There is an old parable about the concept of commitment when it comes to breakfast. The story goes that when looking at a plate of the traditional fare of ham and eggs, it’s obvious that the chicken is an interested party, but the pig is truly committed.

When I tell this story to entrepreneurs, my point is usually to contrast the approach venture capitalists have to startups as compared to entrepreneurs. The VC is an interested party, but at the end of the day, if their startups live or die, they typically still have their job, their office and their portfolio of other investments. The entrepreneur, on the other hand, is the pig – truly committed to the outcome, with no fallback.

But lately I’ve been thinking about the parable of the pig and the chicken in the context of the characteristics that make a great entrepreneur – and the kind of entrepreneur that we VCs in general, and my firm Flybridge Capital in particular, like to back. In short, we like to back pigs – entrepreneurs who are truly and completely committed to the outcome of their venture, have a lot of stake, and no fallback.

How do we discern the difference between the two entrepreneurial archetypes? It’s usually relatively easy, but sometimes subtle. Here are a few of the top characteristics we see in entrepreneurs who appear to be exhibiting behavior that suggests they’re more like “chickens” when it comes to their startup:

1) Prefer to wait to start their venture only after they receive funding (“We are ready to go, as soon as you give us your money.” …um, does that mean you won’t start the company if I don’t give you my money?).

2) Don’t quit their day jobs before receiving funding. (“This has been a side project for a year, and I can’t wait to focus on it full-time” … um, if you can’t wait – why are you waiting?)

3) Don’t physically move themselves or their teammates to be in the same geography when starting their venture (think Eduardo Saverin in the Social Network spending his summer in NYC).

4) Prefer to play a hands-off chairman role or look to quickly hire a COO/president in the early days rather than operate as the hands-on CEO/president. (I’ll leave out the numerous examples to protect the innocent, but as a rule of thumb, companies with fewer than 40 employees don’t typically need a COO).

5) Are unwilling to fully leverage their own personal and professional networks to drive recruiting, fundraising and business development.

On the other hand, the top five characteristics we see in “pig” entrepreneurs include:

1) Commit to the new company everything they have – even if that means moving their families, quitting their jobs, or even dropping our of their schools (as much as I don’t want to condone or encourage this).

2) Put themselves “out there” publicly and visibly with the industry, their relationships, family and friends. If the company is a failure, it will not be a quiet one.

3) Have not yet achieved a mega-success already and/or yet achieved wealth beyond the point of needing to work again. (I remember my mentor and boss at Open Market, CEO Gary Eichhorn, congratulating me when I became a first-time homeowner in the mid-1990s and observed: “I hope you got a large mortgage so that you are locked in and highly motivated to create wealth.”).

4) Participate in a minimal set of outside interests and hobbies that aren’t directly related to their business. Starting a company is a consuming, obsessive, 24-7 endeavor. Raising a family and remaining healthy is enough of a battle. When we see entrepreneurs with long lists of hobbies and outside interests, it’s a red flag. One of my partners went so far as to look up the number of times an entrepreneur played golf one summer (which apparently is public information somehow, although I’m not a golfer so still don’t know how he figured this out) as a barometer for how hard they were applying themselves to their new venture.

5) There exists a rare breed of entrepreneurs that have already had mega-success are so special and driven that they remain obviously hungry and scrappy. For these entrepreneurs, the key is to watch and see if they’re still as hands on as they ever were (e.g., obsessed with the product, knee-deep in the financial model, out in front of the organization in selling). Again, these entrepreneurs are very special.

So what are you – the chicken or the pig? Investors clearly prefer one model over the other, not just in the founder, but in the entire team. As a result, as you are assembling your start-up team, be careful not to hire chickens. In the eyes of prospective investors, you may find it’s even less kosher than hiring pigs.

– Jeff Bussgang is a former entrepreneur and partner at Flybridge Capital Partners. This article originally appeared on his blog Seeing Both Sides. The views expressed are his own. –

There has been a surge in interest with the world of the Navy SEALs since the Osama bin Laden action (this piece in the WSJ was a particularly good profile) and I confess to being caught up in it myself.

