Greylock’s Henry McCance Part 2: Four Things Great VCs Do and Four Ideas to Guide Them
Every venture capital firm and every venture capitalist touts itself/herself/himself as adding value to the entrepreneur’s quest to build great companies. But when it comes to backing up that talk with action, few venture capitalists have the track record of Henry McCance, now chairman emeritus of Greylock Partners.
I recently visited McCance in the firm’s Harvard Square offices. Yesterday, I reported on Greylock’s origins and legacy, and McCance’s views of why the firm moved its headquarters to California and what New England can do to reclaim a greater portion of the center of startup gravity. The legendary investor was objective in his assessment that New England lost its edge with the setting of the minicomputer sun some 25 years ago, but he doesn’t think the situation is irreversible. Harvard and MIT aren’t going away, he says, and a new wave of startup energy in emerging areas such as cleantech might change the game.
Whether we’re talking about a New England resurgence, or generally raising the odds for startups to grow and become successful and boost the economy wherever they may be, VCs, of course, can help—by investing in the right firms and people and providing great connections and guidance. And a big part of my conversation—and follow-up e-mails—with McCance was about what makes a great VC. In straightforward fashion, he laid out four criteria or elements. I thought they might be of great interest to other VCs, but especially to entrepreneurs looking for investors.
1) Find the Visionaries—The best VCs are not reactive, McCance says. “They instead are proactive.” That means they proactively identify and recruit the visionaries in emerging fields. “We want to work with the best entrepreneurs on the ideas they are most passionate about. That’s how you get the great talent,” McCance says. One quick example he gave involved pioneering biotechnology firm Genetics Institute, which was formed in 1980. “We realized in the late 1970s that a new industry called biotechnology was going to be created on top of important advancements coming out of academic research in chemistry and biology,” says McCance. “This was going to enable new approaches to drug development, which before then had been very much a trial and error approach at ‘big pharma.’ Mark Ptashne and Tom Maniatis were world-class Harvard scientists with an entrepreneurial itch. Walter Cabot, the chairman of Harvard Management, had recently invested in Greylock and wanted to be sure Harvard’s key, but perhaps naïve, scientists were in good hands, therefore he steered them towards Greylock. I believe J.H. Whitney and Venrock were our partners. Kleiner Perkins funded Genentech at about the same time, and Amgen was founded a year later. All three companies had their pick of the best and brightest researchers coming out of Harvard, M.I.T., Stanford, Caltech, and UCLA, because there was an exciting, free form, entrepreneurial research environment that big pharma could not replicate.”
2) Support the Visionaries With Top Executive Leadership—Visionaries, and you have heard this before, are great at identifying and pursuing a big view of the world and how it will change, but sometimes they are not so good at going to market. VCs must be able to step in and constructively find executive leadership for a firm that complements the visionary’s strengths. In the case of Genetics Institute, says McCance, “Greylock identified Gabe Schmergel, through a recommendation from another Greylock portfolio company CEO, to become Genetics Institute’s first and only CEO. Gabe was a graduate of Harvard Business School, and a fast-rising executive at Baxter International.”
3) Instill a Culture of Frugality-– “We initiate a culture of frugality” to take “the money as far as we can,” says McCance. This is especially true early on in a startup’s life. “We try to keep the burn rate low in the early years of a venture when the cost of capital is highest. Hopefully, enough milestones or progress will be met with a Series A financing that follow-on rounds of capital can be raised at significantly higher valuations. However, again luck is involved, and market conditions can be favorable (as they were for Genetics Institute, permitting an IPO in 1984) or unfavorable, as they are now.”
4) Dare to be Great—”The fourth and very important things successful VCs and entrepreneurs do is, ‘Dare to be great,’” says McCance. “To me that means that successful new businesses will not be created very often by being only 10 percent faster, smaller, cheaper, etc. The advantages of the incumbent in the marketplace are too great to be only marginally better as the startup. The really great new company successes offered transformational ways of doing things.”
Of course, a great VC does far more than the above—those are just headlines of a sort. In addition to those four principles, says McCance, Greylock founder Bill Elfers instilled the firm with a culture/philosophy that he believes remains important today, 45 years later. Like the principles above, it also has four main elements.
“First is respect for the entrepreneur. He or she strives to be ‘best actor or actress.’ The VC…should strive to be ‘best supporting actor’ or, in other words, the best director the CEO has. Second, you must have a long term investing horizon. It takes a long time to build a great company. Third, have a compatible set of limited partners who embrace this time horizon and treat them as partners.” (Greylock, he says, long held quarterly meetings for its limited partners, and still meets twice a year with its LPs.)
“Finally,” he says, “make sure all interests are aligned.” McCance refers specifically to the fact that “Greylock has always had a budget-based fee structure, with arguably under market current income and above market carried interest.” Here we are getting into the more nuanced details of how venture firms work. You can read this post from Xconomist Paul Kedrosky that explains everything in fantastic detail. Suffice it to say that most venture firms charge an annual fee to cover overhead such as rent and partner salaries that is a percentage (typically 2 percent) of the total funds they have raised. Greylock believes this can create a misalignment of interests between the limited partners who invest in the firm and the general partners who invest the funds in startups by encouraging GPs to raise ever-larger funds and reducing the incentive to perform. Instead of taking a big annual fee up front, Greylock’s model is to ask the LPs to simply reimburse the firm for overhead but to charge a larger percentage of the profits generated by successful liquidity events, called “carry” in VC parlance. In a structure like Greylock’s, McCance argues, “the general partner’s interest and the limited partner’s interest are aligned. We get paid, not for gathering assets, but for helping create great companies.”