From the Partnership

In this issue of our newsletter we focus on what makes for a good venture investor in today's changing (and challenging) environment.

Chris Neal, Founder and CEO of BlueStripe Software, shares his insight on what makes for a good investor partner.

Valhalla General Partner Art Marks discusses how venture capital is changing today, and Dan Gordon offers his thoughts on what venture strategy can learn from poker.

As always, we welcome your comments and questions. Please email to editor@valhallapartners.com.

Valhalla CEOs: Chris Neal

You've been involved with more than one venture-backed startup in the course of your career.  What was your first impression of the strengths and weaknesses of VCs as partners, and what is your thinking today?  To what extent have your views changed because you have changed or because we're in a different business environment today?

In my early experiences I was very skeptical that a VC could give me good advice about my business when they don't live and breathe it every day like I do.

Over the years I have come to understand that great investors can provide crucial strategic advice about your company and can challenge you to think about your market in ways that you won't by yourself.

There are a couple of requirements for this kind of good advice: your investor needs to have a broad and experienced viewpoint, one that spans both current trends and a history of seeing companies succeed and fail over the years. And you have to be brave enough to be honest about your business with them.

Are there any "best practices" you've seen from any Board members (VCs, angels, or independents) that you wish all Board members would do?

I love it when board members have read our board package in advance of the board meeting. This gives them time to really think about our business, so board meetings are much more productive and strategic as a result. I strive to get our board package out at least two days in advance in order to give them the chance to do so, and as a result they are great about coming to the meetings having done their homework.

Are there any "worst practices" you wish you never had to work with again?

In some of my past companies I have seen scenarios where investors try to "take the wheel and drive" -- in other words try to take ownership of solving some problem or directing some aspect of the business. This almost always results in more harm than good. It is one of the reasons why at BlueStripe we looked for and selected investor board members with both many years of VC success and strong operating backgrounds prior to becoming VCs. I've found that investors with this profile tend not to panic when a company faces challenges, and they trust the entrepreneurs to run the business while they give strategic guidance.

How would you fund innovation in a perfect world? How does the current system (Friends and Family, Angels, VCs, etc.) measure up?

In general I think the system of funding for innovation works pretty well. That being said, a perfect world scenario where many more entrepreneurs get some initial capital to prove out an idea, along with experienced guidance at that early stage would certainly result in more great innovation hitting the market. Now keep in mind that the vast majority of those ideas would still fail anyway. And like it or not we live in a world with limited capital and limited people with the right experience to match up with entrepreneurs.

Partners' Viewpoint: Art Marks on Valhalla Values

This month marks the beginning of my 28th year as an investor in venture capital (and the 35th year working with other VC's).

I thought I would take this opportunity to reflect on how the business of entrepreneurship and venture capital have changed during that time period.

In the past, when venture capitalists made an investment our expectation was that an exit would occur through an IPO. Investors concentrated on companies based in the US market, and we were able to assume that if our companies achieved success in the US, the world market would eventually be available. 

We expected our companies to raise prodigious amounts of capital to rapidly gain market share and exit ahead of their competitors.

Finally, in the past, good engineering was a scarce resource.

The view today has to be that exit will occur via a sale or a merger. The IPO market has changed for the foreseeable future, and, even as it comes back today to some extent, it cannot be the default plan for a company.

And today a company ignores markets outside the US at its peril. Plans have to be global plans from the earliest stages of a company in an growth or innovation area today.

Today we work with entrepreneurs to minimize the level of capital (and maximize everyone's returns).

A final difference is that today there are lots of good engineering teams -- here and offshore -- that can do cost-effective and agile development. The shortage today is of agile and talented marketing.

How does this affect the kind of venture partner an entrepreneur should seek out?

Entrepreneurs looking for venture partners should search for those who are agile and know the entrepreneur's sector in depth. Historical track records in unrelated businesses or business models that no longer exist are not particularly relevant. Entrepreneurs need to do as much diligence on venture partners as we do on the companies in which we invest.

Dan Gordon, Valhalla Director of Research, on Venture Strategy and Poker

Last year I read a fascinating profile in The New Yorker of Chris Ferguson, the first person to win over a million dollars in a poker tournament and arguably the best poker player in the world.
For Ferguson, an Operations Research PhD with a strong background in game theory, poker strategy is stripped of odds, optionality, and psychology. There are three "moves", like Rock, Paper, Scissors: Call, Fold, or Bluff.

How does this apply to venture investing? The analogies are not exact, particularly with respect to bluffing, which, in poker, is leading your opponent to believe you have cards you don't. We don't do that kind of bluffing at Valhalla: we don't play with our reputation. But if you think of bluffing as "causing your opponent(s) to fold", it makes more sense.

A couple of examples.

Scenario 1: WidgetCorp is badly missing its plan, is being trounced by its venture-backed rivals, and will run out of cash in the next quarter. Options? You could swap out the CEO or jigger with the sales process, you could take on a round of venture debt, you could merge the company with a rival. From a Fergusonian perspective, it comes down to:

• Call. Insider round. Futz with the company. Double the salesforce. Tough it out.
• Fold. Shutdown scenario. Cut the burn to barely simmer. Call the bankers.
• Bluff. Make an offer to buy one of your rivals for stock.

Scenario 2: Three venture firms are vying to invest in WidgetCorp. CEO advises you that the rivals "are likely to bid" 30% above what you consider your top valuation. Per Ferguson, it boils down to:

• Call. Put in a term sheet at your top valuation.  CEO is bluffing.  He will fold.
• Fold. Put in a term sheet 10% above the 30% "guidance", trying to lock down the deal.
• Bluff. Introduce the CEO to a VP Sales prospect to fill a hole on his team.

The devil is in the details, of course. For Ferguson, or for us, there is a wealth of financial, probabilistic, and psychological observation that goes into the decision. But, at the end of the data-gathering, the question boils down to one of these three. A different and nifty framework for enumerating your options.

Portfolio News

Exits

Verical

Verical, San Francisco, CA

On April 5, 2010, Arrow Electronics, Inc. [NYSE: ARW] purchased Verical, Inc. for $15.0 million. This sale represents the first successful exit for Valhalla Partners II.

"Verical has developed a platform that fills an important void in the secondary market for electronic components," said Hooks Johnston General Partner of Valhalla Partners II and a Verical, Inc. board member. "By providing a channel for electronic component manufacturers and their distributors as well as finished goods manufacturers to sell their excess inventory anonymously online Verical attracted hundreds of millions of dollars of inventory to sell. Buyers looking for a source of safe (counterfeit-free) and reliable supplies of components are increasingly finding Verical to be their best source of quality goods at low prices."

Q & A

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Please click here to submit feedback. We will undertake to respond to every submission, and to print those of general interest in this section. The partnership is happy to address topics such as hot technologies, exit strategies, or due diligence. We look forward to hearing from you.

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