Our Focus

The Opportunity Fund

We founded Union Square Ventures in 2003 to invest in the applications layer of the web. Over the last seven years, we have refined that investment focus. We now invest almost exclusively in Internet services that create large networks. Some might think this focus is narrow. We don't see it that way at all. We believe the irresistible economics of Internet networks will ultimately transform the entire global economy. We continue to be very excited by the opportunity to invest in that transformation. Early on, we recognized that investing in web services was different than investing in chips, routers and...

The Mobile Challenge

We are fascinated by the disruption underway in mobile applications. Carriers seem to have lost their role as gatekeepers for applications as smartphone sales are rapidly ramping and "app stores" or direct downloads are the new distribution models. This is exciting as it opens up a whole new arena for startups to compete in. Here is some of our early thinking about this with the goal of getting a discussion going.

The challenge for startups (and investors!) has been identifying opportunities that are "native" to the new platforms. By "native" we mean opportunities that simply did not exist previously and cannot exist without the phone. For instance, we would not consider delivering breaking news to a mobile a native opportunity, as a startup rarely has a better chance of being "CNN for mobile" than CNN does.

Why We Don't Invest In Competitive Businesses

I was trading emails with one of our portfolio company CEOs last week. The subject was a company that was looking for venture capital that offered a service that was similar to one of the services our portfolio company offered. The CEO was encouraging me to take a close look. He said, "someone is going to invest, it might as well be someone close to our company".

I told him that I completely disagreed with that philosophy. I said "When a VC invests in competitive companies it's like an open marriage. It sounds all well and good, but it's going to create problems down the road."

He laughed and suggested I blog that. And so I have.

Founders and Management

It's been a while since our last post on this blog. Year end activities got in the way. We were in the midst of a string of posts on what we look for in our investments when we went radio silent. We've addressed issues like the stage we like to invest (early), the amount of traction the company has made, our desired role as lead investor, deal size, and our approach to geography.

We figured we'd come back strong by addressing the most important piece of venture capital investing equation - the people we are considering backing.

Background
There are two kinds of people that we have to consider in this process. There is the person or group of people who came up with the idea and started the company, the founders...

Geography

Each month we see something like thirty to fifty new investment opportunities that generally fit our investment strategy. They come from all over the place. Just in the past month, we've seen opportunities in Israel, Australia, China, London, San Diego, Boulder, Atlanta, Boston and the Bay Area. It seems like our deal flow gets more geographically diverse every month. Web delivered technology startups are sprouting up all over the world.

But if you look at the eight investments we've made so far in our current fund, seven have been in the New York area and one has been in Chicago. We have not yet made an investment in the Bay Area even though we have seen many high quality deals from there over the past couple years.

Deal Size

Brad and I have been doing early stage investing since the late 80s (me) and early 90s (Brad). For most of our career, a typical early stage venture round was $5mm to $6mm and you'd put two firms together and each would invest $2.5mm to $3mm.

So when we sat down to build the business plan for Union Square Ventures, we started with that model. But recognizing that we were focusing on a sector (web services) which could be a lot more capital efficient, we put another kind of investment in the model, the $1mm investment. We assumed that about 25% of our investments would start with much smaller bite sizes.

We are about half way through building our portfolio and here is the distribution of initial investment sizes (I am including one investment we are about to close in here as well):

Lead Investor

My good friend Charley says that I "don't follow very well". He means that I don't like to participate in the Series B and C rounds of deals that have been funded by other venture capital firms in the Series A rounds. He's right. I've never been very good at that style of investing and I don't plan on getting good at it either.

When Brad and I wrote down the list of things we wanted Union Square Ventures to focus on, lead investing was near the top of the list. And there are a bunch of reasons why.

Lead investing allows Union Square Ventures to establish the capital and governance structures for our portfolio companies. Once these are set, they are hard to change.

Traction

This is my second post on "other things we look for".

I hesitated to use the title Traction because its certainly one of the most overused words in the venture capital vernacular. But it is also the "shorthand" people use to talk about how much uptake a given project has gotten in the marketplace.

So the purpose of this post is to talk about how much "traction" we want to see in a given project before we will be comfortable investing in it.

We have two rules:

1. don't invest in consumer facing web services without any consumers using them


2. there is an exception to every rule

Early Stage Investing

I thought I'd lead off my series of posts on "other things we look for" with a discussion of our preference for early stage investing. Most of our investment approach is built on top of our foundation as early stage investors.

But what does early stage investing really mean? It means different things to different people. For us, early stage investing means putting capital to work in a company well before it is fully formed and therefore participating in the value creation that comes with developing a new business. We are thesis driven investors who have a very specific set of business characteristics we look for. Brad outlined them very well in his series of posts last month.

Scalability

One of the common concerns about IT enabled services generally and web services specifically is that they do not have the potential to scale. When the focus of venture capital was on IT infrastructure, this criticism was often voiced as " that's a feature not a company". Today, a lot of the most interesting web services do seem to do one thing well - think Google, YouTube, or Skype. There have also been a number of recent s that could lead one to the conclusion that the major web players will buy up all the neat "features" and integrate them into a more "complete" offering. Many would offer Flickr and del.icio.us as examples.

Defensibility

Historically the defensibility of information technology companies has been based on intellectual property - usually patents, sometimes copyrights. From the late 70s until the late 90s many venture backed start ups contributed key components to the information technology infrastructure we all now depend on. These businesses required a big R& D investment and often worked for several years developing their product before they hired their first sales or marketing people. Once they were ready to go to market they distributed their products through major equipment companies that sold a broad range of products to a large base of customers. Because it would have been relatively easy for a major manufacturer to mimic the innovation of a start up, solid intellectual property protection was the only way to defend the margins of these businesses and create an attractive return for the investors.

Information Technology Leverage

Not all IT enabled services businesses get the same value from their IT investment. We look for companies that have substantial technology leverage. When we make this point in conversation with an entrepreneur, it is usually enough to say "think Craigslist not Webvan".

Webvan was a huge and expensive grocery distribution center with a website. The vast majority of their capital was invested in areas that had very little IT leverage. Even if you give them the benefit of the doubt and say that their internal IT systems were state of the art, and substantially reduced the cost picking, packing and shipping groceries, it was still an expensive and ultimately manual operation.

Potential to change the structure of markets

We invest in IT enabled services that have the potential to change the structure of markets. We see many plans that claim to incrementally improve the efficiency of an existing company or market. Some of these have pretty compelling economics, but in our view the upside here is capped by the structure of the existing company or market. We would prefer to invest in a business that at least has the potential to change the structure of market. Google is again a convenient, if over used, example. In their best years, the major TV networks book revenue from 300 to 400 customers. Analysts estimate that Google has more than 600,000 customers. They have fundamentally restructured their part of the advertising industry.

Our Focus

A year ago when we first re-launched our web site as a blog, we did so because we felt that the environment was too volatile for a fixed investment thesis. Instead we suggested that our thesis evolves in a dialogue with the market and that it made more sense for us to publish the conversation. Over the past year we have realized that some of the characteristics we look for in an investment opportunity have remained constant even as the market has continued to evolve. We though we would list those characteristics on separate posts over the next few days...