Alan Patricof, founder and managing director of Greycroft, LLC and a pioneer in the venture capital field, holds many secrets to achieving venture capital success. Before an audience of established Tokyo investors and MBA students wondering how to get into venture capital, he discusses his best and worst venture capital acquisitions, the rise of impact investing, the relationship between VCs and entrepreneurs, and more.
Patricof’s many achievements include establishing the Apax GLOBIS Japan Fund (JPY 20 billion)—which included the highly successful portfolio company GREE—with Yoshito Hori in 1999.
Yoshito Hori (00:12):
Alan, thank you very much for your speech. I believe that it’s been about eight years since you made a speech in Tokyo. And I tweeted that, you know, this is a very rare occasion for us to be hearing from a legend of the venture capital industry. Thank you for coming, and thank you for speech.
I have asked quite a few venture capitalists in Tokyo to come here, as well as staff, and also some of the students from the GLOBIS IMBA, which is our business school in English, taught in English here.
Alan Patricof on Investing in Apple and AOL
Yoshito Hori (00:44):
I’d like to ask some questions, you know, about what you have said. First of all, I can’t stand not asking you about Apple: how it was when you invested in it, and what kind of personality Steve Jobs had, and what kind of impression you had when he passed away.
So could you please tell us about your experience with Steve Jobs and Apple?
I want to be honest. I always am about what I’ve done. I really did not have an active role in the Apple situation. I had a much more active role in AOL. But when I met Steve, he was like 27, 28 years old in 1979. And he had started the company in 1976 or 77. And it already was out in the marketplace, and there was an opportunity to put in a relatively small amount of money.
We invested a half a million dollars at that time. And I can’t even imagine, I don’t have the records anymore to understand what the valuation was, but my guess is it was probably about $20 or 25 million, as opposed to now. Now it’s $350 billion, $84 billion in cash.
I laugh sometimes and say, “If we had just held our stock from that investment and I went to the South Pacific and just went on a desert island for the next forty years or thirty years, I would be a very, very, very, very rich man!”
Which tells you one thing: Sometimes, if you have something good, just hold onto it and don’t do anything else!
But [Steve Jobs] was a very dynamic, very detail-oriented person who was kind of driven at that time. Not your, you know, sophisticated Harvard Business School graduate. He was one of the last people I think I’ve seen that actually started a business in a garage. And they went public a year or two afterwards.
We sold out our interest sometime in the mid-eighties. I don’t remember. Actually, we distributed the stock to our investors, and I can’t imagine any of them still have only their stock, but who knows?
AOL, on the other hand—people don’t know, AOL actually had gone into bankruptcy when it started. It was a game company. It went into bankruptcy, and it came out. And I helped to take it out of bankruptcy. I wasn’t an investor before, but I was an investor when it came out of bankruptcy.
And I was very helpful, actually, in introducing it to Apple. As strange as it may be, we set up something called Apple Link, and getting an investment from Apple at that time. That was of very strategic importance for AOL. I also helped introduce them to a small technology company which became the core of their technology. This was in 1984.
How to Be a Disciplined Venture Capital Investor
Yoshito Hori (04:08):
Thank you, Alan, for telling us about ten steps to be a great venture capitalist. The first thing you said was “curiosity.” You’re always curious about things, and you always push us to be curious. Second is “focused,” and the focus is so important.
Third is “discipline.” So how did you become disciplined when there was a bubble going on? And there was lots of passion and enthusiasm for the internet, lots of high valuation. .. How could you maintain your discipline?
It’s very, very, very hard to do. But all I can say is that if you think that something is crazy priced, it’s overpriced, the market is in a bubble, it doesn’t make any sense—trust your own instincts.
I mean, we’re going through this right now, and we’re gonna see tomorrow—tomorrow the next day—Groupon is going public. And I’m sure you’ve all read about it because it’s been all over the papers. It’s in the papers, on television every day in the United States. A month ago, they were gonna go public at $30 billion. This week, they’re talking about going public at $11 billion. So they’ve lost $20 billion of value in the sky someplace. And no one knows exactly where it will settle in.
I’m not gonna give you any projections. I don’t know anything. I’m not an investor in it. But a lot of people have invested, actually, in private transactions. A lot of well-known people at a $10 billion valuation in the private market with the expectation that it’s gonna go crazy.
