The explosion in incubators for early stage tech companies has spawned a familiar startup storyline: A team of bright founders hits on a promising idea, builds a prototype, and applies to one of the big-name programs. After they get accepted (or sometimes even if they don’t), it’s off to the races for a few intense months of coding, meetings, demos, late nights, long weekends, and camaraderie.

And when it’s over, a big demo day where everyone shows off their hard work—and hopefully lands some investment to really get things going. Not as much ink is spilled about that day-after reality, when the wunderkind founders get to work actually building a business.

That brings us to Seattle-based FutureAdvisor, a startup that graduated from the summer 2010 batch of Y Combinator—biggest of the big-name startup incubator programs. Among the other companies produced in that group are Hipmunk, the travel-booking site, and Contagion Health, which has since merged with another company to form Habit Labs, also based in Seattle.

FutureAdvisor is a Web-based software service for individual investors who want help maximizing their retirement savings, but don’t have enough money to get the attention of a traditional financial advisor who typically focuses on bigger fish—all the better to earn fees.

FutureAdvisor focuses on index investing, a growing trend that eschews professional mutual fund managers in favor of pegging investments to stock market indexes compiled by financial firms, like the S&P 500 or the Russell 1000. FutureAdvisor is still in a beta phase, but says it’s now able to offer services to employees at the 15 biggest companies in the greater Seattle area, with many more in the pipeline.

The company was founded by Bo Lu, 28, and Jon Xu, 32, who met while working at Microsoft on a “skunkworks” project called Catalyst, which eventually became part of the new Windows Phone system—Lu worked on the technology that would become the all-in-one social networking feature on Windows Phone 7, and Xu helped build the system that tied together instant messaging and text messaging.

Once they knew they worked well together, and felt they’d been bitten by the entrepreneurial bug after working on a 40-person team inside the behemoth of Microsoft, Xu and Lu ran through some side projects until hitting upon the idea that would become FutureAdvisor. It’s actually based on a problem that Lu, an active investor since the age of 16, had seen with friends: People wanted his advice on how to allocate their money, but didn’t have the time, patience, or acumen to keep up with the homemade spreadsheet he’d been using since he was a teen.

“Immediately, Jon and I were like, ‘That looks like a software problem,’” Lu says. “So we made something, and we applied to Y Combinator with a super-ghetto prototype that, at the time, had my Fidelity credentials in the code base.”

“But at least it was fast,” Xu says with a smile.

That was the spring of 2010, and the idea that would become FutureAdvisor was just taking off on its wild ride. Fast forward to today, with a team of eight people pretty evenly split between financial and technical expertise, working out of a historic building in Seattle’s Pioneer Square.

They’ve landed financial backing from Silicon Valley venture capitalists, although the amount and investors haven’t been publicly announced yet, and are advertising on social and professional networking sites to recruit more customers.

And they’re still working to add more companies to their database—a painstaking task that requires importing all of the retirement account options available to any given company’s employees, so that when new customers log in, their options show up automatically. (As they note below, FutureAdvisor recently added a big fish to the collection in their old employer, Microsoft.)

Here are Xu and Lu’s lessons from the first few months of living out in the wild.

BUILDING A BUSINESS
BO LU: ”You spend a lot of time in the incubator building a product … once you’re out of the incubator, you spend a lot of time on scalable economics. Which is not something that we as hackers ever did. So rather than staring at code all day, we felt like we stared a lot more at spreadsheets. How much it costs to acquire a customer, how would this channel do, and all of those things.”

HELP WANTED
JON XU: “Shortly after Y Combinator … we were faced with, ‘Well, do we come back here? What do we do? And I think we’d always thought that this was a good area to start a company, but also, more importantly, we knew our technical networks were pretty deep up here, having been from Microsoft.”

BO LU: “This is a unique vein of talent. And we found … after comparing notes with our batch-mates who stayed in the Bay, that it was easier for us to recruit here. We had a much higher accept rate of offers, and it just wasn’t as nuts. So over PG’s [Y Combinator founder Paul Graham] strident objections, we moved.”

JON XU: “Really, you’ve got to get down to actually building a team. Building a machine that generates the actual products.”

BO LU: “No one learns how to hire during the incubator. They all learn how to hire afterward. And they all learn it on their own. … And when you compare notes, some teams do really well and some teams do really, really poorly.”

HAND-TO-HAND COMBAT
JON XU: “A lot of times to get your business started, you need to do some hand-cranking. It’s not going to be a skyrocket all the way, but there’s definitely this grind of hand-cranking the engine to get it started.”

“Because we deal with retirement products, quite often it’s knowing what investment options are in people’s 401(k) plans. … So we’re hand-cranking, essentially company by company in the Seattle area, and we actually launched Microsoft—that was a big milestone for us.”

BO LU: “Every day’s just like every other day. You make your own progress, and you make your own headway. So there are great days, like when you launch to a new company, and there are not-so-great days, like when you launch to a new company and a bunch of bugs are discovered. So that’s where we are.”

STAYING CONNECTED
JON XU: “The way I’ve heard it put, from one of our friends who founded Posterous, was that quite often after the Y Combinator experience where you have such a deep network of like-minded entrepreneurs that you’re dealing with, you kind of go your separate ways to build your own teams, and you kind of have to establish a culture for your own team. So very much by design, you have to spend a lot of time building that up rather than being interconnected with various other companies.”

COMPETITION (OR NOT)
BO LU: “People are always like, ‘Oh, what’s it like competing against financial advisors?’ And the answer is, we don’t compete with financial advisors—financial advisors love us. Which I never thought—that was super-surprising.”

“We meet with a financial advisor, and they’re like ‘Oh my God, I wish that I could give some service to the people who come to me who don’t have enough money for decades. But I can’t do it, my friends won’t do it, no one will help these people, and so I end up doing pro bono work just to be nice and be part of the community.’ But he’s like, ‘Man, if somebody could help these guys cost-effectively, that would be awesome, because I don’t have a business model to do that with.’”

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The Northwest chapter of angel investment group Keiretsu Forum says its members invested $24 million in 36 companies last year, the highest total since the regional group was formed in 2005. And most of those investments—29 of the 36—were for businesses in the region, Keiretsu says. Nine of the investments were follow-on rounds, and 27 were new deals.

That’s a significant uptick from 2010, when Keiretsu reported just $8.9 million invested in 16 companies, an amount that was still billed at the time as “encouraging,” considering the ongoing economic turmoil. While the economy at large still hasn’t rebounded, technology ventures and angel investors are clearly seeing some optimistic signs.

One thing that stood out to me in perusing the statistics from Keiretsu was that a sizable chunk of these investments went to other investment funds, not startup companies—about half the money went into either real estate funds (38 percent, roughly $9 million) or alternative investment funds (11 percent, about $2.6 million). The rest broke down this way: Technology companies, 30 percent; consumer/retail, 16 percent; life sciences, 4 percent.

Keiretsu Forum Northwest—which encompasses the greater Seattle area along with Portland, OR and Boise, ID—has accounted for nearly $90 million in funding for about 150 companies since the regional chapter was founded in fall 2005. Chapter president Nathan McDonalds says 78 new members were added in the region during the last year.

Some of the Washington-based companies financed through Keiretsu included Atossa Genetics, Cadence Biomedical, NanoICE, and Valant Medical Solutions.