One of my portfolio company CEOs, Will Tumulty of Ready Financial, is a former Navy SEAL (1990-1995). Will was kind enough to introduce me to a SEAL classmate of his, Brendan Rogers (SEAL 1990-2000), who joined me and 20 NYC CEOs/founders from the tech scene recently to talk about the SEALs – the training, the planning and the operations behind their combat operations – as well as draw out some relevant lessons for entrepreneurs. Brendan went on to HBS and McKinsey after the SEALs and then started his own hedge fund with a partner, so he had an interesting, multi-faceted perspective.

The discussion was wide-ranging and entertaining. The five key lessons Brendan highlighted were as follows:

• What’s hard is good. SEALs go through an intensive 6-month training program called Basic Underwater Demolition/SEAL training (BUD/S). That training program is designed to test a candidate’s physical and mental limits. Traditionally, by the time of SEAL graduation, the attrition rate is as high as 70 percent. SEALs quickly learn that the punishment and pain of training hardens their minds and bodies to adapt to tough environs. Brendan pointed out that startup executives who go through hard times should learn to relish them, recognizing that the hard times will toughen the team and train them properly for “battle.”
• 80 percent training, 20 percent execution. SEALs are incredibly well-trained and when they are not on actual combat deployments, they are spending the vast majority of their time training for a number of different types of missions. In contrast, at startups, executives typically spend 100 percent of their time executing and zero percent of their time training. Brendan emphasized the importance of training and practice in all areas – employee onboarding, management practices, etc. He commented on the importance of training for unexpected situations. The simultaneous shooting of three Somali pirates at sea as part of a hostage rescue two years ago was an example of the kind of outcome possible when SEALs train under all possible conditions. The CEOs in the room had wide eyes and were certainly thinking hard about their training regimens and scenario planning after that example.
• Every seat counts. Brendan pointed out the price of settling for mediocrity, even in a big organization. Every SEAL needs to know with 100 percent confidence that the man behind them will be able to save their life and get them out of a bad situation. The CEOs in the room were asked if they could say the same about their management teams and if those management teams, in turn, could say that about their lieutenants. One CEO objected that he had 1000 employees in his company and couldn’t possibly hire all “A’s.” Brendan replied by citing the example of D Day. Eisenhower planned D Day with a small number of subordinates who he turned to and said, select 12 men underneath you who you can trust with your life to execute this mission. Each of those men did the same and so on and so on. That cascading effect resulted in the successful employment and combat engagement of over 2 million troops throughout Europe. The lesson? Don’t let a large organization be an excuse for mediocrity.
• Everyone is expendable. The SEALs are trained in a nearly identical manner and no one SEAL is indispensable to the unit or the mission. The nature of combat is that anyone can be lost at any time. Entrepreneurial companies have a harder time executing on this philosophy since there are specialists and superstars, but Brendan’s message was to make sure contingency plans were thought through for any set of personnel circumstances.
• You never know the measure of a person until they are tested. As mentioned earlier, the SEALs training program weeds out 70 percent of participants. Brendan conveyed that the people he thought would never drop out did while others proved to be more resilient and tougher than imagined. Until your people are really tested (see “what is hard is good”), you can never be sure who will step up and who will falter. One sure sign, based on pattern recognition, is that those that talk tough and are full of bluster are predictably those that are the first to blanche in the face of adversity. Quiet strength and determination in a startup are invaluable. When you see it in your people, bottle it.

Everyone left with a great appreciate for those brave men who serve our country so ably, and the system behind it that produces such a consistent, excellent “product.” Brendan is also the co-founder of the Navy SEALs Foundation, a non-profit that helps take care of the families of SEALs when things don’t go as smoothly as they did in Pakistan a few weeks ago. I was inspired to make a donation to the organization immediately after the dinner.