At the end of the day, Groupon, like any other company, is gonna sell based on its growth rate, on how much it costs to acquire a customer, what its retention rate is, the stores or the manufacturers who give them product, how successful it is to give these deals out, and ultimately what kind of profitability Groupon has. We really don’t know the answer to that now.
As a disciplined investor, someone ought to be very careful in extrapolating and figuring out what the economics are. And I’ve never seen a business with more competition [than Groupon]. There must be 150, at least, in the United States. And I don’t know, how many Groupon lookalikes are there in Japan? A hundred?
A lot. Like I’d say, at least 80, at least 80.
At least 80!
That’s a lot.
I mean, it’s not a proprietary technology, that’s for sure.
How to Network for Venture Capital Success
Yoshito Hori (07:10):
Third was “discipline,” and fourth was “network.” How do you cultivate network?
Be curious. And?
Be active. I mean, you can’t sit at your desk. You have to be someone who’s willing to get up and work. In our world, you have to go to meetings at night. You have to go to Meetups. You have to go to conferences. You have to talk to people in the industry. You have to be willing to exchange cards and not just go through the ritual, but actually follow up. Get to know people. And you have to exchange ideas. It takes effort.
And I tell you, I have hired people, and you can tell within a few months that they are just in the wrong business. They don’t have that initiative.
I read an interesting article and research on entrepreneurship. And the research was talking about how you can judge who is a great entrepreneur by the way he or she drifts in their network. If you observe how he or she is in a room or at a party, you can find out who is a good entrepreneur.
And the research report concluded that there’s a correlation between a good entrepreneur and a good networker. So it may be true. I was quite curious to see that you put this as your fourth step, and I totally agree.
I did not, by the way, put them in any particular order.
How to Find the Right Talent for Your VC Team
Yoshito Hori (08:48):
OK. Well the fifth one was “develop skills to judge talent.” This is tough. Isn’t it? Like, how do you develop skills to judge talent?
It comes from being around long enough to be able to say, “This is someone who I think has the character.” And doing reference checking. Finding out how people were on the job.
Whenever I do a reference check, you don’t call and. .. When they give you lists of all the references, they only give you people who are gonna say something good. So you usually say to them, “Can you give me the name of someone else to talk to?” Or you say to them, “Everything about Yoshi is terrific. Except?”
I wanna know about the exception. What should I watch out for? Because that’s the thing you want to know, what you have to watch out for. Not all the good things.
How to Grow Great Venture Capitalists
Yoshito Hori (09:41):
You talked about apprenticeship. And I think it’s quite similar to what you mentioned about skills to judge talent. So how do you educate venture capitalists? What is the best way to educate them and make them become a great venture capitalist?
What I’m really saying is I think someone who’s been in the business three or four or five years is better than someone who just. .. They’re not gonna come in the first year and have all the right instincts.
I think actually having some adversity and some problems and learning how to deal with those skills makes them a better venture capitalist. Someone who’s had the time to build up their network is better. All those things help to make someone a better venture capitalist.
I think the idea is don’t expect to go in and be great right out of the box.
Alan has been my mentor. So he always tells me what to do, and so forth. And you use quite a few keywords. Like you talk about instinct.
You develop that. I think you develop that instinct over a period of time. You don’t get that initially. I think you have to see where you make mistakes. My father used to always say, “Play the stock market on paper first, before you play it with your own money.”
Sit in things and make your judgements quietly. See how it turns out, and see how your instincts are. Keep your own track of how good you are in judging. And then, you know, learn what characteristics work and which ones don’t.
So some good venture capitalists will always be able to make some good investment and make companies grow. Some of them we will not get there.
Yeah. I mean, I still make plenty of mistakes today. This is an art, not a science.
How Venture Capitalists Can Empower Entrepreneurs
Yoshito Hori (11:47):
Number seven is “empower entrepreneurs.” That’s a good one. Empower entrepreneurs.
I remember when I started as a venture capitalist, I tended to feel that I am entrepreneur. But after three or four years, you find your limit to what you can do.
It’s a very natural tendency. I have it. You have to keep yourself in check. You inevitably say, “Gee, if I were running this company, I could do a much better job!”
Sure. Yeah. But you’re not the one who is running it.
The next one is “relationship with CEOs.” How do you actually develop relationship with CEOs? What is your key? What is your secret to be able to build that relationship?
I think you have to have the kind of personality that you can develop and build their confidence. And you do that by having skills. You really can be helpful.
