We chat with Alex Niehenke, a 10-year veteran of the venture capital space, to explore a few things you might not realize about life as a VC.
Tim Anglade, Executive-in-Residence at Scale Venture Partners: Alright, so, Principal at Scale, but this isn’t your first VC firm, right?
Alex Niehenke, Principal at Scale Venture Partners: No, no, I’ve actually been a venture capitalist for basically a decade now, so I started and Montgomery and Company, an investment bank, and we tried becoming a merchant bank, and so was doing some investing there in the mid-2000s and then actually joined a firm called Crosslink Capital and went through a very traditional associate program there, spent three years there and then joined Scale just about four and a half years ago.
VCs Do Most of Their Work Alone
Tim: Nice, nice, and so you’ve been kind of, helping out doing a lot of things, but you know I want to talk to you not about the business of the VC stuff, but rather the personal aspect of it; I found this Quora answer you wrote a long time ago about, I guess it was framed as here are the things people don’t know about what it’s really like to be a VC, the downsides, of being a VC. And you give a very thoughtful answer, and so one of the things you touched in there was this idea that it’s a pretty lonely job — do you still stand by that statement?
Alex: Oh, absolutely, I mean I think I popped on that Quora answer and it just kind of hit me in one of those moments, where you know, I was reflecting on this business and it’s a great job, I mean I really really enjoy this job, like I said I’ve been doing it for a decade, I can’t imagine myself doing anything else, but one of the things that people don’t talk about is what the job is actually really like and I think compared to what I hear from my peer’s jobs, or even what I experienced in my early career as in investment banking, or I was a college athlete, was it’s much less team-oriented than a lot of other things, it can be quite lonely. Specifically if you think about the job as an hourglass, it’s really lonely on the front end, and it’s really lonely on the back end, and there’s this piece in the middle where you collaborate.
On the front end I’m in my office, I really have to ideate which areas that I want to invest in, themes, markets that I’m compelled about, and that’ll induce me to go research, read some white papers online, maybe attend a conference, I’ll probably attend that conference by myself, and lots of entrepreneurs are there, they’re often there with their companies because they’re presenting a booth, there’s sales teams, and I’m there by myself, right and then I go back and then maybe I decide to meet with five companies in a specific market or around a certain theme, and I do most of those meetings by myself.
If there’s one that’s really interesting, or starting to percolate to the top, I’ll start grabbing my colleagues and I’ll start bouncing those ideas off of them, and I start entering that middle of the process and ultimately it gets to a point where yes, as a group, we really intensely collaborate and work with one another, and here at Scale I’m really fortunate to have great teammates that I can rely on and that will step in for getting idea through to a final point and through to the investment point, and at that point in time our whole partnership actually works together. But in that span, you know it can take on the shortest end weeks, sometimes months, and in certain cases years to get to a point where you get to that investment point then you make the investment and you’re on the board of directors.
And once again, you’re kind of by yourself, right, you have the other directors, but those aren’t your colleagues, and you have the management team, but they’re also not your colleagues, and yes you all work together but you’re, you’re kind of in it by yourself to a certain degree, and then you come back and you report to your partnership and you know, maybe I have a very specific problem where one of my other partners has a strong suit and so he’ll come to the next board meeting with me or he’ll jump on a call or she may know somebody that she can introduce me to, but there’s a lot of one on one time, and so when people come to me and they say, hey I would like to be a venture capitalist, I always like to highlight this point, hey, this may or may not be for you, but it’s something worth considering.
Tim: No absolutely, and even the time where you’re meeting people, you know, you’re grabbing coffee, and all that, it’s not the kind of social interaction maybe you find in other jobs. It’s much more superficial, maybe, for lack of a better word.
Alex: I can sometimes go through a day or two where I’ll trade emails with colleagues but I actually don’t talk to another member at Scale for a whole day or two which, you know, I get really excited to go in the office and grab lunch with people I’m like, yes, people who see me every day, or know me every day, whereas when you’re meeting with entrepreneurs often those are first time relationships right, you’re going on, you’re going on you know, like five first dates in a period of two days and you’re finding points to connect with those people and it’s kind of lonesome.
VCs are Partners One Day, Competitors the Next
Tim: Right, and so part of maybe what makes it lonely it seems from the outside is that, that competitiveness that there is between partners sometimes within a firm, but also between firms that we see. There’s a lot of companies to fund but there’s not that many really great companies, people want to invest in the same, and I find that there’s a lot of competition but there’s also a lot of cooperation sometimes.
