We're in the last lap of editing our research study on best practices of private equity and venture capital investors in originating new investments, which has a particular focus on use of social media.  We plan to publish this in a major private equity journal.

If you would like to review a copy of the 12,000-word report, please contact us.  We would greatly value your feedback.

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We have another Founder Institute semester spooling up in NYC, and the early admissions deadline is August 15th, with final admissions on August 29th.  Our host will be local entrepreneur Gabe Zichermann, and the applicant pool so far looks very strong. 

If you are an early-stage entrepreneur, this is a very powerful way to upgrade the sophistication of your company and significantly increase your odds of success.  Among the noteable companies from the inaugural New York Founder Institute are Profitably, Simple.PR, and Plan.fm, and VIMOTA.  Complete list here.

Apply: http://www.founderinstitute.com/apply/24
Applications Due: 08/29/2010
Sessions: 09/07/2010 to 12/15/2010

I hope to see you there!

I'm glad to report some great news from Profitably, a firm I'm advising and Founder Institute graduate.  Profitably provides analytics to increase revenues and lower costs for small-medium businesses.

About 2 months ago, they won the North Bridge Venture Partners venture competition, which included a $50k convertible note. The firm opened that note up to private angel investors, and we are pleased to announce that we closed a $300k seed round last week to get us comfortably through to Series A financing Q1/Q2 of next year. VentureBeat has picked up the story.  

Also, Emmy-nominated Chad Pugh Joins Profitably as Chief Aesthete. From day one, Adam Neary (CEO) and Francis Hwang (CTO) knew that design was critical for a consumer-facing website like Profitably, and so hiring a highly talent chief creative office was critical.

Lastly, Profitably has entered private beta. If you know any business using QuickBooks, they can register to receive free analytics of their business. I've already signed up my mother and cousin as members of the private beta.

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"As more research providers emerge to analyze the public markets (there are now over 3,500 research providers in our database), one gap in the market are research providers for the private markets.  David Teten, founder of the expert network Evalueserve Circle of Experts (formerly Nitron Circle of Experts), is moving into this space.  His new firm . . . will provide origination tools and other analytics to private equity firms.  Teten's exit from expert networks was well timed in retrospect, and his new focus on private equity looks opportune."

You can read the post here.  (Thank you to Sandy Bragg for reaching out to us.)

I'm in the midst of assembling the founding team for a new startup, and seeking a head of Engineering. I've attached details below.  I welcome suggestions!

Seeking Head of Engineering for Navon Partners, Internet Finance Startup, NY

We are seeking a Head of Engineering for the founding team of an internet finance startup, based in New York and soon Asia. This is your chance to get in on the ground floor, shape a new company's technology and culture from scratch, and create a significant company.

Our first product is DealOrigination.com, an automated research and analysis engine focused on private companies, leveraging our experience in sourcing new investments for private equity investors. Our technology is somewhat parallel to that developed by such firms as Alacra, Bloomberg, Capital IQ, Connotate, FirstRain, InfoNgen, SkyGrid, and ThomsonReuters; we particularly value experience from these and similar companies. We are also comparable to traditional investment banks. The startup is led by David Teten, a serial entrepreneur.

YOUR RESPONSIBILITIES

+ For each segment of our software platform, make buy/build/tweak decision.

+ Manage full product lifecycle including infrastructure, development, design, scalability and security.

+ Recruit and manage additional team members.

+ Research strengths and weaknesses of different data vendors we are considering.

+ Build hooks into APIs of major online networks (LinkedIn, Facebook, etc.)

+ Design and implement logic and scoring algorithms.

REQUIRED EXPERIENCE

+ Over 2 years management and 5 years development experience.

+ Proven success in large scale, high transaction systems engineering.

+ Use of formal and agile development methodologies

+ Built complex, integrated, sanitized, normalized databases based on many messy data sources (linear, non-linear).

+ Passion about our startup's vision.

