Since its founding in 2009, Andreessen Horowitz has become a top Silicon Valley venture capital firm by adhering to a simple mantra: It’s all about the talent.
The firm looks closely at business plans, market analysis and the details of new technologies, of course. But whenever possible, it answers funding pitches from entrepreneurs within a few days rather than stringing them along indefinitely, as was customary in the industry. It employs dozens of people who help start-up founders with marketing, hiring and business development — providing fledgling companies with insider knowledge and connections they rarely have on their own.
“They have 100 people on staff, who almost become your employees,” said Ben Milne, a founder of an Andreessen-funded financial services start-up called Dwolla.
In some ways, Andreessen Horowitz is a talent agency as much as a tech investor. Marc Andreessen, the web pioneer who was a founder of Netscape and other companies before trying his hand at venture capital, has made this point explicitly. At a private event in 2010, a video of which The Wall Street Journal made public, he interviewed Michael Ovitz, the onetime Hollywood superagent who started Creative Artists Agency.
“A lot of what we’re trying to do at Andreessen Horowitz is based directly on Michael’s experience building C.A.A.,” Mr. Andreessen told the Silicon Valley big shots assembled for the occasion. The firm declined to comment for this article.
Similarities between the two businesses run deep. It’s not just that the Andreessen Horowitz partners, including Mr. Andreessen’s longtime collaborator, Ben Horowitz, realized that a V.C. firm could be run like a talent agency. It’s that the economics of Silicon Valley are uncannily similar to those of Hollywood. And by exploiting that insight, they may have helped inflate a tech bubble.
For all the attention Mr. Ovitz lavished on his stars — Creative Artists partners sat on boards of hospitals and private schools so they could help clients win preferential treatment — by far the most important things he procured for them were money and control.
In the mid-1970s, when Mr. Ovitz founded C.A.A., the breakdown of the traditional studio system had created a world in which stars had potentially enormous if little appreciated leverage. “For 60 years, the studios really took advantage of the creative talent,” Mr. Ovitz said in an interview. “We tried to change the entire curve.”
The studios still craved stars but no longer had formal sway over them through long-term contracts.
Mr. Ovitz assembled a murderers’ row of clients and used their collective power to win them fantastically lucrative business terms. “Ovitz said, ‘I’m going to straighten out your life,’ and he made a deal for me with Universal,” Martin Scorsese said in 1999. “They built these offices and screening room and helped me with my film foundation.” The firm also represented Dustin Hoffman, Tom Cruise and Glenn Close.
Mr. Andreessen, for his part, exploited a shift in power from venture capitalists to start-up founders in Silicon Valley. In the 1970s, V.C.s fronted entrepreneurs relatively small sums for large equity stakes in their start-ups. By the 2000s, however, new technologies trimmed the cost of getting a company off the ground. “We estimated that it costs 10 percent what it cost even 10 years ago to start a software company,” said David Golden of Revolution Ventures.
Deep-pocketed individual investors known as angels also made it possible for nearly anyone to start a company without a V.C.’s help. By the time an entrepreneur met with one, the business was more likely to be growing exponentially, making the V.C. the supplicant.
Venture capital used to be about ferreting out the best deals, said Naval Ravikant, a longtime investor who founded the investment syndication site AngelList. Now, he says, “the question is who gets access.”
Andreessen Horowitz’s pro-talent stance has helped win over founders, but as with Creative Artists the key to its recruiting success has been the allure of highly favorable financial terms.
The way the typical venture capital deal works is that the V.C. will place a “pre-money” valuation on the company he or she is hoping to fund, then add an equity stake on top of it. For example, if the V.C. deems the company to be worth $40 million before the investment, and invests $10 million, the V.C. will then own 20 percent of the company, now valued at $50 million. The higher the valuation, the better it is for the entrepreneur, who gives up less equity for a given amount of cash.
