this transparency that we have put it in writing in a thing we call the Funding Bill of Rights  (http://lawrencelenihan.wordpress.com/the-funding-bill-of-rights/ )  The entrepreneur has rights and so does the VC.  If we are both in alignment, you cannot have a more formidable partner.

But this is not a  question of either or – almost every one of our ten seed investments as part of our FirstSteps program has one or more angel investors.  Angel investors are incredibly valuable partners in our investment process.  First, they often know the entrepreneur much better than we do since, in many cases, they have worked with them personally before.  Great angels bring unique market insight and complementary relationships.  They bring a perspective that we might not have.  For Angels, we ensure that they will have a partner who will participate in the future when they can’t.  They also have someone on whom they can rely to be there day in and day out, helping to ensure that the company is making progress.

But why does this make sense for us?  It’s simple really.  As the markets change, so must we.  Companies can now be developed for a fraction of the cost than they could just a few years ago and get to market in a fraction of the time.   The impact of this dynamic is that companies develop sooner and grow faster with less capital.  That means that we venture capitalists have to adjust our business model and be able to invest earlier and in smaller amounts.  Ironically, although we are investing closer to the inception of the company than we ever did before, many of our seed investments have far more traction than our Series A investments in the earlier part of this decade!

Seed investing makes for a particularly good strategy in New York City.  Enabling the “capital-lite” nature of company development today is the cloud computing infrastructure that powers companies with purely variable computing infrastructure cost coupled with the vast reach of connectivity of the internet that gives companies the opportunity to connect to every person on the planet who matters to them (2 billion + and counting!).  Now compbine this connectivity and this infrastructure platform with the dynamic changes that are accelerating rapidly across our country’s most important industries: Banking, Healthcare, Insurance, Media, Advertising, Entertainment, Education, Retail and Communications.  The result from the collision of these two waves will be the upheaval of these industries and a new generation of companies that will be created to lead our nation forward.

The New York City region is one of the largest generators or consumers of the services of these industries in the world.  The people who create, shape and influence these industries are here.  Where else in the world is there such a concentration of knowledge, skills, capital and decision makers?  These new companies that will form will rely on the expertise of the people who know these industries and can apply technology innovations to address these business opportunities.  If you want to start a chip company, you should do it in Silicon Valley (or Asia!), but if you want to start a company that will change the most important industries on this planet, you’ll do it where the skills, knowledge, insight and expertise reside: New York.

By taking our expertise and relationships in these industries honed over the past 14 years of our existence and coupling it with an investment program that enables us to assist great entrepreneurs in building these future-changing companies from their formation, we hope to continue to increase our contributions to affirming New York City as the  world’s business capital!

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