+ Highly motivated self-starter who has a track record of continuous self-improvement, high achievement, and aggressiveness.

+ Strong analytical and math skills. High attention to detail.

+ Have managed development teams over time, with hiring and firing responsibilities.

+ Familiar with machine learning, natural language processing (NLP), screen-scraping technologies, semantic web, and/or agent-based systems.

We also value:

+ Experience in social networks, online dating, and/or finance industry, particularly investment banking and private equity.

+ Built consumer-oriented web applications.

+ Belief in the Edward Tufte school of communication.

+ Strong writing experience. Value a high GPA in writing-dependent courses.

+ Strong verbal communication/sales skills. Experience in debate, public speaking, and acting is pertinent.

+ Familiarity with startup environment and networks with local business/ government related organizations

+ Fluency in languages other than English.

COMPENSATION

+ Primarily equity initially. We are currently self-funded and expect to raise outside capital in late 2010/early 2011.   You can start on a part-time basis while staying in your current role.

HOW TO APPLY

Please include with your detailed resume:

+ Link to your LinkedIn profile (or other online identity).

+ Availability.

+ Writing sample

Please send resume and cover letter to Careers(@)Teten.com with "Head of Engineering" in the subject line. We prefer that you save your resume in Microsoft Word format with the name "Last Name-First Name-Year.doc", e.g., "Hayward-Tony-2010.doc".

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The Inside Numbers on the Job Market and the Impending Hiring War

How to Conduct the Perfect Interview

Understanding your cost to hire.

Employment Screening, beware and be aware

Social Network Recruiting - Beyond Employee Referrals

Turn disgruntled applicants into raving fans!

Finding Top Performers

Evalueserve, a global research firm and the acquirer of my former company (Circle of Experts), provided supporting research and analytics in the initial phases of this study. We also thank Yujin Chung and Neha Kumar (Wharton 2010), research associates who provided invaluable support, and interns Corentin Roux dit Buisson, Dan Clark, Nitin Gupta, and Nikhil Iyer .

A highlight from the HBR article:

We've found that late-stage tech investors with geographically diverse portfolios are consistently among the best performers and have continued to attract large limited partner commitments, even during the challenging period since 2007. Almost all such players have been able to raise at least as much cash as they could previously. By contrast, the funds with traditional origination programs, focused on local networks, have had difficulty; most haven't raised new capital since late 2005.

Read the whole thing.

For more data from the study, see the slides below:

Download this presentation.

Download this presentation.

In response to my post on VC's increasing use of operationally focused team members, HBS professor Noam Wasserman sent me an excerpt of his dissertation on 'The Venture Capitalist as Entrepreneur: The Characteristics and Dynamics Within VC Firms'. A key point he makes in this paper is that, "Most strikingly, a large percentage of the firms in the [VC] industry have adopted nonpyramidal structures [i.e., several partners and almost no junior staff], which are particularly predominant among early-stage and single-location firms. This structure has persevered for several decades."

This is very unusual relative to most knowledge-intensive firms. However, Noam observes that the accounting, investment banking, and law firm industries all started off with non-pyramidal structures but now are hard to envision without their current pyramidal model. I emphasize that the trend I discussed doesn't necessarily mean that VCs are becoming dramatically more pyramidal. 8 years after Noam's dissertation, the VC industry is still noteable in lacking the traditional pyramidal structure.

Rather, I see VCs taking 1 or both of the steps below:

1) refocusing some existing staff on operational improvement rather than new deals.  That's exactly what happened in the 2000-02 downturn, and also is a means to differentiate from other VCs.  As New York magazine observes in their recent cover story, the current boom in NY tech startups is painfully reminiscent of the last dot-com boom. Although I'm generally bullish on NY tech, there's no question that we have potential to see another downturn in the VC space. When that happens, just as in the private equity industry in the current downturn, there will be a need for operational resources.

2) adding on staff (senior enough to provide substantive help to a portfolio company at the CEO level) who focus primarily on operations as opposed to investing.

