The Readiness of Arthur Patterson
Prepared Mind
Not a whit, we defy augury; there's a special providence in
the fall of a sparrow. If it be now, 'tis not to come; if it be
not to come, it will be now; if it be not now, yet it will come:
the readiness is all. Since no man knows aught of what he leaves,
what is't to leave betimes? Let be.
- William Shakespeare, Hamlet
Disclaimer
The following post is fashioned from Arthur Patterson's interviews and public statements. Sources are cited. Despite every attempt having been made to preserve their original intent, misinterpretations and errors are, of course, possible. Caveat lector.
Contents
Preparations
Process
Experiments
Persistence
Cycles
Franchise
Doing Good
Sources
Preparations
I got into the venture business in 1971 after working for the Treasury Department for a few years. I began at Citicorp Venture Capital and the business was completely different back then. After the stock market bubble in 1969, the next few years saw venture really dry up. By 1974, the business had virtually stopped. Tandem was the only deal of note that even got done that year. There weren’t any private deals around, so I actually talked the bank into letting me buy public companies, because they were very cheap, and it gave me a lot of experience in public market investing. That whole Citicorp portfolio eventually compounded at 30% from when they started the thing in the late 1960s. [1] [2]
By 1978 the venture business really got going again, so you could begin to raise money and start a new fund. Before that, no one really could. There were a few oddball little funds like Kleiner Perkins who were started in 1972, but they didn't have any money and hardly did anything. So in 1978, Jim Swartz and I started Adler and Company, and we did about 50 deals in the next five years. Then we could raise off of that record, so we were able to found Accel in 1983. [1]
We had the good fortune of starting a new fund at a time when the market had gotten to a scale where you could begin to specialize. It was actually very hard for existing firms to specialize because the partners had all done a variety of deals and were largely generalists. You couldn’t say one partner has to take all the medical deals, while one partner takes all the semiconductor deals. Everybody was just very thinly spread. We took the opposite approach. Jim had done several notable communication deals, while I'd done a few software deals. So, I was going to do software, and he was going to do telecommunications. A little later, we hired a third partner to do medical deals. By virtue of focusing and only doing those deals, we could take a much more systematic approach to thinking about the business, which other people with their portfolios all bogged down just weren't in a position to do. And so we took advantage of the fact that we were a startup and we had a clean start. [1]
The concept of ‘Prepared Mind’ stemmed from this. We were able to be much more intentional in thinking about what sectors we really wanted to be in, and who we should get to know, really in a way that people in venture previously hadn't. This way of going about the business is what we began to articulate as adopting a ‘Prepared Mind’. And we would say the test of whether you’re prepared or not is that when an entrepreneur walks in the door, you should know 90% of his business already, you just haven't found the right person to supply that critical 10% of what was needed for the idea to succeed. [1]
Portal was my best-ever deal, we made a thousand to one on the investment, but it had actually been turned down by all the other venture guys who said they might be interested, but wanted a new CEO. Because I'd been in the internet services business, I knew how important the billing systems were, and so I recognized the opportunity. Essentially, I had a ‘Prepared Mind’, while other people got stuck on red herrings like management, and missed it. [1]
Process
We have certain processes in place to institutionalize the experience within Accel. A venture firm will be more or less successful depending on how professional and consistent it can be over a long period of time. It sounds very easy, but turns out to be very hard. We have been lucky, but we have also been consistently professional. Anybody can have a Google or a Facebook and then you look at the portfolio and it looks very good. The lucky venture firms would probably produce a 30% return per year. Regardless, over extended periods of time, better processes, better people, and professional commitment make a big difference. These little things, however, are hard to do in a consistent way. [3]