One final humorous note – Brendan observed that the spouses of Navy SEALs are as tough as nails themselves and impossible to impress. They still make their spouses take out the garbage, do the dishes and change diapers – no matter how impressive their accomplishments in the field of battle. I suspect many startup executives have similar, appropriately humbling marital arrangements.

I almost never agree with a single thing written on the Wall Street Journal editorial pages. Yet, I found myself muttering “amen” a few times as I read this morning’s editorial on “Whatever Happened to IPOs?”. It’s just stunning to me how little interest there seems to be on the part of a supposedly pro-business Congress and (more recently) Executive Branch on this one simple thing that would unleash innovation and jobs – watering down Sarbanes-Oxley.

The IPO market has improved somewhat in 2011 and so perhaps that has taken some pressure off, but the fact is that the regulations and costs associated with an IPO are so overwhelmingly daunting for our young venture-backed companies that they simply avoid them altogether. I used to hear from investment bankers that a company north of $100 million in revenue and consistently profitable can find a welcome public audience. But recent conversations that I have had with bankers has carried a different, even more depressing message.

I am now being told by investment bankers that if a company’s revenue is less than $200 million and the projected market capitalization less than $1 billion, they are at risk of being relegated into the “public company ghetto” – a sad corner of the public markets where you have no analyst coverage, no float and so no liquidity. Your stock simply drifts down and down without any institutional support. And so even $50-100 million companies in our portfolio and others – growing profitably and creating real value – look at the IPO as an unattainable goal. I profiled a number of companies in New York and Massachusetts that fit this criteria in response to Bill Gurley’s excellent piece (IPO Anxiety) from a Silicon Valley perspective a few months ago. But when I talk to CEOs and board members at these companies, they roll their eyes at the IPO prospect – it feels simply too unattainable.

Some complain that the source of the problem is the lack of mid-tier investment banks. Others complain that the lack of analyst coverage is the issue. In both cases, it’s a cause-and-effect problem. The cause is Sarbanes-Oxley and the lack of volume. The effect is that bankers and analysts follow the money. If the rules were more relaxed, there would be more bankers and analysts, for sure. This is the Information Age – analysis and bankers will follow opportunities. They may not be as well known, but banks like Jeffries & Co, Needham & Co, GCA Savvian and now BMO are aggressively courting companies to help them go public and would be all over a more robust market for companies in the $300-600 million market capitalization range.

In 2009, the National Venture Capital Association (NVCA) made this topic their policy focus. They released a series of spot-on recommendations to help bring back the IPO market. But then everyone got distracted with the financial crisis and (yet) more regulation related to SEC registration and battles over the tax treatment of carried interest. I don’t know if there have been any hearings or serious consideration on policy options to provide more liquidity for the IPO market since the NVCA’s recommendations, but clearly there’s been no action.

It’s time to beat the drum on this. Surely we can find a group of members of Congress who are willing to match their rhetoric on fostering innovation with doing the hard work of loosening up Sarbanes-Oxley. The StartUp Visa movement has made terrific progress thanks to online, grassroots support. Let’s use that as a model for the IPO market. John McCain’s on Twitter (@SenJohnMcCain). Send him a tweet and see if he’s listening.

I had the pleasure of teaching a new case at Harvard Business School recently on Foursquare that I co-authored with professors Tom Eisenmann and Mikolaj Piskorski as part of Tom’s new course “Launching Technology Ventures“.

Foursquare executives Dennis Crowley, Naveen Selvadurai and Evan Cohen were kind enough to allow us to interview them in preparation for the case, which framed some of their current key strategic issues and looked back on the choices they made in the early days to draw pedagogical lessons of lean startup best practices, building a platform business, network effects and running monetization experiments.

The Foursquare team was consumed this week with SXSW preparations, but we were fortunate to have as class guests Charlie O’Donnell, who wrote the original blog post on Foursquare that got many in the community excited about the company, and Andrew Parker, who was an associate at Union Square Ventures (USV) at the time of their Series A investment.

