Wednesday, April 5, 2006
Interview with Jim Armstrong, Clearstone Venture Partners
I spoke with Jim Armstrong, who is Managing Director of Clearstone Venture Partners (www.clearstone.com) the other day, to get a sense of where they are investing nowadays, and for Jim's views on where the venture market is here in Southern California. Jim also talked to me about the whole idea of a venture capital ecosystem, and the challenges of the industry here in the area around experienced management.
Ben Kuo: What is Clearstone up to nowadays—I understand you have a new fund you've been making investments from?
Jim Armstrong: We're already halfway through that new fund—we've been really active. We're doing a lot in Southern California. We have two offices, one in Southern California and the other in Northern California, with the portfolio pretty evenly split between the two. We also have a person on the ground in India, and are making investments in companies selling to the Indian market. We're still learning how to do companies that do business there. Sumant, my partner, has built companies over there, and he's helping to manage that effort. It's not that we have a confirmed point of view on what the opportunity is there, but if you think about media—and think think about half the population of India and China, 1.2 billion each—is under the age of 35. It's pretty incredible how youthful that culture is, versus Europe, which is aging, and other countries, which have dominated youth, media, technology in the past. Historically, things have shifted to where the youth are. Most people there think that the opportunity in India is later stage, but we're actually doing early stage deals there.
In general we're really doing lots of early stage deals—we'd love to do later stage, but just don't see that many opportunities. There's lots of money out there flowing into later stage deals quickly, so we tend to do early stage companies. Everything except one investment we've done in our new fund has been a Series A.
BK: For those not familiar with Clearstone, what you are looking for, and what's your typical investment profile?
JA: We are willing to take management risk. Most investments you can boil down to fours risks – management risk, market risk, and product risk--if you have the right product built, if it's technologically difficult or just trying to figure out the right feature set--and then capital risk –if you have enough money to reach your next milestone. It takes market risk to be an early stage fund, but some firms are less comfortable with taking management risk. However, we are willing to take management risk, and will help find a new CEO and help stage the management to grow--we see the diamond in the rough there. For example, we've invested in Integrian, Siderean, and other companies you know and have talked to. Integrian has a bright CEO there from the get go, but other companies were involved in a Series A include SupplyFrame, where we immediately got involved and worked alongside the founders to find the right CEO. At Siderean and Supplyframe (formerly SupplyFX) the founders were pretty happy with that process.
We're known for consumer Internet, with Overture, Paypal, NetZero, Tickets, Emusic, and the infamous Etoys. We have lots of experience with companies like that, and are still doing that. In general, we try to be contrarians a little bit. By the time the capital market community gets excited about something, and they come to a consensus on something, it's my belief that you should be looking elsewhere. Almost by definition when you make an investment you want people to say “that doesn't really make sense to me”. For example, when we made an investment in Overture, people asked why we were investing in another search engine you've already got Inktomi—that was when GoTo.com got started. The idea is to be in an important market with the right product at the right time and not to have a billion people trying to knock each other's heads in.
BK: I usually ask VCs what areas are hot, but however maybe tell me what areas you think are overinvested?
JA: I think that a lot of the mobile plays – we have our mobile plays, too – are overinvested. I know it's a big market, especially in foreign countries--mobile is adding four million subscribers a month in India. But that kind of underlying fact, thwarted the opportunity here. There's a lot of companies are funding video, and other sorts of content over your mobile device. There are already 30 to 40 companies to help people watch movies through their handset. First you have to build a company with the right management, and with the right amount of capital, then you have to wait for the market to happen. If you look at past investments by VCs – myself included—we have grossly overestimated how long it takes for a market to come online. Then we've underestimated how much impact that market will be when it finally does. One of my mentors at Austin Ventures used to say “I invest in two kinds of bad companies – early and way early.” It's kind of true, if you think about companies that are now taking off we've all invested in and lost money. I had a local search company in 1999, working with SBC and YellowPages (Handshake.com). They were selling IT before the plumber or the pizza shop or hospital was thinking about marketing themselves online. It wasn't until those local people started losing market share and when their competitors started buying keywords that they started advertising online. A lot of the ideas have real merit, but getting the market timing is really difficult.
In terms of our profile – we look at consumer Internet, thinking about services, and are highly interested in software. In the VC community software is considered dead. You can build up a company to 40-50 million in revenue, and it's only worth 40-50 million dollars. Except for Salesforce.com, the multiples of software companies have been crushed. Venture capital firms are shedding their partners who focus on software. However, that's still the main way—through a browser software interface for consumers, or enterprise workers—that people interact with compute power, bandwidth, storage, and everything else. The high level themes I am looking at are correlation and context.
