Monthly Archives: March 2010

[This post is by Ben Horowitz.]

Fred Wilson wrote a counter post to my The Case for the Fat
that you can find here. Before countering his counter, I’d like to say
that Fred is one of my favorite VCs and has a marvelous track record of
success. Further, I’d like to thank Fred for posting his article, as it enables me to
clarify a couple of subtle but important points. 

I actually agree with Fred in the base case and never said
otherwise: entrepreneurs should build the product that everybody wants before
raising a boatload of cash to build the company. But Fred says one thing that
is confusing and another that’s just not accurate:

  • Only
    raise a boatload of cash once you’ve achieved product market fit.
    market fit isn’t a one-time, discrete point in time that announces itself with trumpet
    fanfares. Competitors arrive, markets segment and evolve, and stuff happens—all
    of which often make it hard to know you’re headed in the right direction before
    jamming down on the accelerator.
  • Only Marc
    and I could have pulled off the Loudcloud/Opsware miracle; other entrepreneurs
    shouldn’t even try.
    certainly didn’t script the movie the way it turned out. I’m not recommending
    that you as an entrepreneur pattern your own startup after mine. But as an entrepreneur,
    you have to deal with adversity, as we did with Loudcloud/Opsware.
    My experiences there are highly relevant to other entrepreneurs. In fact, they
    are more relevant than Fred’s pattern matching.

Let’s talk about each point in turn.

Product Market Fit Myths

First, I agree that the best way to build a big company
would be to find product market fit and then raise a bunch of money to build a
big business. But sometimes, things aren’t so clear. Let me try to describe
some of the ways things can get messy as a series of myths about product market

Myth #1: Product market fit is always a discrete, big bang event

Some companies achieve primary product market fit in one big bang.
Most don’t, instead getting there through partial fits, a few false alarms, and
a big dollop of perseverance. By the time it got acquired, Opware had achieved
product market fit for a category of software called data center automation.
But it wasn’t at all obvious that was going to be our destination while we were getting there. We actually achieved product market fit in a number of smaller
sub-markets such Unix server automation for service providers, then Unix server
automation for enterprise data centers, then Windows server automation, and
eventually network automation and process automation. Along the way, we also built a few products that
never found product market fit. 

Similarly, Joel Spolsky of Joel on Software and
Fog Creek Software fame has an exciting new company called Stack Overflow. He has
achieved product market fit in the collaboratively edited Q&A market for audiences such as software engineers and mathematicians.
Is this the primary product market fit? Neither of those markets seem that big.
Will he need significant new features to find the big product market fit?
Probably. Should he invest or stay lean? Good question, and there’s no formulaic

Myth #2: It’s
patently obvious when you have product market fit

I am sure that Twitter knew when it
achieved product market fit, but it’s far murkier for most startups. How many customers (or site visits or
monthly active uniques or booked revenue dollars, etc.) must you have to prove
the point? As I explain above, there may be multiple sub-markets, each of which
need their own product. I show below that Fred himself didn’t realize that
Loudcloud had achieved product market fit even though we had. It’s usually not
black and white.

Or let's try a consumer products example. Apple's first iPod shipped in
November 2001. It took nearly two years (91 weeks, to be precise) to sell its first million units. In
contrast, Apple's iPhone 3GS shipped June 2009 and shipped 1M units in 3 days. At what point is it obvious to the original iPod team that they've achieved product market fit?

Myth #3: Once you achieve product market fit, you can’t lose it.

Fred implies that we raised a boatload of money for Loudcloud prior to achieving product market fit. This is not true. Four months after founding Loudcloud, we had already booked $12M in customer contracts, so we had product market fit by most measures. I’d defy any VC including Fred to point to a company with a $36M run rate 4 months after founding where the VC advised, “stay lean until you achieve product market

But after that bolt out of the starting gate, the market for cloud
services changed dramatically. After Exodus went bankrupt in September 2001, the market for cloud
services from semi-viable companies went to zero and we lost product market
fit as a cloud services provider. We had to rebuild completely and would ultimately find product market fit in a different set of markets altogether.

Myth #4: Once
you have product-market fit, you don’t have to sweat the competition.

fine to stay lean if you are not quite sure that you have product market fit
and there are no competitors in your face every day. But usually there are. In fact, the best markets are usually the ones in which competition is fierce because the opportunity is big. How
long should you stay lean before attacking? Again, there is no formula that works in all (or even most) cases.

Exceptions that prove the rule

Now, there are some companies such as Twitter (one of Fred’s brilliant investments) for which the above myths are actual truths. However, I propose that
Twitter is more exceptional than Loudcloud or Opsware in that most
entrepreneurs are dealing with a situation that looks much more like Opsware
than Twitter.