As I did with the class when USV’s Fred Wilson visited, I asked the students to pull out their phones and tweet throughout the class. You can see the rich “dialog behind the dialog” here, using the Twitter hash tag #hbsltv. Here were some of the takeaways I had from the class discussion framed around three major questions I posed to the students:

1) Why did Foursquare succeed as compared to the same founder (Dennis) in a similar venture (Dodgeball) in a different era and as compared to other teams pursuing LBS services in the same era?

The students concluded that the context around a venture matters tremendously – that smart phones, the explosion of apps and social networking all were important enablers that allowed Foursquare to succeed at this particular moment in time. At the same time, the Foursquare team was incredibly skilled at applying lean startup best practices, specifically:

• Product-obsessed founders: Both Dennis and Naveen were consumed with the product. Always interacting with users in bars and over Twitter, thinking less about strategy, analytics and monetization and focusing more on a great user experience.
• Hunch-driven: They had deep domain knowledge and didn’t need outside studies or market research to guide their prioritization. One of the key takeaways that both Charlie and Andrew emphasized to the students was to be power users in whatever area of focus they choose to develop those instincts.
• Minimum viable product: They didn’t wait years and years to perfect the product, but instead got it out there to solicit user feedback.
• Modest burn: The company only raised $1.35 million in its series A financing and kept the burn rate at less than $100,000 per month to make he money last. Dennis wrote a great post at the time of the financing that showed just how product obsessed he was, even after taking the seed money. There’s no bravado or BS – just a list of the great features they’re going to roll out as a result of having the extra capital.

2) What was the magic of the Foursquare system that drove rapid adoption that so many other consumer Internet companies fail to achieve?

• Game mechanic: Students really honed in on the playfulness of the service, both the entertainment value and the addictive nature of competing for badges and mayorships.
• NYC launch: The fact that the service started in such a perfect venue gave it great advantage – a highly concentrated, very social community.
• VC validation: Having Fred Wilson invest and promote the company helped provide it credibility with an insider crowd that may have provided some strong tailwinds.
• Win-win for all constituents: Unlike many services, the students understood a key insight about foursquare: the local merchants make the service. The fact that merchants are so incented to promote, discuss and reward consumers creates a positive feedback loop that transcends the power of a consumer-only service.
• Online – offline combination: Another aspect of the magic of foursquare is that it is not an online only service. In fact, the ability to drive consumers to actually walk into local venues is a special dimension of the service. As one student pointed out: “Facebook tells me what my friends are doing. Foursquare tells me where they are and where I can meet them.” This is a unique and powerful aspect of the service.

3) Once a company achieves product-market fit and starts to scale, how do their priorities, and burdens, shift?

• Raising money, scaling the team: A rich discussion ensued about what it means to raise big money. When Foursquare took $20 million in venture capital at a reported valuation of $100 million, suddenly they had transformed the company from a lean, product-obsessed startup to a company that would need to generate tens if not hundreds of millions of dollars in cash flow to justify a billion dollar valuation. A product-obsessed management team suddenly had to transition to become an operational scale management team.
• Monetization: Consumer Internet companies have to decide when they begin to monetize – as part of the lean start-up experimentation or only after they achieve enough scale to attract partners and advertisers. But it’s not a binary decision. Foursquare has run monetization experiments from the beginning, but to justify the big valuation they will have more pressure to show real financing results, perhaps at the expense of the user experience. It takes a strong founder to resist that temptation (think Jesse Eisenberg playing Mark Zuckerburg in “The Social Network”, sneering: “No advertising. Advertising isn’t cool.”)
• Vision/Becoming a platform: What does the company want to be when it “grows up”? To be a generation-defining company and enter the ranks of Facebook and, arguably, Twitter, Foursquare needs to evolve from a great application into a platform. But becoming a platform company requires a whole different approach and set of priorities. Do you build out your own features or expand your APIs and invest in supporting third party developers to build applications to your platform. One of the students had coincidentally tried to work with the foursquare API to develop an application and complained that it was very rudimentary and limiting relative to the Facebook and Twitter API.