Alex: I mean, I think one of the fascinating things about the venture industry is people who are your competitors one day are your partners the next day, and so my peers at other venture firms, we collaborate all the time because I’m interested in the companies that are in their portfolio, and vice versa. But then the next week we’re both looking at a deal that you know, both of us discovered and we’re going to be competing because we want to invest in that, and so it creates these fascinating dynamics where we’re all playing this very subtle poker with each other, and I think turning the tune back to where I started my career, gee, my investment banking class had 12 people in it, two of us are now on the buy side, and a number of other people have aspired to do that, there was probably, if you include my year, the year above me, year below me, across the industry in San Francisco, probably 50 people that were venture associates, I think maybe five of us are still in venture, and so it’s this funnel that keeps getting narrowed, of the people that actually continue in the industry and scale in the industry and I think a lot of the people that remain are people that by nature are very driven and very, very competitive, and so you know I think on the one hand we all want to win, and rarely are companies backed by only one VC, but like you said there’s only so many great deals and gee, the people that enter this industry are all very competitive, and you look at your peer who’s at another venture fund, and gee he just did a really good deal and you’re like shoot, now it’s my turn, I need to go find a really good deal. And so it really drives you to work a ton and that, once again kind of starts that loneliness cycle a little bit.
Tim: Yeah, and it seems to also drive kind of, urgency, you know, almost maybe in that hourglass shape. Things take a long long time, up to years, sometimes, to get to investment, but then when the deal materializes, like you really don’t want to miss out on it, you don’t want anybody else to like, swoop in and grab it, so it seems like there’s an intense rush of energy I’ve seen in terms of how that happens.
There are Deep Personal Financial Implications to Being a VC
Tim: So the last thing I wanted to talk about is something I didn’t know about the VC life at all, but when VCs put money into a company, there’s a personal implication there as well. Could you maybe explain that a little bit?
Alex: Yeah, no, I mean I think the economics of the venture industry are not that well understood, but traditionally the way that venture funds make money is the two and 20 model, and specifically what I mean when I say two and 20 is we get two percent per year of our fund size to manage that fund, and then once that fund gets returned, we get 20% of the upside, so if you imagine for simple math, $100 million fund, we get paid two million dollars per year to manage that fund, and once we’ve returned, we invest $100 million and then once we’ve returned that $100 million, each incremental dollar that we return we get 20 cents off of that, so if we return $200 million on a $100 million fund, the partners would get $20 million.
Now that all sounds really exciting, two million dollars, 20 million dollars, you’re like oh my gosh, all venture capitalists are really rich, and I think people read this and they’re like yeah, gee, these guys are all driving Teslas and they all have homes in Sun Valley and life is good, meanwhile I live in a 900 square foot apartment in San Francisco and I don’t own property, so something isn’t adding up and what that really comes down to, and I think for mid-level professionals in the venture industry like myself, VPs, Principals, young partners, is that our limited partners very frequently want us to make a commitment too and once again, this number’s actually two percent, coincidence, versus the other two percent, but if we have a $100 million fund, our limited partners, that’s our investors, will say “Gee, we want you to commit, out of that $100 million, two million dollars. We want you to have skin in the game.” And so we’ll raise $98 million from other investors, and we ourselves will invest the additional two million dollars.
For somebody, you know I’m in my mid-30s now, I don’t have to commit two million dollars myself, my partners all of us would have to, if we had a $100 million fund, would have to commit our portion of that, but you can very quickly realize in a partnership of three, five, seven, 10 people, how these numbers can become quite significant, and so when we make a investment decision we have to write our portion of that investment into the deal and that can pile up; and so as you raise multiple funds, because it’s very common for venture funds to raise a fund every three or five years, you start having multiple funds that all have these commitments and so you’re investing all of this money into companies that you really believe in via your funds, and you’re really fired up about that, because in the back of your mind you’re like, I am going to own a Tesla, I am going to have that house in Sun Valley, but meanwhile you’re looking at your savings account and it’s just going down and going down because the truth of the matter is, in the venture business, the payback cycles can be very long and so it’s not uncommon for a venture fund five years in to not have returned all the invested capital yet. Very frequently, that can take seven, eight years, in less successful funds sometimes as long as 10 or 12 years or in really difficult situations it never happens.
That’s the scenario you’d never hope for, but you can imagine, gee, if these cycles are five, seven, eight years across a couple of funds, you can start being in a position to be an investor in these funds in your late 20s and you won’t see a single check back until your mid, late, potentially mid-late 30s, early 40s. There’s a 10 year gap there before you start seeing any sort of success and so, to put it in company terms, you know, there’s a lot of money going out and not very much money coming back in.
Tim: Yeah but again, it’s not that perception people have VCs playing with other people’s money, right? Your own net worth is really tied up in a lot of these deals.
Alex: Oh, gosh, I mean look, you know, personal finances are always a sensitive matter but I’m very committed to Scale, I’m very committed to venture capital.
Tim: Right, that makes sense, that makes a lot of sense. Thank you so much Alex.