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Last week Steve Case wrote an op-ed in the Washington Post called “Give Entrepreneurs Room and They Will Grow the Economy.” For those not familiar with him, Case was the founding CEO of AOL and has been an active healthcare investor, among other things, for the past seven years. My firm, Psilos Group, has co-invested in a health company with with Case’s Revolution Health Fund.

Anyway, it was a very good editorial and one of the statistics within it particularly stood out to me in light of my venture capital role: firms less than five years old have produced 40 million American jobs over the past three decades—accounting for basically all of the net new jobs created in that period. That is a pretty stunning fact and also one that really makes a person scratch their head about current U.S. policy towards startups.  It is worth watching this Kauffman Foundation 3 minute video that is very instructive about start-ups and job creation.

Nowhere is this issue more relevant than in the healthcare industry, which conveniently happens to be the only thing I know anything about. In a world where there is no way out of the healthcare crisis except through the generation of new ideas to solve our healthcare problems, young companies are the golden ticket to new employment.

In his State of the Union speech last week, President Obama specifically stated that he wanted Congress to work with him to institute policies that advance research in medical devices, a field in which the U.S. has long been the leader. However, due to a combination of factors, including several government policies, we are now in peril of losing this supremacy to other nations like China and India. Research is nice, but tax and other policies that support the genesis of new companies and growth of existing ones are better right now in a world where medical device start-ups can’t catch a break. As AdvaMed President Stephen Ubl points out, the Patient Protection and Affordable Care Act (PPACA) imposes a $20 billion annual tax on the medical device industry to help cover the cost of health reform, and this new tax is already causing layoffs at large and small companies. FYI, the companies that sell branded drugs will also be hit with a $2.5 billion excise tax. Add these taxes to the challenges and costs presented by today’s FDA and it’s a toxic cocktail.

The small start-up companies that have answers to our healthcare challenges should be growing, not shrinking, but they are gasping for air in the current environment. I was in a board meeting at a medical device company just last week where we had a frank discussion about the R&D projects we would have to forego in order to cover this medical device tax, which is being imposed equally on large profitable and young unprofitable companies starting in 2014.

If healthcare startups are not allowed to thrive, I can assure you that the jobs in healthcare are not going to come from larger healthcare entities, either. The American Hospital Association has stated that anticipated reductions in Medicaid and Medicare funding and reimbursement will cost hospitals 278,000 jobs as revenue declines in these programs. The pharmaceutical industry has already laid off over 124,000 people in the last three years; expected further consolidation in this field isn’t going to help. The large medical device companies have also been shedding their staffs. It is the young upstarts that make the jobs appear.

As Steve Case clearly says in his op-ed, “America’s best chance to achieve robust, sustainable growth and prosperity is by ensuring that the United States increases its entrepreneurial competitiveness relative to the rest of the world.” There has been some activity in the form of a variety of bills supporting crowdsourcing of young companies (although that is a mixed bag, if you ask me), relaxed Sarbanes-Oxley rules to encourage smaller companies to go public, the StartUp Act, and others. But so far these are bills, not laws, and startups are having a hard time raising financing, particularly in a world where the IPO market is so compromised. It is worth noting, for instance, that in the last four years there were a total of nine medical device IPOs but in the four preceding years there were an average of 13 per year. In the pharma/biotech sector, a similar phenomenon: 26 IPOs in the last four years in total and an average of 21 per year in the prior three years. This is important because IPOs have traditionally given these young firms the capital to grow exponentially, creating many jobs in their wake.

Case refers to a great Thomas Edison quote in his Op-Ed that applies perfectly to the entrepreneur: “Vision without execution is hallucination.” Nothing could be more true, as I have seen hundreds of entrepreneurs over the years I have been a healthcare investor, and it is only those who have the gene for excellent execution that reach nirvana. I can’t say if the others are merely hallucinating, but I have my suspicions.

Edison’s quote applies equally well to our lawmakers, however, who are all running around saying “Jobs! Jobs! Jobs!” when they are not busy pointing out which Republican candidate is the true pillar of family values. Job creation can be the byproduct of these lawmakers’ endeavors but … Next Page »

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They say the first casualty of war is the truth. Based upon recent events in the U.S. presidential elections, it looks like the truth is a casualty in politics as well. Whether out of desperation, ignorance, or political convenience, current and former contenders for the Republican presidential nomination have been questioning the long-term economic value of venture capital and private equity, which has been wrongly and unfairly labeled “vulture capitalism.”

First, let’s be clear. Venture capital and private equity—while related in that they both involve pools of private capital striving to generate returns for their investors (typically non-profit pension funds, foundations and university endowments)—follow very different approaches in achieving their goals. But neither seeks to undermine employees. In fact, venture capital typically creates jobs over the long term and private equity minimizes job losses.

Venture capital—a key component of the financial foundation for Silicon Valley—is focused on leveraging creative talent, capital, the hard work of employees and entrepreneurial experience to create and grow new businesses based on disruptive ideas. When successful, new businesses and industries are the result—creating new jobs for employees and wealth for investors and contributing to the competitive posture of America. When unsuccessful, the venture capital investors involved and their employee partners bear the costs of the failed effort. There are no government bailouts here—unless the politicians become involved a la Solyndra, the clean tech startup that fell into bankruptcy despite a $535 million federal loan guarantee. A situation like Solyndra is rare, however.

Venture capitalists and entrepreneurs don’t always win in the marketplace, but they don’t quit, either. In many instances, the same investors and talented engineers who failed will form new teams and pursue new dreams—always looking to create value and opportunity from ideas. The innovation flywheel is often successful and very lucrative: According to a 2011 Global Insight study, venture-backed companies accounted for 11.9 million jobs (11 percent of U.S. private sector employment) and $3.1 trillion in revenue in the U.S. in 2010—21 percent of the total US GDP–all based on an annual investment equal to less than 0.2 percent of GDP.

By and large, these are jobs at the higher end of the spectrum with solid, innovative companies—and often those that become global industry leaders, such as Intel, Apple, Google, Genentech, Facebook, Twitter, to name but a few. Ironically, while countries around the world are replicating the U.S. venture capital model and working overtime to encourage innovation and support venture capital ecosystems, U.S. politicos, themselves devoid of any new or creative ideas, have chosen to attack the engine of U.S. technology leadership.

Private equity also plays an important, though different, role in the U.S. economy. It builds and restores established but usually faltering companies. While colorful robber baron images of Gordon Gekko, acquiring functional businesses and breaking them apart for pure financial gain, may still be a popular reference point in today’s media, it is an inaccurate analogy in the vast majority of cases. Like venture capital investors, most private equity investors are paid for building real value, for themselves and their investors, not simply to make a quick buck. They do this by investing in under-performing companies, often in or on the verge of insolvency, in hopes of … Next Page »

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For all of you who’ve felt like cloud computing is some kind of foreign territory that you might never visit or fully understand, take heart. Ignition Partners managing director Frank Artale, who specializes in the sector, says everyone else has spent most of the past two years just figuring out what in the hell is going on.

“2011 really rounded out the year of the transition in terms of cloud computing from ‘What is it?’ to ‘How do I do it?’ Artale says. “2012 and beyond … is really, ‘Now I know what this is. I know how to do it. So what are the first projects?’”

That’s where the venture capitalist, who led a rapid-fire series of investments upon joining the Bellevue-based firm last year, sees the next round of opportunities in cloud computing.

Frank Artale

For me and you, that could mean some tangible benefits, as application developers start putting to use assets like the cloud-based database infrastructure that’s been building up over the past few years.