The verdict? I ended the class by polling the students – who would buy Foursquare stock at a $200-250 million valuation (my very rough estimate of the current trading on the secondary market) and who would sell? One third of the students were buyers at that price at the end of the class. Two thirds were sellers.

One student pointed out in a tweet that the voters were unfairly negatively biased because only 10 percent of their classmates had even tried the application and, besides another tweeted, 3/4 of HBS students apparently wanted to sell Amazon short in 1998. Another student tweeted that if there was even a 3 percent chance that the company could be a $10 billion company, it was worth buying at $200 million. Now there’s a future venture capitalist in the making.

Thanks again to the Foursquare team for letting us write the case and adding to the HBS community’s intellectual capital.

When to become an entrepreneur is a common quandary for many. For whatever reason, this issue has come up a great deal recently (recession-driven workforce dislocation?), so I thought I’d share a few thoughts that might help frame this critical decision.

I have concluded that being an entrepreneur is an irrational state of being. If human beings were purely rational, evaluative, value maximizing individuals (see Harvard Business School professor Michael Jensen’s paper on self-interest and human behavior), they would not start companies. If they sat down and did the expected value calculation by laying out the probability weighted outcomes of being an entrepreneur as compared to taking a safe job, it would not pencil out.

Yet, entrepreneurship is not simply a rational journey. It’s one that is defined by passion and personal satisfaction that transcends purely financial analysis. And, of course, there is always the hope for the big payout, no matter how long the odds.

Despite popular wisdom to the contrary, age is not a major factor in the decision to start a company. The Kauffman Foundation reports the median age of founders is 39 – right at the midpoint of a typical professional career – and 69 percent are 35 or older. Another study by Washington University professors of 86,000 science and engineering graduates showed that age was not a significant predictor of becoming an entrepreneur.

So when should you become an entrepreneur. Here are the kinds of questions you should ask yourself:

1. Do you have an idea that no one can talk you out of? When you bounce your start-up idea off your spouse, friends and trusted advisers, are they able to raise enough objections that you begin to doubt whether the idea has merit. Getting honest, objective advice can be hard because the people you are likely to go to care about you and may be afraid to tell you what they really think for fear of offending you. Thus, you need to get feedback from objective parties (e.g., advisers, experts, prospective angel or VC investors with whom you don’t have a deep personal relationship).

2. Do you have a partner you trust with complimentary skills? Starting a company is a lonely adventure. Having a partner that you can trust and whose skill set and experience is complementary to yours can be a huge functional and emotional benefit.

3. Are you prepared to endure with modest or no salary for a few years? Founding a company often means making personal sacrifices and below-market cash compensation. All the talk about “lean startups” (which I’m a big fan of) sometimes obscures the practical reality of what it means to eat through your personal savings.

4. Are you bored with your current work environment/life situation? There is nothing boring about being an entrepreneur. More apt adjectives might include stimulating, engrossing, obsessive, exhilarating, nerve-racking – but not boring. If you are tired of viewing your work as a chore and if every day is a bit of a grind, then entrepreneurship is for you. I find that the intrinsic motivation behind an aspiring entrepreneur is sometimes the simplest – because it’s fun. Seeking fun can transcend all other factors.

5. Do you perform best in the absence of structure? In my book, “Mastering the VC Game“, I describe a metaphor for the three stages of a start-up: the jungle, the dirt road and the highway. In the earliest stages of a venture – the jungle – there are no clear paths available and the skills required are to thrive in the midst of the chaos. For those who possess that makeup, being a startup executive is an excellent fit. But for those that like clear paths with little uncertainty and a great deal of structure – the highway – an early-stage venture will feel like a very uncomfortable environment.

Reflecting on these questions, I find it intriguing to ponder what kind of environment – either from the perspective of parents raising their children or policy makers thinking about encouraging entrepreneurial ecosystems – can be created to foster more entrepreneurship?

Harvard business professor Noam Wasserman is writing a book called “Founding Dilemmas”, which is coming out later this year (I’ve read early drafts and believe it will be a must-read for entrepreneurs). In it, he quotes career guru Dr. Tim Butler who points out that signals from parents, mentors and local leaders have a large influence on whether people chose to become entrepreneurs.