The Marc and Ben Special

Second, let's talk about the Marc and Ben Special. Fred writes: “Ben explains that Loudcloud raised $350mm in four rounds of financing (including an IPO) in the first 15 months of
its life. Marc Andreessen and Ben Horowitz can do that. Most of you can not.”

It's true that we raised a lot of money, and not all first-time entrepreneurs can raise that much money. But that's not my point. The most important fund raising that we did as it relates to The Case for the Fat
was the very last round (as is very clear in the original post). We
raised that money as Opsware, long after we had lost all of our
magic fairy dust. Marc had moved on to found Ning and I was the CEO who nearly
ran Loudcloud into the wall. I am quite sure that I did not have exceptional
fund raising capabilities at that point.

In summary, let me repeat that I agree with Fred in the base case: first build
the product that everybody wants, then raise enough money to build the company. If you can build a big company that way, by all means do it.

Having said that, your story will almost certainly not be that
clean. You might achieve partial product market fit at the same time as a scary
competitor, you might not be sure that you have product market fit, you might
lose product market fit. When one or more things happen, no pattern matching will save you. You will have to figure out for your own unique situation a)
whether there is a clear and present market and b) if there is, how you can
take it.

Fred implies that what we did at Loudcloud/Opsware was
extremely difficult and while Marc and I could pull it off, other entrepreneurs
shouldn’t try it. My point is that trying it isn’t really a choice. As an entrepreneur, you will sometimes (maybe more often than you like) find yourself in a difficult situation. I hope to have provided some
insight on how you might come out alive when that happens.

These days, nearly all the entrepreneurs who come pitch at our venture firm Andreessen Horowitz highlight how little money they are raising and how "lean" they are planning to run the company. While we don't want to invest a single dollar more than a company needs, there is a case to be made for raising enough money to win the market. 

My partner Ben makes this case convincingly in his guest post on AllThingsD titled "The Case for the Fat Startup." Read it, and along the way you'll also hear the story of how Ben navigated our company Opsware through the turbulent dot-com implosion to a $1.6 billion acquisition by HP Software in July 2007. 

Hint: he didn't do it running lean.

Hot off the virtual press: my partner Ben has posted a great essay on leadership over at TechCrunch.

The post should be of particular interest to entrepreneurs who are raising money from our venture fund, as Ben articulates the three key traits we look for in the leaders of the startups we fund. 

Bonus feature: in the post, you'll learn what we like best about three Silicon Valley icons: Steve Jobs, Bill Campbell, and Andy Grove. 

[This blog post is by Ben Horowitz, the Horowitz of Andreessen Horowitz.]

At our new venture fund, we’ve been spending time looking into new ways that will make the lives of entrepreneurs seeking funding easier. To that end, we’ve linked up with Ted Wang who has been working on an open source legal project called the Series Seed documents. We’re impressed with his work and are going to use these standard funding documents as part of our seed stage investments wherever appropriate.

We have to give a big shout out to Ted: he nailed this. It’s exactly in step with our intention of letting entrepreneurs focus on building businesses in today’s environment, without having to follow old VC rules.

In a nutshell, entrepreneurs and the businesses they are starting have evolved. Start ups today don’t need to build a manufacturing plant (as DEC, the very first high-tech VC investment, did in 1957) to start a business. They need less money to build a product and prove that it works before scaling the business. Yet, the paperwork involved in funding entrepreneurs hasn’t changed to meet these needs. Series Seed is the first to establish this new way of supporting funding suited for today’s entrepreneurs – and we’re big fans.

Let us know what you think: check out the Series Seed documents, and share your thoughts.

Here’s more background on our thinking behind how entrepreneurship has changed, creating the need for these simplified funding documents. I’m speaking here from the point of view as both an angel investor and a venture capitalist, two very different kinds of investors.

Angels vs. Venture Capitalists

Why do angel investors exist?

Before answering these questions, it’s useful to ask and answer a related question: why are there angels and why have they become more prominent in the last 10 years? After all, doesn’t the definition of venture capital include all of the activities that angels perform?

The answer lies in the history of technology companies and the differences between how they were built 30 years ago and how they are built now. In the early days of technology venture capital, great firms like Arthur Rock and Kleiner Perkins funded companies like Digital Equipment Corporation (DEC) and Tandem. In those days, building the initial product required a great deal more than a high quality software team. Companies like Tandem had to manufacture their own products. As a result, getting into market with the first idea, meant, among other things, building a factory.  Beyond that, almost all technology products required a direct sales force, field engineers, and professional services. A startup might easily employ 50-100 people prior to signing their first customer.