There are some obvious areas where this will probably be brought to bear first—finance and healthcare, two industry “verticals” that draw lots of money and produce or track tons of data.

Artale says the less obvious applications, ones that will be more apparent to the wider business world, might include some powerful ways of pulling together knowledge and expertise. As I prepare for my next story, for example, maybe I’d send an e-mail to other people at Xconomy to help generate a list of smart questions or good sources. But a smart software service might be able to extract data from contact lists, old stories, and other sources to give me a head start on my research (without pestering everyone with yet another e-mail).

“I think the investments in the infrastructure—those bets have been placed. Now you’ll start seeing bets on companies taking advantage of this,” Artale says. “You don’t see too many people talking about the applications yet. The noise, the buzz is still around the infrastructure itself.”

“I also believe that in this year, and also into 2013, we’ll see a more general acceptance of platforms as a service,” Artale says, pointing to the Ignition portfolio company AppFog as an example. “The bets are largely being placed right now in various platform as a service startups.”

You probably won’t see quite as many investments from Artale himself this year—he had his six main 2011 deals on a list from existing relationships when he joined Ignition, and ticked those off once he got going. Exceptions included AppFog, which was a new relationship, and Cloudera, a big deal that he called an “upside surprise” for Ignition.

When they do come, Artale says the deals he’s involved in for 2012 might be earlier in the lifespan of startups, depending on which fund the money is drawn from. “Ignition IV is an older fund,” Artale says, which means his deals were trending toward Series B or later in some cases last year. “We’ll start investing out a of a new fund sometime in 2012, and I’ll probably favor more early (deals) at that time.”

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Seattle’s Madrona Venture Group, known as one of the earliest backers of Amazon.com, is promoting partners Scott Jacobson, Len Jordan, and Tim Porter to managing director.

In a release, the firm says the trio led six of Madrona’s 14 investments in 2011, including deals with B.C.-based suit-maker Indochino, and Oregon-based cloud-computing companies AppFog and Cedexis.

Madrona is investing from its $250 million fourth fund, which was raised in 2008, and manages more than $650 million. Madrona says all but one of its investments in 2011 were based Seattle, Vancouver, or Portland. Madrona also notes that it seeded five companies in 2011, four of which were incubated at the firm’s offices.

Jacobson, Jordan, and Porter join Tom Alberg, Paul Goodrich, Greg Gottesman, Brian McAndrews, and Matt McIlwain as managing directors. The three new appointments all have roots at the Seattle area’s biggest tech companies.

Jacobson worked at Amazon.com, including on the Kindle project, before joining Madrona in 2007. Jordan previously was a general partner at Frazier Technology Ventures, and before that was a senior vice president at RealNetworks. Porter previously worked in corporate development for Microsoft, handling acquisitions and investments.

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Josh Felser has three kids. Dave Samuel has four. You won’t hear any highfalutin business-speak from these former tech entrepreneurs about why they started Freestyle Capital, their San Francisco-based seed-stage investing fund. They say they did it because they recognized that it’s pretty hard to create a business and be an involved parent at the same time.

“If we could balance the lifestyle of being a founder/CEO with having large families, we would likely still be entrepreneurs,” says Felser. “But we can’t, so this is the next best thing.”

Felser and Samuel started building companies together 14 years ago, and in one sense that’s what they’re still doing: Freestyle is known as a hands-on fund where startups get recruiting, public relations, and business-development help, as well as cash, in return for their equity. But what gave them the flexibility to become investors, rather than starting over as entrepreneurs once more, was a pair of healthy exits. The Internet music service Spinner, which they co-founded in 1997, was acquired by AOL Time Warner in 1999 for $320 million. Their next venture, the video network Grouper, was acquired by Sony in 2006 for $65 million in cash. (It’s now known as Crackle.)

The pair got back together to start Freestyle in 2009. After a two-year shakedown run in which they invested only out of their own pockets, they’ve now raised $27 million, and have completed 29 investments averaging about $500,000 each. They get investing help from a trio of startup veterans, including Joe Stump, the former lead architect at Digg and the co-founder of SimpleGeo; Lane Becker, the co-founder of Adaptive Path and Get Satisfaction; and David Bill, a veteran of Spinner and the ex-CTO of CoTweet.

For rookie investors, this team has a pretty good batting average: already, seven of the Freestyle portfolio companies—About.me, Backtype, Cardpool, CoTweet, Indextank, SimpleGeo, and Typekit—have been acquired.

I’ve seen Freestyle’s name turn up in so many interesting seed-stage deals since I got to San Francisco that I wanted to meet Felser and Samuel in person and hear their whole story. I visited their Mission District office—which doubles as the headquarters of Typekit, now part of Adobe—back in November. Felser introduced himself as “the talky one” while Samuel is supposedly “the quiet one,” but to be honest, I didn’t notice much difference. In any case, what follows is a compressed version of our conversation.

Xconomy: Is it really easier to be an investor than a founder? How are your lives different now?

Josh Felser: Venture investing is a way to be close to entrepreneurs and have a family without being an entrepreneur or starting a business. We have complete flexibility about work location. As a founding CEO, you have to set the culture and tone in the office, and there is no way to do that, that we have figured out, and to spend time with our young kids. Being an investor, I am still working as hard as I did as an entrepreneur, but I can do it from anywhere. I can go online from home at 8:00 pm and work until midnight.

Dave Samuel: I think that’s definitely true about the lifestyle, but there is also a little bit of ADD in each of us. We are able to have our hands in a bunch of different, great companies. Josh is in charge of five companies per year and I am in charge of five. So we are able to leverage our experience and background across numerous companies.

JF: We sat back and said, ‘What can I do with my life that would at least let me have dinner with my family, and also be part of creating really interesting, world-changing companies.’ There aren’t actually many opportunities to do that, if you try to put those things together. Early stage investing was the best fit.

For the first two years, we were just investing our own money, to make sure we liked it, and we didn’t try to run those companies. We were decent at it, and we were able to check off a lot of the boxes and then raise a larger fund of other people’s money.

X: Why do seed-stage investing? Why not become partners at established venture firms?

JF: You don’t ever stop being an entrepreneur. We enjoy helping entrepreneurs like us get their businesses off the ground. If you are doing the kind of seed investing we strive to do, you are … Next Page »

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Even though our local economy is far from strong, I am pleased to report that at the Northwest Energy Angels, we continue to see and invest in interesting deals across the spectrum of clean technologies.

In the past year, we’ve seen and closed deals in virtually every segment of the cleantech industry, including more efficient lighting, purer water technologies, and more productive renewable energy. Contrary to the popular press, our shrewd entrepreneurs are doing it with little reliance on special subsidies or government funding.

For 2012, there are several trends that I expect to see emerge and develop in these segments (borrowing the category definitions from the Cleantech Open):

Air, Water, and Waste
For the last few decades we have been wrestling with the need to develop alternatives to fossil fuel reliance and are now clearly on a path to consider water and its shortages in a similar vein. In many respects, the clean water segment is where the energy industry was a couple of decades ago. We will continue to see companies looking to develop ways to use water more efficiently, measure water and its cleanliness more precisely and cost-effectively, and recoup water that was previously thought unusable.

Domestically, vigilance in air quality makes opportunities for dramatic improvement difficult. Obviously, carbon dioxide emissions are a huge exception to this, but uncertainty over government mandates and/or incentives will make CO2 control a market that startups will have a hard time making a dent in.

The area of waste will continue to offer a wide variety of disparate, but valuable opportunities as cost of disposal and potential value of the refuse continues to be recognized.