“We receive very powerful messages (from those around us) about what’s important, what success is, what failure is, what counts for achievement and what doesn’t,” said Butler.

Celebrating entrepreneurial success stories in our culture and putting folks like Steve Jobs, Bill Gates, Larry Page (the new Google CEO) and even more accessible local heroes on magazine covers and in front of audiences is obviously a huge factor.

Every college kid in America looks at Mark Zuckerburg and thinks, “Why not me?” Why not, indeed?

Photo credit: A man does the Superman dive during the Red Bull Cliff Diving series in Sisikon, Switzerland September 5, 2009. REUTERS/Romina Amato

One of my favorite business books of all time is Patrick Lencioni’s “Five Dysfunctions of a Team”. Like all books by Lencioni, it begins with a short fable in a corporate setting of a management team that is operating dysfunctionally. Then he provides a framework that analyzes the situation and draws out the general lessons as to why teams operate poorly together and how to systematically combat it.

The following pyramid graphic summarizes his advice:

Each of the layers of the pyramid resonate with me (which is probably why I have this pyramid printed and hung up in my office), but the one that I always come back to and re-read is “Fear of Conflict”. Again and again, I see management teams and boards of directors shy away from conflict.

It’s quite natural for humans to avoid conflict. In fact, our deeply programmed “fight or flight” instincts are designed to protect ourselves and run away when we sense danger. Interpersonal conflict is a danger we all prefer to avoid as it makes us uncomfortable. Your stomach gets a little queasy, your heart beats a little faster, and you think, “How do I get out of this situation?”

So, you tell a joke. You change the topic. And you feel a sense of relief.

When I see this happening in management teams and in board rooms, it makes me uncomfortable because I know where it leads. It leads to mistrust, simmering issues, politics and dysfunctional behavior. Here are a few techniques I’ve found that help address this issue, particularly in startups.

1. Building trust. The foundation for handling conflict productively begins with building trust amongst the management team. It’s easy to say, but particularly hard to do in a startup when people have been slammed together quickly and are so crazy busy, that it’s hard to stop and take the time to understand each other more deeply. One technique I have found very helpful here is to conduct a facilitated, day-long offsite where each management team member takes the Myers-Briggs test to help surface how each party thinks, processes information and makes decisions. I did this with my management team at Upromise and again when we were starting off at Flybridge. In each case found it helped us understand each other at a far deeper level.

2. Annual reviews. It’s easy to be running so hard and so fast that CEOs and boards forget to conduct systematic reviews where a broad range of feedback is collected and tough development issues are addressed head on. I try to do this at each of my boards. At Flybridge the general partners conduct 360 degree reviews of each other. Done correctly, these can be emotionally draining and difficult, but very productive exercises where a safe forum for brutal honesty and constructive dialog can be developed.

3. Systematic post mortems. In my early product management days, I learned the value of the post mortem – the process of gathering all the relevant team members into the room to talk about what happened after a product ships and why errors or schedule issues occurred. Extending the post-mortem process into all business activities can be very valuable. It allows a clinical, unemotional examination of what has happened, how everyone operated under pressure, and what process improvements can be made for next time. Whether it’s done post product release, when an executive team member departs because things didn’t work out, after a board meeting in an executive session, or after an investment goes bad, an analytical examination of what just happened is a useful exercise that forces all parties to address difficult issues.

4. Go direct. At Flybridge, we have developed a mantra for addressing issues amongst the partnership: Go direct. When one of us has a concern about how another partner is handling a portfolio company situation or evaluating a deal opportunity, we don’t allow indirect conversations. If two partners find themselves talking about a third partner, we stop the conversation and bring in the third partner so the issue can be addressed directly, out in the open rather than it festering behind closed doors. I learned this lesson as an executive team member at a startup that was not good at going direct. The VP of sales would come into my office and complain that he wasn’t getting good support from the VP of marketing. Ten minutes later, the VP of marketing would storm in and complain that the sales force wasn’t properly executing on our strategy. The entire executive team avoided going direct because it was uncomfortable, so we had false harmony in our Monday staff meetings and deep divisions the rest of the week.