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Within private equity, these groups are often called "portfolio operations", sometimes "portfolio resources groups", or what Riverside Company calls its Toolkit. At larger funds, "operations" may be distinguished from governance, talent selection, pre-investment involvement, or even strategy, partly because "operations" is a term that management may infer to mean backseat driving.

By definition, these groups focus on improving the operations of the existing portfolio, not on diligencing potential deals or on deal structuring. Just a few of the many major private equity funds that have well-developed private equity operations groups: 3i (Business Leaders Network); Cerberus; Irving Place Capital; Bain Capital; TPG; General Atlantic; and Welsh, Carson, Anderson & Stowe.

A Bain study found that "as much as 80% of private equity returns [going forward] will come from real performance improvement, rather than [ ] financial structuring." According to a 2006 KPMG study of 100 private equity exits (below), 48% of the value-add during private equity ownership came through organic revenue growth, as opposed to capital structure changes and multiple arbitrage.

Source of Gains in Private Equity-Backed Companies

I see six major reasons why limited partners now expect that private equity funds will have a formal operating strategy, minimally an operating partner and/or a formal portfolio resources group. I should mention my thinking throughout this blog post and especially in the list of factors below is shaped by a number of presentations I've seen by Jon Weber, who has run portfolio resources groups at three major private equity funds.

1) Global economic crisis. Particularly in 2008-09, most portfolio companies required operating changes to survive. In most cases, the existing management teams were hired for their ability to grow revenues, not their ability to restructure. The funds had to supplement and/or replace the existing teams.

2) Commoditization of financial engineering. The classic question Michael Jensen asked is: if leveraging is so wonderful, why don't companies do it themselves instead of waiting for an LBO fund to buy them out? Since Jensen first began researching this area, larger companies increasingly chose to lever themselves, and there has been a massive boom in the private equity industry---thousands of funds all of whom can offer leverage. It has become much harder for a private equity fund to make high returns simply by borrowing some money and taking advantage of the interest tax shield.

3) Investors seek differentiation. Building a formal portfolio resources group has been a way that private equity investors can differentiate themselves and ease the capital-raising process.

4) Maturing private equity industry. According to the Parthenon Group, the larger size and greater complexity of funds has led to greater role specialization. As one investor said to me, "We've moved from the 'great man' to the 'great team' model."

5) Risk mitigation. The deal team tends to have a strong incentive to do a deal, and then move on to the next deal. An operational perspective adds a counter-balance to the deal team.

6) Strategy driven. Certain strategies -- deep value investing, turnarounds, mid-market focus, and industry-specialized funds -- require a hands-on approach.

I remember speaking at a Capital Roundtable Private Equity Portfolio Operations conference back in June 2008, and I was struck at the number of attendees who commented publicly on how they felt like "second-class citizens" at their funds, both in status and in compensation. However, when I spoke at the IIR PE Ops conference in October 2009, in the midst of cleanup from the economic crisis, the mood of the operating professionals was much more buoyant (despite the challenges they faced in their portfolio.) On a relative basis, they knew that their professional contribution had become much more apparent at their firms.

We have not yet seen a similar boom in portfolio resources teams in the venture capital industry, but it's coming. I recently had a conversation with Chris Farmer about this, which sharpened my thinking considerably (he is the coauthor of my forthcoming study on "Best Practices in PE/VC Deal Origination"). According to the NVCA and PWC Moneytree, the average VC round has doubled in the last 12 years with the growth of the industry (from $4m to $8m). At the same time, the cost of starting a company and proving concept with a new product has declined dramatically in many sectors.

Some such as Marc Andreessen argue that costs have dropped as much as 100x over the last couple of decades since the current venture capital model was created. As a result, many innovative venture capitalists and entrepreneurs are creating new fund models from Andreessen-Horowitz to Betaworks to Founders Collective and Floodgate. Fred Wilson wrote, "The venture capital asset class does not scale . . . . I think 'back to the future' is the answer to most of the venture capital asset class problems. Less capital in the asset class, smaller fund sizes, smaller partnerships, smaller deals, and smaller exits. The math works as long as you don't put too many zeros on the end of the numbers you are working with."