Energy Efficiency
The Pacific Northwest has been blessed and cursed in this segment. The ethic of the region is very pro-conservation but our energy costs are among the lowest of any region, which gives priority to other faster-paying investments in this economy. As we look at efficiency technologies, the key questions are, first, will it sell in California (and elsewhere) and second, is there any way for a local company to deploy, test and further develop its technology for commercial roll out?

Given recent predictions for climbing energy costs, the second question is most often the decider for investor involvement. As I’ll explain below, I see a very positive trend here and am bullish on this sector for our local companies for the first time in a long while.

Green Building
As in the case of efficiency, our region enjoys quick consideration for new green building products here and enthusiasm for early winners. Status quo materials and practices are, unlike our energy, on par cost-wise with the nation, giving local solution providers an excellent chance to gain early market traction.

Renewable Energy
This segment of the cleantech world is seeing the biggest changes. The sunsetting of many U.S. government incentives is causing entrepreneurs to rethink their prospects. Opportunities will continue for those companies that have a “mine the miners” strategy to help established renewable energy equipment manufacturers to improve their product offerings—especially when products are aimed at the world market, which is expected to see much less retrenchment in 2012.

One area of exception to the slowdown is renewable transportation fuels, aviation fuels in particular. Our region has a leg up with Boeing and military interest in the subject as well as the nation’s largest operating biodiesel producer, Imperium Renewables. While it won’t be built overnight, I do see more and more opportunities for companies that can contribute to the success of this industry.

Smart Power, Green Grid, and Energy Storage
The Smart Power, Green Grid, and Energy Storage category encourages links between information technologies and electricity delivery that give customers greater control over when and how their energy is delivered and used.

In many regards, startups in this space have a chicken-and-egg problem: Utilities and regulators want to see products before using these new technologies at scale, while startup companies (and their investors) want to see buyers ready to write checks before gearing up for production.

Our region is rich in the technologies needed to implement the smart grid and its cousins—we have a tradition of progressive utilities that have implemented its precursors. But I remain skeptical of a fast market uptake in 2012.

Our Secret Weapon
Military installations. The local cleantech community has been sought out by representatives of the Navy (Naval Base Everett) and the Army/Air Force (Joint Base Lewis-McChord) to help them achieve some truly remarkable sustainability goals for waste, water, and energy.

Don’t get me wrong—this isn’t to say that the procurement floodgates have opened. They haven’t. The military is on a downward budget trend and they know it. But what they do have is a long view and a willingness to invest in projects that will pay off over a longer term than most homeowners or businesses would.

These military installations capture a complete subset of our local economy: industrial operations, commercial/office buildings, residences, and more. In some cases there are also financial partners who will step in alongside military sustainability initiatives, to provide funding where others wouldn’t.

Perhaps most importantly for our entrepreneurs, these bases are looking for good, early commercial products to test, demonstrate and embrace to achieve their goals.

The Road Ahead
While I don’t think that cleantech is in for any 1990′s-style boom, I do think we will continue to see a wide variety of clever entrepreneurs with great market insights and technological breakthroughs in 2012. And the Northwest Energy Angels will continue to be ready, willing, and able to fund them.

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[Editor's Note: We asked selected Xconomists a series of questions designed to zero in on the big issues of the year, including "What would you be willing to throw a punch over?"]

What would I be willing to throw a punch over? Solving the small-cap IPO bottleneck … to unleash the job creating potential of emerging growth companies.

For more than 25 years, America’s entrepreneurs have benefited from a capital system that has uniquely supported their independence and innovation. Once they had developed their products using private capital, emerging growth companies could capture markets or invent wholly new ones by accessing public capital to continue their growth and compete successfully across the globe. High-growth companies that go public create more jobs, generate more revenues in the U.S., and grow at a faster pace than their public peers.

But because the hurdles and costs of going public are higher today than ever, more and more companies delay or cancel their plans to go public. In fact, most turn to being acquired—a job killer in the short run as redundant positions are eliminated. If you look at the number of venture-backed company IPOs as a proxy for all small, high growth companies, there was a 75 percent decrease in IPOs between the last two decades. The result is a dangerously threatened ecosystem that is delivering fewer jobs, creating less wealth, and delivering lower tax revenue. Like any healthy ecosystem, the American economy needs new companies and competitors to continue a prosperous cycle of growth and replenishment.

So how are we starving this engine of growth that has served the U.S. economy for decades?

Over the last 15 years, market regulations intended for large public companies have disproportionately impacted emerging growth companies—those very same companies that deliver the job growth our economy so desperately needs. For example, accounting scandals from massive public companies like Enron, Tyco and WorldCom forced legislators and regulators to respond with an understandable “never again” approach. However, the accounting and reporting compliance designed for the complex accounting structures of large conglomerates like these are not scaled to fit newly public companies.

But it’s not just recent legislation that has impacted the growing companies of the innovation economy. Truth is, the bulk of financial market regulation that guides public companies today was created before the computer had been commercialized or the polio vaccine invented. These rules and requirements should simply be … Next Page »

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It’s one of the most nagging questions for Seattle-area technology entrepreneurs: How do you get more of the region’s tech wealth invested in local startups? Business veteran John Sechrest sees a possible answer in Oregon, where investors have created a series of events that help get newbie angels into the game.

He’s hoping to replicate that model with an event called the Seattle Angel Conference.

The project is still in the very early stages—when I talked to Sechrest over coffee this week, he was heading to the first organizing meeting of 10 or so people interested in working on the project. But he’s no rookie with the idea, having already organized the Willamette Angel Conference when he worked in Corvallis, OR.

“If you listen closely to Seattle, Seattle has the opportunity to pop like the Bay Area popped. It really feels like something’s happening here,” says Sechrest, currently serving as an advisor and organizer for Startup Weekend. “Just a little more push on it, and maybe we can make it go.”

John Sechrest

The Puget Sound region does already have established groups for angel investors, such as the Alliance of Angels, the Keiretsu Forum, and Zino Society.

Sechrest, whose resume includes an early stint at Hewlett-Packard and the spin-out of an Internet service provider from Oregon State University, says those groups do a great job. His pitch is that adding a new initiative—particularly if it’s focused on recruiting new angels—can only help make the community more robust.

“If we’re going to double the number of successful exits in Seattle, what has to happen? Somebody has to put more money into the puzzle,” he says.

The Angel Conference model from Oregon is fairly straightforward: A group of investors each contribute a small stake—about $5,000. That serves as the “prize” pool for entrepreneurs, who enter the conference’s multi-month winnowing process for a chance to pitch as finalists. In the end, a winner gets the collective investment.

Like other competitions of this kind, the Angel Conference model runs competing startups through their paces with weeks of due diligence and preparation, to ensure the finalists are worth getting a chance at the investment.

Sechrest says the combination of a low dollar amount and weeks of engagement with entrepreneurs and other investors helps foster fledgling angels who might not know a whole lot about the system of selecting and backing early stage companies.

“In Corvallis, we were able to get a significant number of H-P middle managers to invest, and they did fine and now are active angel investors,” Sechrest says. There are similar Angel Conferences in several other cities in Oregon, where they’ve been running for several years.

The lack of early stage investors involved in the Seattle tech scene is a longstanding gripe in the region, especially given the amount of tech-based wealth. Economist Dick Conway once estimated that the number of “Microsoft millionaires” created in the region by 2000 might be around 10,000. But experienced investors and entrepreneurs say you wouldn’t necessarily know it by their impact on startups.