At Accel, we spend a lot of time thinking about where we want to be before we decide to be the first institutional investor in a startup. There is intense discussion about which areas are evolving, which ones are passé, and which ones will be the most fruitful for us to focus and be really up-to-speed on. Our philosophy is to think about business areas deeply so that when an entrepreneur comes in to present a plan, the partners gauging him know 90% of what he is going to talk about and can focus on figuring out if he is the right entrepreneur can put all the macro factors together. So you are just looking at the entrepreneur to bridge that last 10%. Unless you have prepared yourself well, you are not going to recognize either the opportunity or why this is the team for that opportunity. Being first, the market share leader in any market is going to make the most money. But you have to choose the right spots: being first does not mean things will necessarily fall into place. [3]
Prior to investing in Facebook, we actually had an internal project where we were monitoring the consumer usage of software. We looked at some of the newer companies in this area and made ourselves very knowledgeable and available to people in the business. Then we met Mark Zuckerberg and recognized that it was the 10% that we were looking for. So we moved very quickly despite the company having no revenue at that point. We paid a very good price going in and it made sense to us as the company had already made brilliant progress. [3]
While 'logical potential buyers' can always be conjectured, we do not get into any startup thinking that we are going to sell at the first chance possible. We are keener on figuring out if there is a big enough opportunity both in terms of the company being funded and the segment it is going to play in. Now, if it scales up attractively, it will naturally attract buyer attention. However, selling a stake to a big- ger company depends a lot on the politics within those companies. Those are very unpredictable. Besides, in our experience, it takes anywhere from three to 10 years for a fledgling to scale up. We can't predict what or who in those 'logical buyers' would be interested in something in those time frames from now. [3]
Experiments
While the clock speed in a very ebullient financial market picks up, I don't think the fundamentals in the business pick up. And what is generally not recognized, certainly by the press, is that it's all a supply question. Venture guys think they're important, the entrepreneurs think they're important, but they’re just cogs in the wheel. There will be x number of new opportunities created by the technology and that's it. Now, there are better cogs and worse cogs, but you can't change the number. The Soviet Union probably would have invented something like the iPhone, it just would have taken them another 50 years. [1]
So, the fundamentals really haven't changed, but the later stage of venture has completely changed. The amount of money companies are able to raise is akin to public market investing, and the people doing this aren't venture guys, they're basically public investors. At Sequoia, probably only 10% of the guys there now are early-stage investors. [1]
At an early stage, the key thing is to treat each startup like an experiment. Now, if you go in and throw a lot of money at it, you'll probably be unsuccessful, because the whole process muddies the evidence, and you're not able to learn. You're administering sales forces instead of learning what they're doing out in the field. It’s better to try the product out on customers and see how to make the model work. Because it's going to change, and if you put 10 sales teams out in the field, you can't tell what's working, and what's not. [1] [2]
I’d say the importance of undertaking careful experiments at the beginning hasn't changed one iota in terms of building at the early stage. In Silicon Valley, you really are just conducting an experiment to find out where the next supply is. [1]
Persistence
Working in early-stage deals takes time. I’ve been in one for 23 years now. Eight is a more reasonable number, and five if you're lucky. Different firms have different approaches to this. Being new at Accel and being focused on industry, we took an approach that if we thought we had the thing pretty well dialed in as a good idea, we were willing to be patient. Now, it’s not just the entrepreneur, you have to get a tailwind in these markets, but the timing of that is really hard to predict. So we were very persistent in our projects and would carry them a lot longer and we'd have much higher percentage wins, but sometimes they took quite a while. In contrast somebody like Sequoia, who'd been in the business for a long time, because they had the franchise and a lot of supply coming in, if a company didn’t perform, they could be pretty ruthless. [1]
At Accel, the question was whether the company was making progress or not and whether what you were doing was the leader of this new opportunity. At that point in time, every year you had to go out and raise money from somebody that was a third party. Some companies may be making progress, but the market's evolving a little bit differently than you thought, and so they’re having to pivot. Thankfully, software can be malleable. That's why we pretty much gave up hardware projects because, if you don't get those right on day one, there would be no money for the next generation. Now, working on early-stage deals is kind of lonely. Even if you're in a partnership, it's your deal and it's your problem and you've got to keep coming back to your partners and telling them, we should keep supporting it. So you're responsible. We always have a “backup guy” at Accel, but he can get pretty far back when things aren’t working. [1]
