InLab Ventures, Based in San Diego and Orange County, Pursues Alternative VC Path
Some folks have been saying for at least a couple of years that the venture capital business model is broken. But is the venture capital industry really ready for a different business model?
Orange County investor and entrepreneur Chip F. Parker founded InLab Ventures two years ago as an early stage venture firm with a fundamentally different approach to screening and picking its startup investment deals. The firm, which debuted its new business model during the Demo Conference in Santa Clara, CA, in September, intends to focus on deals in San Diego and Orange County. But few venture investors, at least in San Diego, say they’re familiar with the firm, its founders, or its business model.
“They consider this industry a home run hit industry, says InLab managing director Greg Doyle, who works in San Diego. “But a home run in this industry is an IPO, and the IPO market is almost dead.” At InLab Ventures, Doyle says, “We’re not just looking for home runs. We’re also looking for singles, doubles, and triples.”
One of the chief differences at InLab Ventures is that the firm takes no annual management fee—a charge that, at other venture firms, typically ranges from 2 percent to 2.5 percent of the current fund.
Doyle, who works in San Diego, told me that conventional venture capital firms are hooked on management fees, because such fees provide a lucrative income—regardless of the returns on investments. Getting a percentage of assets under management also gives VCs a strong incentive to increase their fund size, which Doyle says is one reason why the average VC fund size has ballooned from $48 million in 1980 to nearly $400 million today.
InLab plans to realize substantial gains, though, when its portfolio companies are acquired or go public. Under its deal terms, InLab claims 35 percent of the proceeds from its investment (or 35 percent carried interest, in venture industry terms). The remaining 65 percent is returned to the limited partners who originally invested in the fund.
“Every deal is different, but the average equity position we would take for our investment is 25 percent to 45 percent ownership of the company,” Doyle explained in an e-mail. “The remaining ownership [in the company] remains with the founders and employees.”
Parker and co-founder William H. Fairchild raised $6 million for InLab’s inaugural fund, which has been invested in nine companies, Doyle said. In recent months, Doyle said, “We’ve spent the majority of our time raising $100 million for the second fund. In the meantime, we continue to work on the infrastructure of our business model.”
Since it can take years before a startup reaches a liquidity event, InLab’s founders also conceived an alternative to management fees that covers the salaries of the firm’s managing directors and staff. InLab formed what it calls an “Outsource Management Services organization,” which generates revenue by providing overhead and general administrative support for InLab’s portfolio companies. Much of the effort is focused on providing media and marketing services (more on that later), but the group also manages office space and IT services, and negotiates with law firms and other service providers to provide more specialized support for portfolio companies.
“One of the things we did was look at all the ways in which venture-backed entrepreneurs waste their time,” Doyle says. “The genius of it is that they have to pay for it anyway.”
Doyle says the arrangement provides some cost advantages, for example, including all of its portfolio companies under a single group health plan. More importantly, Doyle says managing such details engages InLab partners much more closely in their portfolio companies’ operations.
InLab says it also has developed an “enhanced due diligence process” for candidate companies that emphasizes a quantitative, scientific, and objective assessment. The firm says its “Venture Capital 3.0 lab-based process” was validated last year when the law firm of Wilson Sonsini Goodrich & Rosati and Hitachi Consulting used it to analyze the business plans of 10 venture-backed companies launched between 2000 and 2003. InLab says its process correctly forecasted the seven-year business and investment outcomes of all 10 companies.
Another key aspect of InLab’s approach calls for significantly increasing the number of investment opportunities. The basic premise is that picking 20 investment deals from a field of 2,000 candidates represents a much higher quality of deals than selecting 20 deals from a pool of 200 potential opportunities. To increase the number of opportunities, Doyle said InLab invested millions of dollars to develop news media capabilities, including a mobile studio truck, as part of its integrated marketing services group. Through a partnership agreement with Demo, Doyle says InLab’s media crew attends every Demo conference and formally interviewed executives from every company that presented. InLab provided a similar service during the fourth annual “quick pitch” event in October, which was organized by the Tech Coast Angels’ San Diego Chapter.
“Demo looks at 2,000-plus companies a year, and we get access to their entire deal flow,” Doyle says. “We get tremendous value out of the way we interact with these companies.”
Moreover, Doyle says InLab Ventures’ marketing group promotes the interests of the firm and its portfolio companies through a website that includes in-house news broadcasts, a magazine, events, events calendar, and “The Entrepreneur Challenge,” a competitive online social media platform for attracting entrepreneurs. Naturally, the firm also provides marketing services for the portfolio companies.
It is indeed a different approach. All that remains now is for InLab Ventures to show that its approach works, and Doyle said that’s coming too. San Diego-based Channel Islands, an inLab’s portfolio company that develops software for cable TV set top boxes, is under contract to be acquired. He predicts that two others are within 12 months of similar buyout deals.