Chris DeVore of Founder’s Co-op recently wrote that if he could “wave a magic wand and change one thing about our local community, it would be to turn every Microsoft and Amazon alum who walked away with at least $5 million in personal net worth into an angel investor.”

“Paradoxically, because the vast entrepreneurial wealth Seattleites enjoy today was created by just a few massively successful companies, too little of that wealth is being recycled in the next generation of local entrepreneurs,” DeVore wrote. “And with fewer dollars flowing into the local innovation economy, the odds of the next Microsoft or Amazon emerging in the region are that much lower.”

After the recent TechStars Demo Day in Seattle, entrepreneur, investor, and former Microsoft executive Charlie Kindel wrote that “I personally can think of 30 or 40 people who I worked with at Microsoft who should have been there, but probably didn’t even know about it. They probably can’t even spell angel.”

“Early stage startups looking for seed money (e.g. $100-200k) are having to seek out angels in other cities,” Kindel wrote. “This makes no sense to me given Seattle’s economic base. I believe the population of people in the Seattle area who could be involved is much, much larger than those currently engaged.”

Kindel is among the Seattle investors who are interested in making a Seattle Angel Conference happen. Sechrest says if there’s enough interest to get a solid group of investors together in January, the goal is to have the pitch competition at the end of May.

“I’m now into the next phase to find out whether or not I can get to a reasonable number of investors,” he says. “I’ll run this if I have 20, but I’d like to have 40 because I’d like to have the prize be $200,000.”

If Sechrest is right about the Oregon approach enticing more wannabe angels off the sidelines, you’ll probably be reading about the newest Seattle-area pitch competition a few months from now. If not, one of Seattle’s biggest gripes about itself might get a little louder.

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Seattle-based venture firm Voyager Capital is raising a new fund pegged at up to $125 million, according to a new filing with federal regulators. The VC firm, which also has offices in Portland and Silicon Valley, finished raising its last fund in 2007 at $107 million. Notable investments from that fund included Ontela, which acquired Photobucket, and Yapta, an online travel service.

Voyager officials didn’t immediately respond to messages seeking comment, but that’s not unusual, since VCs try to avoid the ire of regulators while they’re out looking for cash. It will be interesting to see how Voyager fares in raising this fund, which is its fourth, as the continuing economic downturn and somewhat spotty market for technology IPOs have left VCs feeling pinched recently.

The broader VC sector has also seen consolidation nationally, with fewer firms raising capital. And in Seattle, we’ve seen some decline in VCs overall, with Polaris Venture Partners closing up its Seattle office this summer in favor of a Palo Alto, CA office.

Voyager focuses on clean IT, digital media, software, and wireless—here’s the full list of its portfolio companies. Its most notable exit over the years is probably aQuantive, which was acquired by Microsoft for $6.4 billion in 2007. Voyager’s managing directors are Bill McAleer and Enrique Godreau III in Seattle, Erik Benson in Seattle and Portland, and Daniel H. Ahn and Curtis Feeny in Menlo Park, CA.

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Will the startup accelerator model that’s proved so popular and successful in the Web and mobile sectors also help to boost entrepreneurship in other industries, such as healthcare and cleantech? In a tottering economy that needs all the job-creating companies it can get, that’s a crucial question. And here in the Bay Area, it’s been getting a thorough test this year.

Back in August I reported on the first class of 13 startups graduating from Rock Health, a new health-tech incubator with offices in San Francisco’s Chinatown. In just five months, the startups came up with a dazzling array of products and services, ranging from diabetes-prevention programs to iPad fitness training to meditation aids. I won’t be surprised if several of these Rock Health alums strike it rich.

Just as Rock Health was winding down, another new accelerator, Greenstart, was getting underway a few blocks down the hill, in San Francisco’s Financial District. Greenstart invests in cleantech companies, with the goal of promoting renewable-energy technologies and reducing the nation’s carbon footprint. Four companies participated in Greenstart’s inaugural 12-week session, and yesterday they made their formal “demo day” pitches to investors (though one of them, Tenrehte, didn’t need the money—it had just signed a Series A term sheet with unnamed venture investors).

Greenstart's Demo Day session ended with a networking party. At far left: Tenrehte founder and CEO Jennifer Indovina.

Once again, I was impressed by all that these companies had accomplished. Their founders gave polished presentations, and seemed to have a solid grasp on the potential markets for their products, which include self-tinting windows (SmarterShade), an inexpensive way to mix biofuels with diesel fuel (Sylvatex), an online game designed to heighten consumers’ awareness of their energy consumption (Wa.tt), and a wireless system for managing the energy flowing through electrical plugs (Tenrehte).

So while the sample size is still small, there’s starting to be some evidence that accelerators are effective, even in slow-moving fields like healthcare and energy.

That definitely wasn’t a foregone conclusion. The most famous tech accelerators, such as Y Combinator, TechStars, AngelPad, and 500 Startups, are able to churn out dozens of promising new companies every year in part because their canvas is generally limited to the Internet and the world of Internet-connected devices. In that realm, a magic confluence of infrastructure components such as open source software, cloud computing, and app marketplaces has made it drastically easier and cheaper to start new companies. The healthcare and energy industries, by contrast, are about as Neolithic as they come. Software and the Internet are only beginning to have a real impact in these businesses. More money is at stake, the big players are far more deeply entrenched, and getting a new product to market means negotiating a daunting maze of existing supplier-customer relationships.

Rock Health and Greenstart have both found formulas that help get their companies off to a strong start despite the long odds against them. One of Rock Health’s main techniques is to avoid a frontal assault on the healthcare system, and instead deploy companies building various health-related Internet and mobile products to nibble around the edges. (Blueprint Health, a new accelerator in New York, is adopting a similar strategy, but with a focus on enterprise software rather than consumer products.)

Greenstart’s key tactic, I gathered from attending yesterday’s event, is slightly different. It aims to succeed mainly by … Next Page »

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I read the book and found it quite enjoyable.

And with all due respect to Eric Ries and all of the VCs out there chasing lean startups, I recognized one simple truth. I still like my startups Phat.

A phat startup aims to solve a very big, very difficult problem that will transform an industry. They typically take many millions, or even tens of millions and 1-3 years to get the first product out the door. They are big ambitious bets on deep technology and market transitions that are difficult to predict. They require invention and problem solving and risk, yes risk. They are a venture in the true sense of the word.

But my goal is not to dismiss the good ideas in the Lean Startup bible. There are many, but some simply don’t apply.

For example, in Phat startups, the challenge is not whether customers will want it (or whether you need to pivot or iterate or some other euphemism). The challenge is whether it can be built in the first place—will it work at all? Will it perform to spec? Will it scale? Will it be reliable? Can it be manufactured? Will it hit the price point?

Very frequently, the last question is whether customers will buy it. I know this sounds “unconventional” and decidedly old-school, but in many of these cases, if you CAN build it, they WILL come.

Why? Because phat startups often address problems that simply can’t be solved any other way, and customers are in dire need of solutions—from cancer treatments to robots for bomb disposal to switches capable of handing exponential growth in mobile data.

And that’s why, once the product is proven, phat startups have been many of our region’s, and our country’s fastest growing and biggest winners. All of these were $1B market cap companies:

*These are my estimates based on VentureSource.

