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The Venture U-Curve

In the venture business, and private equity more broadly, the J-Curve is a well-known phenomenon. It says that venture funds tend to produce negative returns in the early years as capital is deployed but as the portfolio matures and some liquidity is achieved, returns turn positive. Unfortunately in recent years, the average level of this positive return has been underwhelming to say the least.

Naturally, this has caused a number of GPs and LPs to question whether venture is broken. What’s clear is that while average returns in the venture industry over the past decade have been terrible (and perhaps will only marginally improve), there are funds that have clearly outperformed. So what exactly is going on here?

One generally accepted theory, originally proposed by Andy Rachleff, partner emeritus at Benchmark, is that every year 15 companies are created that reach $100m+ in annual revenue, and it’s these companies that generate the lion’s share of aggregate venture returns. Recently, our friend Elad Gil blogged about the incredibly short list of companies that reach $5B and $10B or more in enterprise value.

So the number of breakout successes of this magnitude is exceedingly small suggesting that the number of “winning” venture funds must also be small. This line of thinking has led institutional investors to concentrate their venture portfolios in an increasingly small number of firms. But as LP demand for this select set of funds has grown, so has the size of these funds. And in venture, size is the enemy of returns, as Bill Gurley recently remarked. The fact is that large funds have historically underperformed by a wide margin. According to this SVB study, smaller venture funds, defined as less than $250m, are 7 times more likely to return 3x than large funds (returning 3 times called capital being generally regarded as a very successful venture fund return).

Enter the U-Curve.


Using the simple illustration above, which is a riff on an isoquant curve, the #1 goal for any venture fund is to get into the purple area.

The challenge is that for larger funds, it becomes mandatory to invest in several of the next billion dollar winners to have any hope of generating a 3x net return on the entire portfolio. History suggests it’s pretty hard to do. This is the right side of the chart.

On the other end of the fund size spectrum, angels increase the odds of being part of one of the big winners through broad portfolio diversification. However, most angel investments result in relatively small ownership in any given company. So again, if a 3x or better return on the portfolio is the goal, and the percentage ownership is small, an outcome must be very large to have meaningful impact on the fund. See the left portion of the graph.

Between these two extremes are smaller, focused venture funds. I’ll define these as funds in the $75m to $250m range that typically target meaningful ownership stakes in each underlying investment. Structurally, this is where I think the sweet spot is. In this middle zone, billion dollar outcomes aren’t required in order to produce a winning fund. This is where the jump into the purple zone is shortest. Of course this doesn’t mean homerun investments aren’t targeted or desired, they just aren’t required to get into the purple zone. And if this type of fund does have a billion dollar exit, the fund return will look more like 5x or better. Given how few super homeruns are hit every year, it’s best to have a fund structure that is built for success with or without them.


Posted in Venture Capital.

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Our investment in ModeWalk


This was originally posted on our Merus Capital blog several months ago. I meant to include here as well…better late than never I suppose. And check out the San Francisco Chronicle’s profile on how the company came to be.

It’s 2011 and virtually anything can be purchased online. There have been many innovations in e-commerce in the last 10 years—group buying, flash sales, retargeting, dynamic merchandising, penny auctions (evil!), monthly subscriptions for almost anything, daily deals, just to name a few. But we still have a ways to go to capture in a browser the charm and rich experience of physical retail. Perhaps charm isn’t the right word to describe a trip to Costco, but when it comes to categories like luxury goods and haute couture fashion, the buying experience is part of the product.

While I certainly wouldn’t call my partners and I at Merus experts in the world of high fashion, we have been discussing this year the fact that we haven’t yet seen a great deal of truly engaging or immersive online shopping experiences. Particularly as tablet adoption increases, which are inherently more personal devices than your desktop or laptop, it seems the time is right to improve the typical flow of browsing and buying. Enter ModeWalk. When we first met with the founders of ModeWalk, we were immediately drawn to their vision of providing an emotionally engaging e-commerce experience while affording luxury fashion brands the opportunity to share their unique perspectives directly with consumers. Add to this vision the team’s unique blend of skills, experiences and connections, and we were sold. We recently led the company’s Series A round, which also includes an accomplished group of angel investors and fashion industry executives.

ModeWalk has just launched in private beta. Here is what Vogue had to say. We are proud to partner with the ModeWalk team as they redefine luxury e-commerce.

On y va!



Posted in Commerce, Investments, Merus Capital.

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Seeking Authenticity

This was originally a guest post I did this past Summer for Wasabi Ventures, which is a great resource for entrepreneurs.  Finally getting around to re-posting here.

As an investor, what I seek more than anything is authenticity. Actually, simply as a person, that’s what I seek.

I mean a couple of things by this.