A corollary of Fred's point is that the small number of portfolio companies which do hit hypergrowth need more support. Chris and I think that one logical new model is: seed a large number of companies with quite modest amounts of capital. Then, double down with follow-on rounds on those concepts that do take off. For those companies that experience rapid growth, it makes sense for a fund to bring extra support, since those companies can't hire good people fast enough to do everything they need to do. In addition, a portfolio resources group can share learnings across the portfolio. This is much easier in venture than in private equity, because VC funds are much more likely to specialize in tightly defined industries. In addition, the portfolio companies are smaller and so it's easier for a VC to shape their growth according to the fund's beliefs in best practices.

In the case of companies that do not reach hyper growth, the companies will have raised modest amounts of capital and can be sold for much smaller amounts while still resulting in a win for entrepreneur and VC alike. Of course, failing to provide a follow-on investment is a signal that can hurt the company, but that has always been a part of the business and we are confident that models will evolve to minimize the negative effects.

Here are some models of VCs Chris and I identified which are building out portfolio resources groups:

- Andreesen Horowitz has said very explicitly that their model is to be able to invest at a wide range of capital levels in the 10-20 companies per year which have true potential to scale. They have built out a small value augmentation group: Ronny Conway (point person on business development for the portfolio) and several recruiters (1 for college-level talent, and 1 for experienced talent).

- Insight has the "Insight Onsite team" which is particularly focused on sales, SEO, and SEM.

- Accel has a Venture Development group and firms like Oak Investment Partners and Bessemer have Operating Partners to lend added support to companies. Charles River Ventures had a similar approach during the bubble.

- Bessemer also has a Designer in residence (showing the increasing importance of design for internet companies, e.g., Mint.com).

- Highland Capital Partners, Union Square, and numerous others have "Thought Summits" with noteable guest speakers. These events usually are organized by portfolio functional role, e.g., a portfolio CTO summit, portfolio CEO summit, etc.

- As I mentioned above, Union Square Ventures announced that they are hiring a General Manager of their portfolio.

- There has been a boom in accelerators: Boostphase (Atlanta, GA); Bootup Labs (Vancouver, BC); Capitalfactory.com (Austin, TX); Charles River Ventures QuickStart (Boston, MA); DreamIT Ventures (Philadelphia, PA); Iaccelerator.org (Bangalore, India); Launchboxdigital.com (Washington, DC); Nextstart.org (Greenville, SC); seedcamp (London, UK); Shotputventures.com (Atlanta, GA); SeedStart (New York); Summer @ Highland (Lexington, MA and Menlo Park, CA); Techstars.org (Boston (MA), Boulder, CO, and Seattle, WA; The Difference Engine(Sunderland, UK); Y Combinator (Mountain View, CA); and Y Europe (Vienna, Austria). For more information on how to build a replica of Y Combinator, read Jed Christiansen. For a comparative listing and more background, see Readwriteweb and Dan Veltri. TechStars recently released very positive data on the success of their incubated companies.

This approach differs from the incubator and acceletor trend (e.g., cmgi, antFactory) of a decade ago. That model was often criticized for selection bias: the less-competent entrepreneurs found the incubators more attractive. In addition, too much of the core competency of the company was driven by the incubator instead of in the company itself, creating ambiguity in attribution of value between the two entities. The new model looks more like the VC as consigliere instead of a bacteria splitting off new progeny.

I've had a front-row seat to this phenomenon, since I've done a lot of work in the past with portfolio resources groups at some of the major private equity funds. I've presented in the past on "Finding New Deals and Improving Portfolio Company Valuations by Working with Operating Executives," which covers some of the structural options private equity funds have in working with their portfolio.