And there’s a new generation of New England companies following in their footsteps:

Demandware (on-demand e-commerce), QD Vision (display color enhancement), 24M (grid storage), 1366 (direct solar wafer), Plexxi (10 GB networks), Affirmed (4G Mobile), Actifio (secondary storage), Qualtre (smartphone components), Xtalic (electronic components), Akiban (scale out databases).

But a key question comes to mind: Are phat startups riskier than lean startups? It depends how you measure risk.

One of the great virtues of lean startups is that they … Next Page »

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“Yeah, I love being famous. It’s almost like being white, y’know?”-Chris Rock

On Monday, November 21, the National Venture Capital Association and Dow Jones VentureSource released the results of the 2011 Venture Census, which reported statistics about ethnicity, gender and other characteristics of the venture capital industry garnered from a poll that included 600 VC industry participants. Not surprisingly, the census reaffirmed what most of us already knew: it’s good to be a white male.

Of the total 600 respondents, 87 percent were Caucasian, 9 percent were Asian, 2 percent were African American or Latino, and 2 percent were of mixed race. This is pretty much exactly the same as when the survey was done in 2008, when 88 percent were white guys.

The only thing worse than being non-white when it comes to your chances of getting a VC job is being female. While 79 percent of the survey respondents were male and 21 percent were female, it’s a misleading figure since so many of the women respondents were not in true investment roles. According to the NVCA, of those who identified themselves as investors, 89 percent were male and 11 percent were female. This is actually worse than the 2008 census, when 86 percent of investors were male and 14 percent were female (the NVCA notes that the measurements in the two years were done slightly differently). I am not surprised to see this decline, because we have seen a major contraction in the VC industry over the last three years. Women were last to the party and thus they are pretty much the first out the door when the jobs go away.

Similarly, the people lower on the totem pole tend to lose their jobs first when money gets tight, so that doesn’t bode well for the next generation looking any less like a day at the Polo Fields. It is worth noting that among NVCA census respondents there were far more women among people under 30 years of age (28 percent) than among people in their 40s and 50s (22 percent); additionally, there were far more people of color among those with less than 5 years in the field (23 percent vs. 13 percent overall). In fact it appears to be a straight-line correlation between newness to field/youth and the chance one might be female or of a non-Caucasian ethnicity. Of course, the younger the person the more likely they are to hold a junior role in a firm. Thus, if the ongoing industry contraction takes with it the XX chromosomes and the people with pigment on the theory of last in first out, the future of our field is going to continue to feel a great kinship to Caspar the Ghost: male, white and flying high.

One of the most interesting statistics in the census, in my opinion, is that 49 percent of respondents, when asked where they expect to be in five years, expect to be at the same firm in the same role, while 16 percent expect to be at the same firm in a new role. If you read my post from last week entitled, “Hey, Where is Everybody Going?” you know that, at least in the life sciences sector of the venture world, venture capital jobs are not as secure as they used to be. Look at it this way: there were 462 active US venture capital firms, defined as investing at least $5 million in companies, in 2010. This compares with 1,022 venture firms in 2000. If you define the universe of US venture capital firms as those raising money in any of the last 8 years, the 2010 count was 791, according to NVCA.

However you slice it, there are fewer chairs at the table now then there have been in the past. I would think that this would make venture capitalists pretty paranoid. Note to self on the next great investment opportunity: a company that treats the sore necks of VCs who spend lots of time looking over their own shoulders to see if someone is coming to get them. It may be a small market, but it’s becoming a chronic condition, thus a recurring revenue model.

A last note from the census: despite the fame and fortune garnered by the VCs who have made their names investing in social networking/social media businesses, use of these modes of communication are a mixed bag. Of the 600 respondents, 62 percent use Facebook and just 30 percent use Twitter, although 85 percent use LinkedIn (job search anyone?). Only 33 percent report that they read blogs and only 11 percent report writing blogs (I am actually aware of only 2 or 3 other women VC blog writers).

So to those 33 percent of my colleagues that actually might see this post, it would be interesting to hear your thoughts on the NVCA venture census. Do you think our field will look more diverse 10 years from now or just the same? Will there be more women and minorities or fewer? What do you think it will it take for the venture capital field to look less like Maroon 5 and more like the Black Eyed Peas? And most importantly, who wants in on my sore neck deal?

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It’s that time of year: annual investor meetings for limited partners (LPs). LPs are the people who fund venture firms and the general partners (GPs) are the people who lead them. At these meetings, LPs pour over general partners’ (GPs’) reports, calculate TVPI (total value: paid in)/ IRR (internal rate of return), digest confidential past results, test the waters on new funds, jockey themselves into better funds, and mentor their investor base as to what is new and emerging.

I am getting invited as a VC into these pretty special LP meetings for my work in doing entrepreneur lead generation. Perhaps some LPs see my work with pre-entrepreneurs as innovative. There have been zero other VCs in attendance at the LP meetings I have gone to. Basically, I am special because LPs liked my ideas, liked my silly fund name and liked my investment theory based on a conference they met me at: Venture Alpha. My invites all came from doing well at that one conference where I crashed one CS major in (Cory Levy, CEO of ONE) and hugged one CS major who was the Venture Alpha keynote (Aaron Levie, CEO of Box.net). In the same way you do credit card application lead generation for a 19-year-old junior who eventually takes out a loan to buy a car at age 26, you also lead-gen 26-year-old CS major CEOs by finding them when they are 19. That’s the pattern that LPs recognize that I am attempting to replicate.

But I am only in my third week of being a VC, so it is still very weird to be a fly on the wall at LP investor meetings. The meetings are extremely exclusive. And comprehensive. LPs drill down into the details of their specific VC funds—it’s all information the public almost never sees. While I listened, it hit me that the VC model is not broken. Silicon Valley is cyclical. LPs know VCs need to find a whopper of an IPO within every fund to meet TVPI goals and IRR goals (internal rate of return). But getting there is a numbers game. How many entrepreneurs, founders, CS majors, developers, pre-entrepreneurs are in your VC firm’s lead-gen funnel? Saying “deal flow is everything” does not put a concrete, executable plan into motion. I argue it paralyzes.

That led me to think up a few questions that LPs at these meetings should be asking their GPs—but don’t seem to.

1. What does playing Moneyball mean to your firm?

There is one right answer.

Your firm had better be building a massive farm system of IPO potential. We all might have zero clue about which firms will eventually go public, but the key is to have a specific, distinct, transparent, tactical, granular, measurable farm program in place. That takes massive work. Executing Moneyball is about generating a large pool of talent, and making that large pool of talent more talented.

VCs have gone on record at public events talking about Moneyball. They have cited the OBP stat. The “on-base-percentage” statistic does not have an equivalent in VC investing. (It is also inherently obvious that none of those VCs who poo-pooed the Moneyball concept ever read the book or saw the movie.)

VCs who actually have read the book include Roelof Botha. He even recommended the book in public at MJAA conference in 2006 , around the time he invested in YouTube. In short, the data analysis part of the Moneyball concept is not the nugget of knowledge…It is the work that scouts now must do to develop massive and specific entrepreneur farm systems.

From the movie: “Every at bat is like a hand of blackjack played in a casino where your odds massively change based on each pitch dealt.” That has applications for farm team member mentorship and development. I want my fund to have entrepreneurs batting during 3-ball, no strike counts. Getting to a 3-0 count is more likely when you execute 2 to 7 guacamole recipes for entrepreneurship.