Conflict can be stressful, draining and uncomfortable. Yet, it’s an incredibly natural, healthy part of life, particularly in a startup. And creating a culture that can handle conflict effectively clearly has a positive impact on performance, as recent research has shown (see i4cp study: “Leaders With Low Emotional Intelligence May Be Depressing Bottom Line“).

If you want to avoid your startup feeling like a soap opera, try some of these techniques.

“Security Analysis” is cited by Warren Buffet as one of his top four favorite and most influential books. Written by Columbia University professors Benjamin Graham and David Dodd, it was first published in 1934.

The book is a thick tome that articulates the thesis of value investing – the analytical techniques for valuing securities and seeking to invest in those securities in the context of their underlying value. The latest printing, the sixth edition, contains a foreword from the Oracle of Omaha himself as well as a preface from hedge fund investor Seth Klarman of The Baupost Group, who is regarded by many to be one of the modern masters in the art of value investing.

As a venture capitalist reading the book and trying to absorb its investment lessons, I wondered: can VCs be value investors? After all, the philosophy of value investing, in theory, should cut across all asset classes and managers. The precepts and principals therefore should apply to the venture capital business as well.

Sadly, they don’t.

Klarman writes: “Investing in bargain-priced securities provides a ‘margin of safety’-room for error, imprecision, bad luck, or the vicissitudes of the economy and stock market.”

Unfortunately, VCs don’t operate with a margin of safety, even if they are able to find and negotiate good deals. Later stage investors may have downside protection if they buy smart, but early-stage VCs do not. If a portfolio company goes bad, there is typically barely any salvage value.

As one of my partners is fond of saying, “A good price doesn’t help a bad investment”. That is why VCs tend to emphasize “clean terms,” which are entrepreneur-friendly rather than focus on complex bells and whistles to protect downside. And that is why you will see large loss ratios in VC portfolios, sometimes as high as 20-30 percent. In fact, if a VC doesn’t have high a loss ratio, one might argue they aren’t taking enough risk. As one Silicon Valley veteran put it to me the other day: “I can only lose one time my money.”

There is a see-saw debate often heard in the hallways of VC firms – does success come from being a good stock-picker or company-builder? In other words, will a VC generate strong returns because they are good at finding the best companies and entrepreneurs to invest in, or will the returns be generated by adding value to companies through shrewd strategic guidance and savvy recruiting and team-building?

The answer appears to be both, but even the debate itself is also framed incorrectly, I would argue. Entrepreneurship is all about people. The VC business has evolved into a world where the challenge is less about choosing the best entrepreneurs to invest in, bur rather convincing the best entrepreneurs to take your money. This dynamic is unique as compared to other asset classes. Imagine a world where the highest quality forests choose which endowment they’d like as their owner; or a public stock chooses which hedge fund they want to own 10 percent of their outstanding stock. Sounds ridiculous? That’s precisely what is happening when VCs compete with each other and chase after the best entrepreneurs, offering entrepreneur-friendly terms, supportive advice and value-add.

But although the VC business doesn’t lend itself to value investing, VCs would benefit from many of its lessons. For example, placing an emphasis on thoughtful analysis and due diligence of business models and market dynamics rather than pure, instinctual speculation. Further, in a world of multi-hundred million dollar exits and a weak IPO environment, exerting some price discipline makes sense for VC investors, who are often pushed by entrepreneurs beyond their limits (“If you like the deal at $20 million pre, why wouldn’t you like it at $25 million?”). Deal prices must be scrutinized in the context of realistic growth assumptions, future capital intensity and target-market sizes. As Graham and Dodd put it, when an investor is blinded by the pursuit of growth, “Carried to its logical extreme, there is no price too high for a good (company), and that such an issue was equally ‘safe’ after it had advanced to 200 as it had been at 25.”

