Less is More

I did a panel yesterday at the NY Venture Summit with five other VCs:

Habib Kairouz, Rho Venture Capital
Charlie Federman, BRM Capital
Charles Crockett, Ascend Ventures
Greg Case, APAX
Deven Parekh, Insight Ventures

These are smart guys.  And they told it like it is.

We talked about the changes in the IT sector, the NY market, and the venture business.

At the end, our moderator, Stephen Davis, asked where all of this is going.

Everyone provided answers and they were all good.  I got to go last, so I tried to summarize.

I said, "in three words, less is more".

Less is more in the technology and venture business these days.  It takes less to start companies, it takes less to operate them at scale, and most smart entrepreneurs are raising less and diluting less.

There is this ideavirus (I hate the word meme and will never use it on this blog) going around right now about small is the new big.  I think Seth Godin started it.  Jeff Jarvis picked it up. And others are blogging it too.  I may have that wrong.  It's often hard to tell where these ideaviruses start on the internet.

As I was riding my bike this morning (where I do my best thinking), I realized that less is more is a corollary to small is the new big.

Our dream at Union Square Ventures is to one day fund a company that gets to a billion dollars of revenues with less than 10 employees and does it legally.  We may never do it, but someone will.  Because less is more.

Comments

[Dan Cornish]

I have to agree that the whole point of a technology based business is to allow the technology to do the work of people. We are much more productive with 3 people than we were with 35. BTW, we have three times as many customers now and are nicely profitable. The Craig's List model teaches us that if you are relentlessly focused on delivering value to your customer and use technology to do it, you will be rewarded.

The downside to all of this is that the perception of a small staff means you are not a big or serious business. Or the perception that there are no MBA's from the right schools means you have no management depth. I say BUNK!

[David Gibbons]

Hi Fred,

What a GREAT post - until the last line - where you hit a nerve. Did you contradict yourself? If the new 'big' is 'small', and the 10 person / $ 1Bn firm you describe fits the profile, why would they need VC? Unless cash flow is the issue (the bank?) or the VC is one of the 10, the new 'big' is probably not where the (VC) opportunity lies. Hold on - its not all bad news:

Here's my take on where I think VC's could be playing in the future:
1) acknowledge that the new big is small - and that the entire economy will move in that direction.
2) look back at when 'big' was 'big' and understand that the Venture money wasn't made investing in the 80% of co.'s that got 'big' but in the 20% of companies that built the "platform" for 'bigness'.
3) ... when being big was the trend, the huge companies were selling the tools for being big - i.e. IT, ERP, KM, DW, CRM etc. - so, Microsoft, SAP and Oracle were the HUGE companies - because they built the 'bigness' platform - at their 'big' customers, the strategy dujour was about agregating, measuring and allocating a 'big' pool of common resources. The 'huge' investments were in companies selling bigness!
4) now apply (2) and (3) above to the new paradigm in (1). For me, there are 2 natural corollaries:
4a) The way to find a huge investment in the "small is big" economy, is less to look for the "big small" company (do they even need money?) than it is about finding the defacto standard platform for enabling "smallness". Find that company any you have the new huge; i.e. where the VC money should go & is probably needed.
4b) The huge investment will be the company that serves up the tools for smallness and effectively brings those to market as a coherent platform. What are the tools for smallness? Easy - look at what it takes to be small - and compete with big - what does big have that small doesn't that could be sold to small. The chalenges of smallness, will differ by market segment but what need is it that all 'small' firms have in common? What is the 'how to be small' toolset and how will it be sold and distributed? The first wave of enablers of smallness are mostly relics of the tools of bigness - namely technology and communications, which is now comoditized to the extent that its readily available to small firms - hence the whole 'small' trend in the first place. Some money will be made here - split between existing firms that can sell to 'small' (MS) and new upstarts who see that their competitors can't (vonage).

If selling 'big' was about selling agregation, automation and decision support, I think that selling 'small' is going to be about selling the things that small needs. Small needs domain expertise, independence and productivity - things you can't easily be when you're small that aren't already comodities of the previous era. Who is selling small?