I'm looking for software that doesn't necessarily have a deep infrastructure behind it. I'm looking at analytical, algorithmic software. I don't know what your biggest issues are Ben, but I know that at 10pm at night, you have 30 emails, and you need to figure out if you want to check it, or do I go to bed, and in the morning you'll have 70 emails, and if you don't get them by lunchtime it will be 100 emails. Software that can help people take information, correlate it to other information in their lives, so you can put it into context—software that can say, Ben—Jim Armstrong just sent you his new cell number—the number you have in Outlook is out of date--would you like me to update this for you, or that goes ahead and updates it and lets you know. That's one theme I'm working on. A broader theme is company building—companies that are building software functionality, sold to enterprise customers to non-IT budgets. If you think about Salesforce.com, they sell software functionality to the sales and marketing budget. If you think about Google—their constituent is the consumer, but their customer is the enterprise marketing budget. They are trying to get people to shift money out of traditional marketing to keyword marketing. For people who can sell software to non-IT budgets, there are lots of opportunities.
BK: I often hear people mention you in the context of an ecosystem around venture capital. What are you thoughts about this?
JA: To me, this is rapidly proving and scaling. The idea actually came from Ted Alexander at Mission, Jay Houlihan at Innocal, and Brad Jones at Redpoint, along with others. For me, I still spend thirty to forty percent of my time up there in the Bay Area—I'm flying up there in the morning, and I'm going to spend the week working out of my Menlo Park office. Up there, there are really well worn syndicate relationships. These relationships help VCs take more risk, which is always a good thing. In general, many VCs are more risk averse than they are being paid for by their LPs. Their LPs would be disappointed in what the asset class is trying to do and what people are trying to do with their resumes, there's a mismatch there. Anyway, in general, anytime you can say, this is a really risky investment I normally wouldn't do it, but I know I am working with a good guy, there's another venture fund to support it, he makes me think better, he/she challenges me every time, so I will make this investment--that helps companies get funded. That's an important part of the ecosystem. It's not the most important—it's kind of a poor man's second to the entrepreneurs getting together.
In Northern California, the capital community is syndicating. This sometimes gets described as cliques, but in general it's a very positive thing. In Southern California, at least a few years ago, this absolutely was not happening. We were all working here in the community but not calling up each other. Now, we have a more mature venture community. The other problem is that we're so spread out. We have 5 markets. It's so different that you have to think relocating the CEO, employees just to move within the area. You've got the Westlake Village, 101 to Santa Barbara area. You've got Pasadena, with Caltech and JDS Uniphase out there, Idealab has had a great influence out there. Nowadays if you go out to Pasadena, it is just crawling with top notch Yahoo executives, vested and ready for the right opportunity. It's just amazing what Yahoo has done for the area by not moving Overture. Then there is Web 2.0. You've got Google's market cap, you've got a couple of M&A's up north– but Web 2.0 is all about Santa Monica. In the last 16 months there was Rent.com, Lowermybills, Shopzilla, Pricegrabber, Neopets, Jamdat, MySpace--you'be got EA moving a lot of their gamers from Redwood Shores to Playa Vista--Yahoo taking a quarter million square feet, Ebay taking a quarter million square feet, Google taking 50,000 square feet in downtown and raising their big obnoxious flag--that all bodes well. In Orange county, you have Emulex, Qlogic, Broadcom, Western digital—an many assembly manufacturing companies—and other companies moving in to draw the best of engineering from both Orange County and the Los Angeles basin. San Diego has really become a wireless hub. It's table stakes to have design center in San Diego—you need to have presence there if you are in wireless. We'll see if that develops around gaming or mobile. When you think about those 5 markets in Southern California – that's tough. I don't get down to San Diego as much as I like, or up to Santa Barbara, or to see what's going on at Caltech very often. It's a lot of ground to cover. Anybody who does anything – whether it's Bill Gross at Idealab, whether it's the guys coming out of Myspace with their incubator, whether it's Clearstone, or Redpoint to try to aggregate that community – just get us talking more. One thing we've done well is to get the venture community to talk more, with quarterly events.
No matter where we start the conversation, whether it's talking about fundraising, what's going on with other venture markets—and we have twelve to fourteen VCs talking about this tuff—its always end up on management, management, management. We've got all the raw materials here, we're just trying to get more and more serial entrepreneurs—people who have “seen the movie before” as I like to term it—people who get the whole scaling of a company—matching funding, hitting milestones, not wigging out when a company doesn't go smoothly—knowing how to recruit talent, not being a big company person, not just an engineer, not just an MBA, but who have all those skill sets wrapped together. Those serial entrepreneurs area like gold in my business, and we'll do anything to hang on to them. That's some of the challenges in the ecosystem.
There's an incredible amount of talent in Southern California right now. The challenge is to create the right opportunities to keep them here. Invariable, I hear the same things from executives—I love it here, my wife and family are here, but all my interesting offers are coming from up north, looks like I'll have to relocate even though I don't want to. The VC community needs to do better job of maximizing that talent.
BK: Thanks for the interview!