First, the smaller picture. To us at Merus Capital, the most critical element of a pitch for any type of startup is that it must come across as something that you are truly passionate about and really, sincerely want to see become a reality. No shortcuts, no BS, no quick flips, and no pretending that there aren’t massive challenges ahead.  Challenges are OK. Finding ways to overcome them is what we’re all trying to do. Otherwise, where’s the fun?

Second, the bigger picture. And this part is more personal to me than just my capacity as an investor. I would love to find startups that are building products and services that encourage, and allow for, greater authenticity. Authenticity of information, opinion and emotion. And hopefully in ways that *help* people–don’t just entertain me, rather allow me to be more productive, make more informed decisions, work or play smarter, be safer, save money, whatever it is that can improve lives personally and professionally. Certainly the social web is helping us get closer to the vision. As examples, I’ll look briefly at three well-known communication platforms through the lens of productive authenticity: Facebook, Twitter, and Quora.

Facebook may be the leader in this light but to me, it doesn’t go far enough. I don’t really have 250 close friends and for me, it isn’t a useful productivity tool. Entertainment and personal connection, yes, but productivity and all the things mentioned above, not really.

I find Twitter to be a better productivity tool than Facebook, and thus a much more integral part of my daily life. And while the ability of Twitter users to spread important and useful information worldwide instantaneously is a fundamental societal shift, the cynic in me would say that at times Twitter can be a self-promotor’s dream–a bazaar of false modesty, feigned exuberance and hollow praise.

Quora starts to get at the issue. Real people with real knowledge on certain topics and events sharing their perspectives. But it still suffers from much of the blatant self-promotion that other services do. No doubt they are working hard to reduce the noise in the signal.

But how about the next communication platform? Can we build one that promotes and preserves true authenticity, exploits deep personal and professional relationships and helps people in their daily lives? I would love to find out.


Posted in Investments, Merus Capital, Venture Capital.

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Our Investment in Authentic8

We’re excited to announce that Merus has invested in the online security company, Authentic8. Guest post by my partner Peter.  Originally posted here.

It’s a Big Idea
The web has become the primary vector for criminals to deliver malware to scam users. Since it’s the browser on your machine that downloads and runs code from the web, it’s impossible for you to know if the code that’s downloaded is secure and trustworthy each time you go online. What’s more, the criminals’ attack “surface area” is even broader than the browser–there’s URL redirection and other potential weak points all the way across the chain from the user’s machine to the web destination.

At the same time, tracking one’s passwords has grown increasingly unmanageable. It seems like each site has different password strength requirements, minimum (or maximum) password lengths, set of characters you’re allowed to use, etc. To deal with this complexity, people end up setting weak passwords, re-using them across sites, or storing them in unsafe places. As a result, online accounts are more easily compromised by criminals.

Dealing with online security is a major pain point for consumers and businesses of all sizes. Authentic8 turns the problem on its head: What if you could simply outsource the headache of keeping your browser secure and managing all of your passwords to a trusted and reliable party? Authentic8 delivers the Simply Safe browsing experience.

Real Software Solving Real Problems
How they solve this problem is quite novel. Each time you access the web, Authentic8 launches a Disposable Browser in the cloud. In essence, you’re surfing the web in real-time from Authentic8’s servers where they manage all security aspects on your behalf. It’s called a disposable browser because they’re “single-use”–Authentic8 gives you a fresh browser instance each time you access the web and discards it when you’re done, a bit like dental floss or latex gloves. The implication is quite powerful: Malware never touches your machine.

What’s more, once you’re using Authentic8’s service, they do all the hard work of validating the destination site you’re trying to reach, as well as securely and automatically submitting your login credentials. So there’s no need to remember any passwords or manually generate new ones, as some sites periodically require. The company precisely fits our goal of investing in entrepreneurs building real software solving real problems.

Exceptional Team
Perhaps what we like most about our investment in Authentic8 is that we get to work with the two exceptional founders again–Scott Petry and Ramesh Rajagopal. Scott and Ramesh worked together for several years at Postini, the company Scott founded in 1999, which was a pioneer in security-related SaaS, where Ramesh was VP of Corporate Development (Google acquired Postini for $625M in 2007–an acquisition sponsored by my two partners, Salman Ullah, who led Corporate Development at Google, and Sean Dempsey, who led the overall acquisition).

The three of us at Merus also had the privilege of working with Ramesh for several years when we were all part of Microsoft’s Corporate Development & Strategy team. We’re also excited to be partnering with Foundry Group, which recently announced their investment in Authentic8.

To be considered for Authentic8’s beta program or for more information on the company:
Click here to be put on the list of future beta invitees. For some great insights and discussion on Internet security (like this one: “Macs & Volvos: Where perception transcends reality“), check out Authentic8’s blog, OSMoSis.



Posted in Cloud, Investments, Merus Capital, Software, Venture Capital.

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