That’s why, in the end, the VC business is still a blend of art and science. It’s part financial asset class, part creative entrepreneurial endeavor. And, under any analysis, is not for the faint of heart.

I love Jackson Hole, Wyoming. It’s one of the most extraordinarily beautiful settings in the world. One cannot help being in a good mood when observing the breathtaking wildlife, open sky and the awe-inspiring Grand Tetons.

Thus, reading the reports from last weekend’s annual economist confab in Jackson Hole could not have been more depressing. If the practitioners of the dismal science sound this pessimistic amidst such an uplifting setting, what will their attitude be when they trade in their cowboy boots for green shades and return to their drab offices to stare at spreadsheets? A usually staid Allen Sinai sounded positively hyperbolic, yet apparently spoke for many at the conference, when he told the New York Times, “I’m more worried than I have ever been about the future of the U.S. economy. The challenge is unique: poor and diminishing growth, a sticky unemployment rate, sky-high deficits and a sovereign debt that makes us one of the most fiscally irresponsible countries in the world.”

In his Oval Office speech on Iraq, President Obama acknowledged his concerns about the economy and declared, “Our most urgent task is to restore our economy and put the millions of Americans who have lost their jobs back to work… we must unleash… innovation… and nurture the ideas the spring from our entrepreneurs.”

So here’s what I don’t understand: If everyone, including the president, believes that supporting innovation and entrepreneurship is the best path forward, why aren’t the policy leaders taking action? Thomas Friedman of the NY Times has been hammering on this issue for the last year, calling on the president to “launch his own moon shot” and make innovation and supporting the start-up economy his top priority.

First, let’s review the data. The Kauffman Foundation did a comprehensive study of historical job creation and, not surprisingly, found that small businesses are the main source. “Without startups,” writes Senior Fellow Tim Kane, there would be no net job growth in the U.S. economy. This fact is true on average, but also true for all but seven years for which the U.S. has data going back to 1977.” See the following chart:

But despite the obvious data and the presidential rhetoric, we are not seeing any action from policy leaders on either side of the aisle. It’s almost as if the policy makers think speeches exhorting innovation are more important than doing the hard work of pushing forward legislation that will actually positively impact the innovation economy.

I’m no policy expert, but it strikes me that there is a clear innovation agenda that has been put forward by those who are the most knowledgeable about the issues. A few of the ideas being proposed seem obvious, but are stagnating due to a lack of leadership. For example:

• We need to make it easier for immigrants to start companies in the U.S. The Start-Up Visa movement addresses this issue squarely in the head and yet the bill proposed by Senators Kerry and Lugar six months ago appears to be caught up in the more partisan immigration debate.
• Sarbanes-Oxley needs to be reformed. We may have had too little regulation of complex financial instruments like credit default swaps and other derivatives, but we clearly have too much regulation being imposed on the public selling of the securities of $100 million companies that are very simple for investors to understand. Why haven’t Facebook, LinkedIn, Zynga and many others gone public? It’s just too onerous and expensive. You want to unleash innovation? Make it one-third as expensive for small companies to comply with public regulations. There have been numerous proposals in the past to rethink Sarbanes-Oxley, we need to see some form of them come to light.
• Other important policy ideas have been put forward by the National Venture Capital Association (NVCA) and others – such as patent reform, increased investment in broadband, increased investment in NIH funding, reforming the FDA approval process.

The amazing thing to me is that none of these ideas – and many others floating around the entrepreneurial community – require big dollars. Instead, they require big leadership. Where is that leadership going to come from? Who will be our champion for entrepreneurship? Ted Kennedy played this role in health care. John McCain played this role in campaign finance reform. Who will step up and be the champion for entrepreneurs?

If only we could get our policy leaders to take big actions to match their big rhetoric. Then next year’s Jackson Hole conference might be a lot more fun for everyone.

Photo credit: Morning sun hits the Grand Tetons as bankers and economists gather at the Jackson Hole Economic Symposium in Grand Teton National Park. REUTERS/Price Chambers