Within Silicon Valley, Andreessen Horowitz is famous for bidding valuations to heights that make rivals uncomfortable. To offset the dilution of ownership that comes from such prices, Andreessen Horowitz — which says it manages $4.2 billion in assets — increases the amount of money it invests. The firm often kicks in more than the entrepreneur asks for, according to rival V.C.s who have been involved in these deals. (Some investors agreed to speak only on the condition of anonymity.) “They want to basically change the table stakes in a poker game,” said Greg Kidd, an angel investor in several companies Andreessen later funded. “There are some other folks who can cut checks like that, but there aren’t that many.”
Venture capitalists who have bid against Andreessen Horowitz say the firm often comes in 50 to 100 percent higher than many other bidders, as when it led an ill-advised $40 million investment round in a daily deal site called Fab in 2011, which valued the company at $200 million. (The firm has occasionally passed on big deals, like one with Uber, that it felt were too costly.) These prices are flattering to the entrepreneur, who suddenly runs a company worth twice as much on paper as previously thought.
It is an article of faith in Hollywood that hiring stars significantly increases the chances of scoring a blockbuster. Alas, this is not the case. Studying movies released between the mid-1980s and mid-1990s, Arthur S. De Vany, an expert on film economics, found that the participation of only 19 star actors and directors appeared to improve a movie’s chances of grossing more than $50 million. And the stars’ stunning paydays often leeched away studio profits.
The forces that govern movies and start-ups are remarkably similar. They both follow what is known as a power-law distribution, meaning that the overwhelming majority of investments lose money, while a small fraction break even or become marginally profitable, and an even smaller fraction become wildly successful.
Mr. Andreessen and his partners seem to believe they’re playing a role analogous to that of Mr. Ovitz and his fellow superagents: They do what it takes to lock up talent, which they eventually sell to someone else at a huge markup. This generates profits for themselves and a nice payday for the stars, whether they are Hollywood celebrities or entrepreneurs.
But what if the Andreessen Horowitz partners have the analogy wrong? Rather than profiting like Mr. Ovitz and his fellow agents, the venture capitalists may be more like the Hollywood studios — chronically overpaying for projects whose costs they can rarely recoup. Mr. Andreessen and his partners have invested so much in so many start-ups that it would take a remarkable string of successes to make the approach pay off. For all their skill — the firm bought into the likes of Airbnb, Instagram and Pinterest relatively early — their track record suggests it’s unlikely. Already, they’ve suffered a few impressive flameouts, including Fab, on which they are likely to lose tens of millions of dollars.
Even when they pick well, they often bid so much for stars that the return is relatively modest. It’s easier to triple or quadruple your money when you’ve invested $10 million in a $100 million company than when you’ve invested nearly $100 million in a $1 billion company, as they did with the daily deal site Zulily. There are only so many companies that are acquired for billions of dollars or reach that kind of price through an initial public offering. Fewer retain such valuations — Zulily’s stock price has fallen sharply since last year.
More than is the case with other firms, the fate of Andreessen Horowitz may be closely tied to that of the overall tech market. If prices remain buoyant, the eye-popping valuations of the firm’s top-performing companies will keep it profitable and losses will be containable. But if the market turns, Andreessen Horowitz could have serious trouble.
Worse, Andreessen Horowitz isn’t just a beneficiary of behavior that’s driving up valuations. If a bubble is forming, it is ultimately because too much money is chasing too few companies. But the firm’s own aggressive bidding may be partly responsible. “Because there is competition for deals, when you have actors in the market showing no price discipline, it drives up the cost for everyone,” said one investor.
Naturally, Mr. Andreessen has argued that the tech market is rational — that tectonic forces, like the proliferation of smartphones, have fundamentally changed the value of popular software. But even Mr. Andreessen has expressed some concern. Last September, he posted on Twitter: “When the market turns, and it will turn, we will find out who has been swimming without trunks on.” He warned that companies that hadn’t conserved their cash would “vaporize.”
It may have been a plea to entrepreneurs on whom his firm had lavished tens of millions of dollars. Stars have many virtues. But the lesson taught by Hollywood is that they tend to make everyone poorer but themselves.
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