So, frequently you're just working away on this thing with the entrepreneur trying to help them figure it out and help them raise money and help them find the strategy and recruiting people. It's this sort of long, lonely process. It might go on for five, or eight years or more and you have to have individuals that are intelligent, earnest, and curious, and just don't have too much hubris. Remember, if you go in and grab the steering wheel, you're dead. [1]
At some firms, it's very tempting to go out and hire “executives” who have been notably successful in successful companies. Kleiner Perkins made a religion of that, but the early successful guys at the firm actually didn't, that wasn't their background. When you get to be really good at being an executive, you learn to hold on to the steering wheel, but this largely doesn’t work in venture. We found learning the business from the ground up to be by far the best model in terms of hiring at Accel. [1]
In the venture business, you don't need to be a genius, but you’ve got to be curious. You’ve got to be looking for people smarter than you, rather than being the expert yourself. Curiosity and personal sustainability, I think, are really important, as are luck and initiative. These are important factors, but they're not, in my view, enough. That's why we believe in this top-down, thinking-it-through, look-before-you-leap methodology. ‘Prepared Mind’ is about looking as hard as you can before you leap, because you may be in this thing for a long time and you're not going to discard it on its first hiccup. [1] [2]
There is no question that you learn much more in companies that you struggle with because there is a lot more work and involvement and harder problems to solve. In the portfolio perhaps only 10% of them are going to work just like you thought they were going to work and be straight up just like the spreadsheet said they were going to be. In over 80% there will be setbacks. One of the fundamental reasons Silicon Valley throws up successful companies is because they have to raise money once every year, approximately, in their early years. Since it involves third parties, it is a very competitive and objective process. So when a startup can't raise new money, you know that it’s gone off-course in some way. You can see there is no new direction, the progress made isn't enough and there is no realistic alternative because you have miscalculated the market development speed. Then it is a question of how long you work to get it back on trajectory and how patient you want to be. That depends on how good the team is, and how big the area is. Our investment approach has very high quality control at the front end and that is why we are a lot more patient on getting things back on track. [3]
Cycles
In the technology cycle, digital media consumer-oriented projects always seem to succeed the first. The heavy-duty projects that tend to lag are SaaS, Big Data, storage, and infrastructure. But to some extent, they are pulled forward by the demands of the digital media companies, the Googles and the Facebooks whose dependence on back-end infrastructure is high. The first wave was more the consumer digital media companies; that is now shifting and infrastructure companies are receiving more funding and beginning to go public. [2] [3]
If you look at today's companies many of those ideas were talked about in the 1999 period. But the enabling infrastructure in terms of broadband availability, computing power, and social capabilities, just didn't exist then. Successful companies always capitalize on and ride these external forces. Some things start as just an application, like Facebook. Today Google and Facebook have become a big external factor to many startups as they have become a standard. Getting the timing of these external forces right is half luck and half skill - perhaps 80% luck. For the really big winners, it is 90% luck. [3]
It is one thing to say it is a cycle, but quite another to establish the causality. My view is that it is driven by the 30% improvement that happens in the underlying raw materials of the business. It is like oil getting 30% cheaper every year. It won't make much of a difference in the first year or the second. But by the time it is down by 80-90%, businesses depending on it will have changed dramatically. [3]
You couldn't do Facebook in 2000. The technology just wasn't there. But by 2004 with this steady improvement, you could. Then you get this jump and then this thing accelerates because companies like Facebook become platforms themselves that others like Groupon or Zynga build on. But when you get past the peak, then everything built on the fundamentals will diminish. [3]