2. What matters more in how you recruit and develop venture staff: entrepreneurial experience or operations experience?

The answer I’d be looking for is entrepreneurial experience. You don’t have to have a team made entirely of former founders, like Founders Fund or True Ventures. But what experience do your GPs have as entrepreneurs, besides roping your one LP that launched Fund Uno?

3. How are you using board seats to generate leads and wedge your fund into the best deals?

The old way was to match an emerging hot portfolio company with sexy brand name partner at your firm. The partner or principal who sourced the deal might get … Next Page »

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If you are simply reading the paper or engaging in any random cocktail party conversation these days, it doesn’t take long before you are reading or talking about healthcare. Health and healthcare issues have been a dominant topic in the national media since the 2008 Presidential election and have been constantly in the news as the Patient Protection and Affordable Care Act (PPACA) has taken center stage. Even if PPACA weren’t always in the headlines, stories about employers who are grasping for solutions to their healthcare cost crises would still be.

Given the massive amount of change currently underway in the U.S. healthcare economy that has resulted from PPACA, the earlier healthcare IT stimulus legislation (ARRA) and the acts of employers saying that they’re mad as hell and not going to take it anymore, we have bona fide industry upheaval on our hands. And where there is upheaval, there is opportunity. Today more than ever there is a tremendous opportunity to find new ways of doing business in the world of healthcare through changing delivery systems, insurance models, technology solutions, drug discovery, device innovation and just about everything else that takes place in the healthcare system. Never before has there been so much energy and so much necessity to produce innovation in our field.

So given this, why are venture capitalists in the healthcare field fleeing like female co-workers from Herman Cain? Historically the source of funding for so much innovation and employment in the healthcare field, venture capitalists with lengthy histories funding the drug, device, service and IT companies of tomorrow are picking up their marbles and going home. Last guy out turn out the lights.

Last week the National Venture Capital Association (NVCA) said the following in their blog:

“…today we can say officially that we are seeing an alarming trend in the area of life sciences investing with the announcement that Scale Venture Partners will cease healthcare investing permanently. This exit follows the announcement last week that long time, established funds Morgenthaler and Advanced Technology Ventures would be effectively spinning out their healthcare investment practices and the announcement just over a month ago that Prospect Ventures would not raise a fourth healthcare fund and return committed capital to limited partners.”

What they didn’t include in their article were the additional facts that Highland Capital Partners recently decided to cut back its healthcare practice, CMEA Ventures has decided to make no more medical device investments and that Versant Ventures appears to be on the verge of reducing its healthcare practice if the industry buzz is correct. There are rumors afoot that a slew of others firms on Sand Hill Road are in the process of divesting themselves of their healthcare practices and there are several others that I know for sure already have taken steps in this direction but have not yet announced it formally.

To add to the pile, the NVCA released a report in October called Vital Signs. The report documents a survey that found that U.S. venture capital firms have been decreasing their investment in biopharmaceutical and medical device companies over the past three years and are planning to decrease their commitments to these areas even more. 39 percent of the 150 firms surveyed report decreasing their investments in life sciences companies over the last three years and the same percentage expect to further decrease these investments over the next three years, some by greater than 30 percent. According to NVCA, this is twice the number of firms that plan to increase healthcare investments.

Given this, I suppose the mass extinction we are now watching is predictable, if sad. It is certainly possible there was too much capital chasing healthcare deals, but now we are likely to swing too far in the other direction. Also, … Next Page »

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Yesterday’s announcement by Scale Venture Partners that it will make no new investments in healthcare companies may not have come as a huge surprise to some insiders. Kate Mitchell, a founder and managing director at the firm, says ScaleVP has been pondering the shift for two or three years, and that it effectively stopped investing in the life sciences a while ago. “It was known to people who know us,” Mitchell says. But now that the shift is public, she says, the firm and its life sciences partners Lou Bock and Mark Brooks will have an easier time taking part in discussions about what ails the biotech industry.

The ailments are many, but if they had a single name, it would be the Food and Drug Administration, in Mitchell’s view. When I reached her by phone yesterday and asked her to elaborate on yesterday’s announcement, Mitchell returned over and over to what she called the FDA’s “capriciousness” when it comes to reviewing clinical trial results. In the post-Vioxx years, she says, the FDA’s approval process for new drugs has grown so drawn-out and unpredictable that ScaleVP can no longer, in good conscience, ask its limited partners to risk new money on drug development deals. (She says the company will fully back the healthcare firms already in its portfolio, however.)

ScaleVP’s announcement did not go unnoticed in Washington. Mitchell (an Xconomist) says several members of Congress called her for more information yesterday after the announcement appeared—and she was happy to share a piece of her mind with them. “I hate to have ScaleVP be the sacrificial lamb, because I believe in this sector,” she says. “But if we can use this, we are going to.”

An edited version of our phone chat follows.

Xconomy: This must have been a difficult decision. Can you tell me how it came about?

Kate Mitchell: We have a very open and close-knit group. We think of venture as a team sport, not an individual sport here. We talk about these things as a group over time, and sometimes we go off-site and think about the sectors we want to focus on and the challenges and opportunities of each. So we have been talking about this, really, since the 2008 or 2009 time frame.

Our strategy in technology is that we like to invest after the pure science experiment is over and a company has a product that’s complete, and they are usually hiring sales and building out their commercial capability. In healthcare, our strategy had been to look for drugs that had some preliminary data in humans. One of our companies, Prestwick Pharmaceuticals, was going after a drug for Huntington’s disease. It was already approved and selling in Europe and Canada. Therefore it should have been a six- to 10-month process with the FDA. Well, it took us three years to get it approved.

There is such turn over at the FDA that there are a lot of people who are former insiders, so we have had some of these folks come in and talk to us about [the regulatory process]. As a result, we evolved our emphasis further to look at repurposed drugs. Orexigen is in our portfolio now; they make a version of wellbutrin, which is available generically and is one of the most widely available antidepressants. Early this year, the FDA said, ‘We can’t approve it and we aren’t even going to tell you what we need…We are going to wait for a year to even tell you what you need to go forward.’ They got some pressure from Congress, and now they have agreed that there should be another trial—after we had already done a successful Phase III trial. So, starting in 2008 through this year, we have had a continual series of problems with the FDA.

Our very first investment after we founded the fund was Seattle Genetics, which was a very successful investment for us. So our question to ourselves was, … Next Page »

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Life sciences investing is up against the ropes. The sector has been beset by such high capital costs and such long paths to market that many venture partners don’t seem to want early- and mid-stage biotech companies tarnishing their portfolios anymore. Hence the news last week that Menlo Park, CA-based Morgenthaler Ventures and Boston-based Advanced Technology Ventures are shedding their life science investing teams and merging them into a new independent biotech fund—and the news today that Scale Venture Partners of Foster City, CA, is ceasing new healthcare investments altogether.

The ScaleVP announcement came this morning in the form of a blog post and press release. Kate Mitchell, ScaleVP’s managing director, said that after long discussion with limited partners, the firm decided that healthcare investing—where the unpredictable rigors of FDA review are making it harder to get new treatments to patients—is not compatible with the firm’s focus on mid-stage investing.

As its name indicates, ScaleVP generally focuses on identifying companies that have early revenues and helping them scale up until they’re ready for an IPO or acquisition. The firm has successfully shepherded a few life sciences and healthcare companies to that stage, including Seattle Genetics, Cellective Therapeutics, IPC The Hospitalist Company, and National Healing. But for other companies in its portfolio, the process has become too expensive and unpredictable, largely due to the “vagaries” of the regulatory review process for new drugs, Mitchell says.