Final note:
caveat - this entire comment focuses on B2B business opportunities (more like B2b). there will be huge B2c opportunities going forward, but won't those mostly be small?

[Michael Weiksner]

Interesting post.

I didn't have the same adverse reaction to your final vision that David had about 10 people creating a $1 billion company. Who has the best chance of making that happen? Just look in the mirror: a boutique VC shop...

[drinkof]

Dead right, and it explains a lot about what was wrong with the dot.com business model, doesn't it? Forced bigness to be taken seriously, causing many of the groups which would best be at n to shove themselves into a 10n model? And others who would naturally be at n to walk away from a 10n VC world?

[scott partee]

As unbelievable as it sounds, I've seen that even the HUGE and BIG are beginning to embrace this theory a little bit.

As background, I do Technology Architecture work (I put it in capital letters so it seems important) for a Giant Telco. We are the antithesis of all you describe. However, we are starting to give business to "little" guys -- something that was unheard of just two years ago.

As an example, we needed a tool (don't we always need tools) and only a handful companies offered it, and we narrowed it down to a couple through our usual RFP procedures. One company was a tiny startup of 10 people -- the other was a giant systems and services company that everybody has heard of.

We ended up selecting the small company, because their tool did the job better than the other tools. There were, of course, many sessions of hand-wringing and much fretting over "financial stability." In the end, we place draconian contract measures on the company that I think were extreme, but they took it because they needed a huge client. But the fact remains we gave a seven figure deal to a 10 person company.

Now, in the early Internet days, my company's online work, which was major, was done almost exclusively by a handful of tiny interactive agencies and application developers. Then, we got caught up in the BIG bug and took it all away from local firms who were doing great work to giant consulting firms who promptly delivered much greater capabilities at an enormous cost. Turns out, we only needed the small guy capabilities, so we're coming around on that.

But my company isn't even the best example. I know many small scale companies that are now getting work with the biggest firms. I know a ten person company that just launched a major initiative for one of the big TV networks. I know a guy who hacked together something that's now for the HUGE.

Back during the boom, a friend of mine, who was CEO of an interactive agency that had just been aquired for major money was interviewed by the local paper. The question was put to him about the timing. How did you get so lucky to get big so quickly? His response was that in the early days of the Internet boom, only small companies and startups were flexible enough to deliver the services for Internet 1.0. His prognosis was that in the "new Economy" (during the boom), small companies were not going to get the access to the large company opportunities that his company had in the early days. The BIG companies were looking for the HUGE guys to deliver what they needed to be made HUGE.

He was right for a while, but looking around I can see that's no longer the case.

[Charlie Crystle]

We sell small.

[steve]

i guess i admire the sentiment here, and gosh knows i try to practice less is more all times possible, but, come on. small is not the new big. HUMUNGOUS is the new big. and its getting bigger all the time. if friedman is right, and the world is getting flatter, then the small will suffer. has to be the case, i fear -- the old barriers that made small enterprises practical are going going gone, e.g. geography, ethnography, etc.

if small is good, then why are they getting BIGGER:

comcast
sony
matsushta
pfizer
oracle
viacom
airbus
exxon
johnson & johnson
bank of america
google
j.p. morgan
mcdonalds
omnicom
news corp
verizon
procter & gamble
ntt
hsbc
yukos
wal mart
toyota
UBS
Intel
GTech
Unilever

... and how about hedge funds?

The challenge is to figure out businesses and models that can stay under the radar screen of the BIG concerns (e.g. by out-innovating them and/or by filling niches they can't or won't or don't want to fill) long enough to actually make it to market and/or create defensible I.P. so as to position the newco for acquisition by one of thiose BIG players. Sure, once or twice you see a Yahoo or a Google so thoroughly capture a new niche that they themselves become BIG. But how many venture backed entities EVER became big stand alones? Virtually none. Virtually all ended up gobbled up by the BIGGIES. Who are getting BIGGER and BIGGER and BIGGER...