If you look at the 1969 peak, what companies sold for is much more extreme than the 1983 peak and the 1999 peak was more extreme than the 1983 peak. The causality is that people have forgotten the last cycle and they are less cautious. In comparison, in this cycle, the startups that are getting funded are much less speculative than was the case in 1999. We are manufacturers of companies. If we can sell what we have got, we will make more of them. That is why I say hundreds of companies will go public before the cycle heads down. [3]
During the 1999 gold rush, listed incubators such as CMGI and ICG fuelled startups before flaming out. But largely, liquidity goes into commodities and real estate and can't flow into venture capital even if it wants to. There is just no place for it to go. [2]
As it is, the best new ideas don't absorb much cash. The size of our early-stage funds has actually declined. Later-stage funds can absorb more capital, which is happening. There is some expansion with angel investors participating and that always changes the business for a little while. [3]
There is always too much venture capital for a small number of really good ideas. Ever since I got into the business in 1971 it has been too much. It is a supply-driven business, not a demand-driven business. Liquidity constitutes demand. [3]
Franchise
Looking ahead, I think funds that have raised enormous amounts of money will be at a disadvantage in doing good early-stage investments. What they do have going for them is that they've got good franchises. It's so valuable for a new company to get Sequoia's name on them that they will continue to have a good supply at the front end. We had to take a distinct approach at Accel because we didn't have a built-up franchise, so we didn't have as good a supply of companies to invest in. [1]
Maintaining a franchise is hard, and to do that you have to keep renewing by getting new people in the firm. Otherwise, the team and the efforts at a firm can become diluted. Look at Kleiner Perkins. They neglected their early-stage stuff to some extent, and they didn't protect their franchise. It's hard to protect your franchise, because it's so much harder to do this early-stage business than the later stage, so people at the firm will naturally gravitate towards the latter. [1]
There’s no question that a Sequoia partner who's now got five houses and two yachts is not going to be rustling around Silicon Valley at seven o'clock in the morning looking for a new deal, but a newer and more energetic guy might. Beneath these established firms, there’s been an enormous explosion of early-stage funds. These guys, may not have the franchise flow going for them, but they may be able to compensate for some of that by just making more effort. It’s a competitive world out there, and the question is, how can you make the best of your advantages and diminish your disadvantages? [1]
Doing Good
I find the profession to be very satisfying because I feel you're doing good, you're doing well by doing good every day. You're working with companies and trying to teach entrepreneurs all the mistakes you've made so they don't waste money making the same mistakes. Plus you're creating all these jobs for so many people, and you're making out well yourself. [1]
I believe our whole standard of living is dependent on the free market system, and entrepreneurs are a critical element of that. I think these big companies just become so unproductive that our standard of living in the country wouldn't be very good if they were left as they are. Look at the contribution of Silicon Valley, not just to the United States, but to the whole world. [1] [4]
I think it's a very satisfying profession to be in. The individual company can go up and down, and it definitely feels better when they're going up, than when they're going down. But, fortunately, I’ve usually got some marbles on either side. [1]
Sources
Patterson, Arthur, and Tom Chavez. "Q&A with Accel Founder Arthur Patterson." super{set}, 2023. https://www.superset.com/feed/q-a-with-arthur-patterson-hosted-by-tom-chavez.
Patterson, Arthur. “Investing in the Dot-Com Bubble." Stanford MS&E 476, 2016.
Mahalakshmi, N, and Rajesh Padmashali. "Being first does not mean things will necessarily fall into place." Outlook Business, 2013. Available at: https://www.outlookbusiness.com/specials-34/masterspeak/being-first-does-not-mean-things-will-necessarily-fall-into-place-1315.
Patterson, Arthur. "Acceptance Remarks for NVCA’s ‘22 Lifetime Achievement Award." Accel, 2022. Available at: https://www.accel.com/noteworthy/acceptance-remarks-for-nvcas-22-life-time-achievement-award.
Patterson, Arthur, Jim Swartz, and Harry Stebbings. "20VC Special: Accel Founders Arthur Patterson and Jim Swartz on Building Accel Into One of the Most Prominent Venture Firms Over Four Decades." The Twenty Minute VC, 2021. https://www.thetwentyminutevc.com/jim-swartz-arthur-patterson/.
Efrati, Amir. "2014: The Beginning of the End of the Tech Boom." The Information, 2013. Available at: https://www.theinformation.com/articles/2014-the-beginning-of-the-end-of-the-tech-boom.