Overshooting and Undershooting: Scale Venture Partners’ Kate Mitchell and Rory O’Driscoll on the VC Pendulum Swing

7/29/10Follow @wroush

Part of the point of opening Xconomy San Francisco last month was to put our ear to the ground in the world capital of venture investing. Toward that end, I sat down earlier this week with Kate Mitchell and Rory O’Driscoll. They’re both general partners at Scale Venture Partners, a Foster City, CA-based firm that focuses on helping startups through the middle stage of their growth—after they’ve proved that there are at least a few customers for their products, but before they’ve shown that there are lots of them.

That’s an unusual and tricky place for a venture firm to dwell, and it means that Scale’s team is heavy on partners with operating experience, especially in sales, marketing, and business development. In fact, Mitchell herself co-founded the firm in 1996 after working at Bank of America, where she had guided the development of the bank’s first Internet offerings. (Scale was known as BA Venture Partners through 2006, reflecting Bank of America’s majority ownership in its early funds. The bank has been a minority partner in Scale’s last two funds, a $400 million fund launched in 2007 and a $255 million fund launched this year.) O’Driscoll, meanwhile, has a background in manufacturing and has been a venture investor for nearly two decades, working with mobile, Internet, and enterprise software companies from Omniture to Box.net.

Lately, Mitchell has had a second job as well: chairing the National Venture Capital Association, the main trade association representing the venture industry in Washington, D.C. In that role, she’ll face many of the same challenges as her predecessor, Polaris Venture Partners’ general partner Terry McGuire. It’s her responsibility now to promote legislative changes such as immigration reform that the association sees as key to boosting innovation and entrepreneurship, while at the same time working to prevent changes that she says could make venture investing a less attractive career path, such as proposals to raise taxes on carried interest.

She’ll also have to help the industry through what’s likely to be a rough patch in the next two or three years, as limited partners react to the subpar investment returns of the past decade by pulling money out of this risky asset class. It’s a shakeout that Mitchell describes as necessary and healthy, but it’s one that will likely be painful for venture firms and entrepreneurs outside the Silicon Valley and Boston corridors, where the venture ecosystem is bigger and more likely to be able to weather the shakeout.

We had a wide-ranging conversation that focused first on the overarching trends and policy issues affecting the venture industry, and then on the way Scale picks its investments and works with the companies in its portfolio. I’ve divided my writeup of the conversation in the same way. In Part 1, published here, Mitchell and O’Driscoll tackle my questions about the health of the venture industry. In Part 2, coming next week, the conversation will focus on the unique challenges facing companies in the middle stages of their growth, and how Scale helps them scale up (hence its name).

Xconomy: Let me ask you to put your NVCA hat on first and talk about the big picture for the venture industry. How would you describe it right now?

Kate MitchellKate Mitchell: This is one of the greatest times, but it’s also one of the worst times. It’s a bit of both. It’s a record low time for money coming into the industry, but it’s probably the best time to invest.

Our thesis is that we are finally getting the excess capital out of the industry. We created too many competitors, too many entrepreneurs chasing the same opportunity, so they had to compete on price. We need to trim the tree or go on a diet, whichever metaphor you like. You never want to be the limb that gets pruned or the pound that gets lost, but we all know we’ll be healthier at the end of the process.

The only negative right now is that in many regions, venture fundraising has become much more of a challenge. In any place except Boston and Silicon Valley, it’s harder. I was in Michigan recently. I met with the Michigan Venture Capital Association, and they are worried. The average VC fund size in Michigan is $39 million, and they are worried about … Next Page »

Wade Roush is a contributing editor at Xconomy. Follow @wroush

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