[Charlie Crystle]

Something about the idea of Small is the New Big annoyed me so much I posted Small is the New Noise at http://charliecrystle.blogspot.com.

Folks, small has always existed. The context changes, but it's the New Big because it's something to talk about. It's always been here, just with different tools. It's still small.

[Alan]

Fred Beste and Todd Pietri had some good comments on this subject. Below is an excerpt from an interview Fred in May...

Until, that is, in March of last year, when I received the latest copy of Milestone Venture Partners' newsletter, and read the following sage words of Milestone partner Todd Pietri:

Think Small

Milestone is in the small deal business. We focus on small transactions in part because our investment size is small… In addition, we believe that the market for small transactions (less than $5 million) is the least competitive and thus the most attractively priced segment of the venture capital market. But all small deals are not created equal. In fact, we insist on one very important characteristic when we evaluate an investment opportunity: capital efficiency.

Capital efficiency to us means we invest in companies that have the option to build growing, profitable enterprises with one or two modest rounds of investment (e.g., $7 million over two rounds). Of course, it does not always work out this way, as companies often stumble and therefore consume much more money than anticipated. In the opposite case, where a company is thriving, the smartest thing to do may be to raise a much larger second round of capital ($8 million+) and swing for a home run; for example, when a company is fortunate enough to be in a large, growth market with tremendous demand for it products and services but where only a short window of time exists to capitalize on the opportunity.

The problem is that very few entrepreneurs, and venture capitalists for that matter, want to admit that their company is not one of those fortunate few firms that merit a large capital infusion. Like the children of Lake Wobegon, every child is "above average." Therefore, too often, the preferred course of action is to pursue a "get big fast" strategy, even when valuation has hopelessly outpaced the underlying fundamentals of the company. The hope is that somewhere down the road, the gods will be kind and it will all work out as hoped.

There are several reasons why this line of thinking generates poor shareholder returns. First, financial common sense tends to evaporate when a large pile of money is in the bank (emphasis mine). The virtue of having very little money as a young company is that it focuses the mind, inspires resourcefulness, and promotes wise decision-making. On the other hand, when lots of cash is available, management can easily lose focus by pursuing new markets, new products and acquisitions before there is a rational case….

There is, as well, an equally vexing structural problem with over-funded companies, which presents a stark new reality venture capitalists must contemplate going forward: the venture capital market is in the process of reverting to its historical mean in terms of exit values. When median IPO valuations for venture-backed companies crested above $300 million in 1999, it didn't matter if a company raised an extra $15-25 million of capital; 5-10X returns were still very achievable and the payoff came so soon that all interested parties were euphoric.

However, if IPO valuations return to their historical norm (and they have every indication of doing so) of between $70-110 million (total value), as they were from 1994 thru 1997, then companies that raise more than $15 million of venture money are going to have a very hard time generating 5X to 10X returns for their investors. The problem is compounded by the fact that it is going to be harder and take much longer to get public in the first place.

The historical merger and acquisition market paints an even worse picture. From 1994 to 1998, average venture-backed valuations for M&A transactions ranged between $45 million and $70 million. The outlier years were 1999 and 2000, at $156 million and $221 million, respectively. Given that most venture investors get liquid from M&A events, not IPOs, every extra $5 million of unnecessary capital that goes into a company can make or break an attractive return.

After considering such thorny logic, we find it strange that over 70% of new money going into venture funds (recently) went to large funds (over $250 million). Large VC funds are in a tough position. They need to put $10 million or more into each deal. If they syndicate, which promotes good risk management, each of their portfolio companies will have a minimum of $15-20 million of venture money (of course usually much more goes in). We just don't feel there will be sufficient liquidity to provide attractive exits for all of these over-funded deals.

Thus we are sticking to an investment strategy where we invest in capital-efficient companies that have the option to generate 5-10X returns on exits between $50-150 million. We hope a few, maybe even several, can do much better, with or without a large capital infusion, but we don't want to depend on it.

[eric johnson]

Great blog Fred! I riff'd on the topic and took it in a software specific direction.

http://ejohnson.blogs.com/software/2005/06/less_is_more.html

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