Based on these challenges, startups developed specific requirements for venture capital partners:

  • Access to large amounts of money to fund the many complex activities
  • Access to very senior executives such as an experienced head of manufacturing
  • Access to early adopter customers
  • Intense, hands-on expert help from the very beginning of the company to avoid serious mistakes

In order to both meet these requirements and build profitable businesses themselves, venture capitalists developed an operating model which is still broadly used today:

  • Raise a large amount of capital from institutional investors
  • Assemble a set of experienced partners who can provide hands-on expertise in building the product and then the company
  • Evaluate each deal very carefully with extensive due diligence and broad partner consensus
  • Employ strong governance to protect the large amount of capital deployed in each deal. This includes requisite board seats and complex deal terms including the ability to control subsequent financings
  • Manage own resources effectively by calculating the amount of capital/number of partners/maximum number of board seats per partner to derive the minimum amount of capital that must be invested in each deal

It turns out that building a company has changed quite a bit since the early days of venture-backed technology companies. Building a company like Twitter or Facebook is quite different from building Tandem. Specifically, the risk and cost of building the initial product is dramatically lower. I emphasize product to distinguish it from building the company. Building modern companies is not low risk or low cost: Facebook, for example, faced plenty of competitive and market risks and has raised hundreds of millions of dollars to build their business. But building the initial Facebook product cost well under $1M and did not entail hiring a head of manufacturing or building a factory.

As a result, for a modern startup, funding the initial product can be incompatible with the traditional venture capital model in the following ways:

  • Lengthy diligence process. Venture capitalists take too long to decide whether or not they want to invest because they are set up to take large risks and have complex processes to evaluate those risks.
  • Too much capital. Venture capitalists need to put too much capital to work – often a VC will want to invest a minimum of $3M. If you only need 4 people to build the product and get it into market, this likely won’t make sense for your business.
  • Board seat. Venture capitalists often require a board seat and, for that matter, a board of directors be formed. If 100% of the company is building the product and the team knows how to do that, then a board of directors may be overkill. In addition, it may be too early to decide who you want to be on the board.

As a result of the above, a venture capitalist usually requires a serious commitment from the entrepreneur to pursue an idea that is highly experimental. If the product doesn’t stick, it might make sense for the entrepreneur to pursue a totally different idea or drop the business altogether. This is much easier to do if you’ve raised $300,000 than if you’ve raised $3,000,000.

As entrepreneurs needed someone to bridge the gap between building the initial product and building the company, angel investors stepped up.

Angel investors are typically well-connected, wealthy individuals. They generally use their own money and come with none of the above VC constraints describe above: they don’t go on boards, they don’t need to put in lots of capital (in fact, they usually don’t want to), they prefer dead simple terms (as they often don’t have legal support), they understand the experimental nature of the idea, and they can sometimes decide in a single meeting whether or not to invest.

On the other hand, angels do not manage huge pools of capital, so entrepreneurs need to find someone else to fund the building of the company (as opposed to the product) and most angels do not plan to spend a great deal of time helping entrepreneurs build the company.

One more thing before answering the original question

Before getting back to the need for the Series Seed documents, it’s important to distinguish venture rounds and angel rounds from venture capitalists and angel investors. It’s possible for a venture capitalist to invest in an angel round and vice-versa. Sometimes this is a great idea and sometimes it’s tragic. We’ll first examine the rounds and then the investors.

When should you raise an angel round and when should you raise a VC round?

This question really comes down to the company’s development. If you are a small team building a product with the hope of “seeing if it takes” (with the implication being that you’ll try something else if it doesn’t), then you don’t need a board or a lot of money and an angel round is likely the best option. On the other hand, if you’ve developed a strong belief in your product or your product idea and you are in a race against time to take the market, then a venture round is more appropriate. You will benefit from both the extra capital and extra support that comes with a serious and large commitment from your investors.

So who is qualified to invest in each?

Obviously angels can invest in angel rounds, but what about VCs? Is it safe to have them participate? The answer turns out to be “if and only if they behave like angels.” What does it mean for a VC to behave like an angel? Well, they must:

  • Be comfortable investing a small amount of money, e.g. $50,000.
  • Be able to make an investment decision quickly, e.g. in one or two meetings
  • Be able to invest without taking a board seat
  • Not require control of subsequent funding rounds
  • Not impose complex terms

If the VC wants to be in the angel round, but refuses to behave like an angel, then entrepreneur beware. Having a VC who behaves like a VC in the angel round can jeopardize subsequent financings.

Angels can be great participants in venture rounds, but it’s generally better to have a VC lead those deals as they have more financial and other resources required to build the company.

What does this mean about Andreessen Horowitz and the types of investments we’ll do?

As I stated above, at Andreessen Horowitz, we invest in both venture rounds and angel rounds. When we invest in angel rounds, we behave like an angel. As angel investors, we can invest as little as $50,000, we do not take board seats, and we do not require control.

Rooted in this desire to help germinate quality ideas, our support for Seed Source legal docs will allow both us as investors and the entrepreneurs we fund to focus on building a winning product rather than scrutinizing legal docs.