We are all about change…and want to walk the talk. That being said, we also know what we are and are not.

The site has been functional (and non-functional at times) but needs to better reflect the diversity of Houston’s startup community. So I am placing an all points bulletin to anyone with some skillz (which I lack) that is interested in helping us revamp the site to reflect some expansions we want to implement.

If you are interested in donating your time, either comment on this post or email me (josh@startuphouston.com) so we can discuss what we need done. Startup Houston wants you!

So today I got a nice little note from the guys at DFJ Mercury letting me know that they made Entrepreneur Magazine’s VC100 list of Top 100 venture capital firms for a second straight year. The guys did 4 “first time fundings” last year (Phurnace, Marval, Illumitex and Glycos Bio) which was as many as our friends to the west of us did. Congratulations to the guys for a heckuva year and continued success.

As part of the note, DFJ Mercury founder and Startup Houston supporter, Blair Garrou was quoted as saying:

“Although we appreciate the recognition, it’s not a numbers game for us. We are excited about playing our role in the Texas startup eco-system and look at every deal, one at a time. We only wish more VCs were funding seed and early-stage Texas companies.”

First of all, G-d love Blair’s humility. For those of you who have never spent quality time with him, you are missing out on his wisdom and passion for Houston’s technology eco-system. But my digression is not to lay praise on DFJ and Blair as much as broaden the discussion about the venture market’s current temperature.

Jeff Cornwall (I love this guy…it’s a forum, not a blog) addressed some interesting points that came out of a recent report from the National Venture Capital Association (NVCA). It is no secret that the IPO market has all but dried up and strategic sales will also be under pressure with expensive oil and a cheap dollar. With all of that plus global unrest shoved in our faces by the media, I can imagine startups are quaking in their boots.

Don’t.

Let me explain venture investing once again: money goes where it can earn a return high enough to compensate for the level of risk involved in the investment. Higher risks require higher potential returns. Luis Villalobos and Bill Payne, Managing Director, Angel Venture Partners wrote about this in a piece for Kauffman eVenturing:

“In a typical angel investor’s portfolio of ten investments in seed/startup companies, half the companies perish with no return to investors, and an additional three or four companies return some capital or provide a modest return on investment. Investors hope these three or four companies will at least return the capital for the entire portfolio-all ten investments. Ultimately, only one or two of ten investments will strike it big and bring virtually all of the return on investment to the portfolio.”

What this tells me is that venture investing is a numbers game and that the numbers need to be big for it to make any sense to play the game. Think about this, venture capital funds sustain themselves until the fund returns back to the limited partners (which could be 5-10 years) anywere from 1-3% in the form of a management fee. To make that number material enough for you to quit your high paying job and start a fund requires a large enough fund to keep you out of the poorhouse. So now you’ve got $100 million dollars and the average indicates that 50% or more of your bets will fail miserably. That leaves you with 30%-40% that may make the partners money back for them. Since the fund managers did not get into this crazy business to breakeven, that leaves you with 10%-20% that are potential black swans that might generate the >35% return that venture investors look for at a minimum. And don’t even get me started about dilution.

So ignore what you read…stats are not gospel. Venture capitalists need to keep laying bets all over the place just to make the returns happen. Without volume, they will succumb to the bell curve and be back looking for work in no time. And just because for 3 months out of the last 60 some odd years there were no venture backed IPOs does not harken the apocolypse. Come up with a disruptive technology or business model and funding will fall like manna from the heavens…or maybe from a guy named Blair.

I got the horse right here
The name is Paul Revere
And here’s a guy that says that the weather’s clear
Can do, can do, this guy says the horse can do
If he says the horse can do, can do, can do.

“Fugue for Tinhorns” from Guys And Dolls

I like analogies (and music lyrics also if you can’t tell by now). People often ask me what investors look for when evaluating an investment in a startup company. Marc Andreesen identified three core elements of a startup: team, product and market. One could argue which is the most important of the three and Mr. Andreesen makes the case for market…which I somewhat agree with and will explain how momentarily.

But many would-be starter uppers seem to have a difficult time comprehending the issues with ensuring that all three core elements are focused on. So here is another way of looking at this: horse racing.

• Product – the horse is the product and is developed from a young age to compete through natural (organic growth) and artificial means (mergers and acquisitions). The owner (founder) is usually the one with the vision and keen eye (not always) who identifies the horse at a young age or acquires stud rights to a proven race horse (commercialization or technology transfer) from a quality breeder (university or research and development arm within a company).
• Team – In a race, the team is comprised of a jockey, trainers and owners (think of investors as the people in the stands placing bets on the race and not as owners…investors own to sell.) We’ve already identified the owner and the trainer is usually the second hire or partner (technologist or engineer) brought into the team. The trainer develops the horse by means mentioned above and as the horse shows promise, adds to the team to compete on a grander scale. The jockey (CEO or team leader) is either an up-and-coming talent or an experienced racer whose sole purpose is to get the most out of the horse on race day.
• Market – This is the race or season in which the horse and jockey compete. Horse racing occurs on a dirt track. Track conditions play an important part in the race as well as position, field, stakes and multiple other factors.

Here is why I agree that the market is the most important element: the best horse trained and run by the best team will lose if they run the wrong race, at the wrong time, under the wrong conditions, etc.

Skill, preparation, experience, funding are all of tantamount importance in getting up to the day of the race. You will not even be able to compete without them. That being said, once the gun sounds, luck has more to do with winning than any other factor. Investors know this (and so do the bettors…venture capitalists are the ones in the fancy hats and blazers) and can only evaluate what is known. That being said, investors like to bet where the odds allow for a big fat return.

So back to the original question: what are investors looking for?

Investors are looking to make a bet on a good horse managed by a good team to run a race with a purse big enough for him/her to make it worth there time and effort. They will evaluate the jockey’s history, trainer’s experience, strength and conditioning of the horse, conditions of the race, the odds of a win, place or show and how large the payoff will be.

If you don’t get it now…let me know and I will try another analogy.