“In the last four years, our companies have filed seven NDAs [new drug applications]; five of them have been approved and two are pending—something we are proud of,” she writes in today’s post. “Unfortunately, they took longer and used more capital than planned from the start…The partners believe that the vagaries of the FDA and the resulting increase in time and capital needed to take these companies through to a real exit doesn’t fit our mid-stage fund strategy any longer.”

Mitchell (who is an Xconomist) has been active in efforts to remove regulatory barriers to growth for emerging healthcare and technology companies. She’s a past president of the National Venture Capital Association, which puts part of its lobbying energy into Washington lobbying into promoting streamlined FDA regulations. More recently, she chaired an “IPO Task Force” that issued a report last month calling on Congress, the White House, and the Treasury Department to ease rules that make it prohibitively complex and expensive for emerging companies to go public.

But Mitchell says that none of these changes will happen fast enough for ScaleVP’s purposes. “Our team has been closely watching the regulatory environment in the healthcare field for years, and we are heartened by the dialog that is beginning to take place between our industry and the regulators,” she writes. “We will continue to be active in that conversation but think that the timing of a resolution that benefits emerging companies tackling important healthcare issues will be beyond our investing horizon.”

Mitchell hastened to add that ScaleVP’s decision is “not a signal of the end of healthcare investing for VCs. Healthcare should and will continue to be a good place to invest for many of our peers who have earlier or later stage mandates.”

Since May 2009 ScaleVP has been investing out of its $255 million Fund III. Managing directors Lou Bock and Mark Brooks oversee the healthcare part of the portfolio, which includes Alimera Sciences, Ascenta Therapeutics, LivHome, National Healing, New Century Hospice, Oraya Therapeutics, Sonexa Therapeutics, and Spinal Kinetics. They’ll stay on with the firm, according to Mitchell’s announcement, in order to “support their portfolio companies and maximize return to investors.”

ScaleVP has already changed the front page of its website to indicate that it invests primarily in Internet, software-as-a-service, mobile, and cloud computing companies. Reflecting the new focus, the firm announced that Stacey Bishop, who led ScaleVP’s investments in ExactTarget and Omniture, has been promoted to managing director.

Xconomy is scheduled to talk with Mitchell later this morning, and we’ll update this story as warranted.

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His last name means “forest” in Norwegian. Which is appropriate, because this guy sees the forest for the trees.

David Skok of Matrix Partners is one of the most talked-about venture capitalists in town, among young entrepreneurs and experienced ones alike. He is best known for his investments in JBoss, the open source middleware company (acquired by Red Hat for $420 million in 2006); AppIQ, the network and storage management firm (bought by HP in 2005); Diligent Technologies, a data protection company (bought by IBM in 2008); and CloudSwitch, a cloud infrastructure startup (acquired by Verizon this year). He currently serves on the boards of tech companies such as HubSpot, CloudBees, Digium, Enservio, and Solidworks.

Critics say he hasn’t had a big exit in a while. Supporters say he has a real knack for building companies and getting them acquired for good prices—and that what he touches often turns to gold.

Whatever you think of him, Skok has carved out a reputation as a hard-working investor with both technical expertise in business software and a deep understanding of sales and marketing from a customer’s perspective. For the past decade, he has been a general partner with Matrix. But when I sat down with him recently, I was more interested to hear about his previous life as an entrepreneur and five-time CEO, and how that shaped who he is today—both the decisions he makes as a VC, and the kind of mentorship he provides to startups.

It’s not quite Batman Begins or Casino Royale, but here is the David Skok origin story—and its lessons—in three parts.

Act I: A New Hope (Software)

The story opens in Johannesburg, South Africa, where Skok was born to an English mother and Norwegian father. His parents didn’t want him to grow up with apartheid, so they sent him to school in England, where he lived from age 8 to 20, in London. From there he went to college at University of Sussex, where he was part of the first class of graduates in England to be awarded computer science degrees. That was 1976.

His father made him come back and join the blue-collar family business, which involved machining equipment. He went to apprentice training school and survived his first week when all the tough guys tried to haze him. By the end of the course, he knew how to use a new tool for machining parts that followed a program stored on punched paper tape. The problem was, if there was a tiny error in the tape, the part would be ruined and “you’d have a huge wreck on your hands,” he says.

So Skok wrote a piece of software to get around this. “If you designed the part on the computer, you’d be able to do the machining without worrying about the geometry,” he says. That led him to start his first company, Skok Systems, which became a computer-aided design (CAD) firm.

“I’m accidentally an entrepreneur,” Skok says. “I didn’t plan to be an entrepreneur, I didn’t have any training in it, I didn’t have any mentors to turn to to teach me how to be an entrepreneur. I’m trying to figure out all the sales and marketing stuff that’s going on.”

The company went through a few shifts, but the pivotal moment happened in … Next Page »

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A man who carries a cat by the tail learns something he can learn in no other way.
—Mark Twain

Venture capitalists who are serious about turning their firms into more than one-fund wonders may want to have their associates actually start and run a company for a year. Running a company is distinctly different from simply having operating experience—(working in bus dev, sales or marketing). None of that can compare with being the CEO of a startup facing a rapidly diminishing bank account, your best engineer quitting, working until 10pm and rushing to the airport and catching a redeye for a “Hail Mary” close of a customer, with your board demanding you do it faster.

Today, you can start a web/mobile/cloud startup for $500,000 and have money left over. Every potential early-stage venture capitalist should take a year and do it before he or she makes partner.

Here’s why.

Venture capital as a profession is less than half a century old.

Over time venture firms realized that the partners in the firms needs a variety of skills:

• People skills (ability to recognize patterns of success in individuals and teams)
• People skills
• People skills
• Market/technology acuity (patterns of success, domain expertise)
• Rolodex/deal flow (deal sourcing/ability to make connections for the portfolio)
• Board skills (Startup coaching, mentoring, strategy, operational/growth)
• Fund raising skills

Some of these skills are learned in school (finance), some are innate aptitudes (people skills), some are learned pattern recognition skills (shadowing experienced partners, hard won success and failures of their own), and some are learned by having operating experience. But none of them are substitutes for having started and run a company.

How to Become a VC
Early-stage venture capital firms grow their partnerships in different ways. Some hire:

• partners from other firms
• associates and put them on a long career path
• venture/operating partners to get them into new industries
• an executive who had startup “operating experience”
• rarely a startup founder/CEO.

In surveying my VC friends, I was surprised about the strong and diverse opinions. The feedback varied from:

• “.. because culture is such an important part of who we are, we will probably never hire a partner from another firm. The idea of bolting on someone from another firm is somewhat antithetical to who we are. We think that our venture partner role is the most likely path to general partner.”
• “..we have a partner-track associates program. We want to find someone who has a lot of consumer internet product experience as either product manager, founder, VP Product, etc. with 3-7 years of experience.”
• “…we do not even try to train new partners. We bring people into our firm who have learned how to be VCs at the partner level somewhere else and have demonstrated their talent in boardrooms alongside of us. We completely and totally punt on the idea of ‘training a VC.’ It’s an ugly and painful process and I don’t want to be part of it.”
• “…if they don’t have operating experience the odds of them knowing what they’re talking about in a board meeting for the first five years is low..”

Carrying the Cat By The Tail
When I finally became a CEO it was after I had spent my career working my way up the ladder in marketing in startups. I did every low-level job there was, at times sleeping under my desk (engineering was doing the same). By the time I was running a company, … Next Page »

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