If you’re really just saying things and you don’t have the ability to be helpful, you’re not gonna have a relationship. It won’t take very long before they say, “This is a waste of my time. I’ve gotta focus on my business. He can’t really be of help.”
How VCs Can Prepare for Adversity
Yoshito Hori (13:06):
Ninth is “adversity.” Prepare for adversity. How do you actually prepare for adversity? And what are actual things that you have to do to prepare?
Well, maybe the right word isn’t “prepare” but “be prepared.” Which means don’t be surprised when you have problems.
Do you know anything about problems in your portfolio? <laughs>
It goes with the territory. I mean, you know, there are always problems. And so I think rather than running away from them or just avoiding them, be prepared for them. Act quickly to do something about it.
The Diversity of a VC’s Role
Yoshito Hori (13:54):
Your tenth point is “diversity.” So I’d like to ask one or two questions about diversity.
Diversity means to enjoy the profession, you should be prepared for a diversified experience.
I’d like to ask two questions, and then I’d like to open up the floor. What has been a good investment? If you were to choose one good investment, which deal would you choose? And what is one bad investment you have made?
It’s very hard to pick. I mean, I’ve made so many bad ones. It’s very hard. I can just tell you one.
I mentioned we did an animal feed supplement business back in 1972. The guy was very, very talented. He really was a great scientist. And I remember his words: “Every step in the chemical process of developing this supplement” (which was to take waste oil and convert it into animal feed). .. And he said, “Every step that we’re doing in the process has been done before.”
What he didn’t tell me, what I didn’t understand is yes, every step had been done before. But they had never been done before together. And it was the together that didn’t work. I can almost remember some of the technical words, the steps that were done.
But in terms of a success, that’s like saying, “Who’s your favorite child?” Which is the favorite of your five children? He has five children. So ask him which is his favorite. It’s very hard.
I can give you a couple of examples. The ones I think you get the most satisfaction out of are the ones that you had something really actively to do with. I don’t want to be dishonest and say I did this or that. I did nothing for Apple. Apple did itself.
But I was very involved with a medical electronics company. We started with $50,000. It wasn’t in a garage. It was in an abandoned dentist office in a remote part of New York with a concept of developing a cardiac monitoring device which was designed for a doctor to carry in his bag when he made a house call.
Now, I don’t know about Japan, but in the United States, you can’t get a doctor to make a house call today. It doesn’t exist. Can you get house calls? Will they come to your house if you don’t feel good? No, no, it doesn’t happen. But it used to be, a doctor would come with a little bag, and this was a scope that you could put into the bag.
We spent six months, and it was very early on. I was early in my career, so I was very helpful in terms of financing the company and helping to recruit.
The CEO went around to so many doctors’ meetings and doctors, and finally realized that doctors don’t like to spend money. They’re the cheapest people. They just don’t like to spend money. Besides which, the world was changing. What you did is you took this scope and you’d plug it in the wall next to the patient, and you could monitor his heart in a very small scope.
And so, instead of going out of business, we talked about what else could you do with this technology. I mean, you could have drowned by saying, “I’m determined. This doctor needs this. He should have it!” Instead, we ran around to the hospitals and went all around in the hospital to say, “Where could they use this small scope?”
And we found that the anesthesiologist in those days was really—even though he kept people alive, he was very unimportant in the operating room. It’s really the surgeon who’s the genius, who has the delicate figures. But the truth is, the anesthesiologist gives you the oxygen to keep you alive in the right proportion.
And so we found that the anesthesiologist had to look at the surgeon’s scope, which was at the other end, perhaps, of the room. And he was not treated very well. So we took this little scope, put a tripod on it, grounded it, and came out with a scope for the anesthesiologist in the operating room. And the hospital paid for it.
And from that start, we built a $600 million business over twenty years. And I take a lot of pride for having been involved with that every step of the way. I was on the board for twenty, twenty-five years,
Is There a Wrong Time to Take VC Investment?
Yoshito Hori (19:04):
So we have a half hour left. I’d like to open up the floor for questions. And for those of you who would not feel comfortable in English, you can speak in Japanese. I can translate for Alan.
I actually teach here at GLOBIS, and on the side I run a recruitment firm. We started up probably eighteen months ago. Things are going well, seventeen employees. But I wonder, for the benefit of other entrepreneurs in here. .. When you don’t want VC money, when does it makes sense to not take it? For us, we have positive cash flow. We have great internal IRR. Unless we needed to expand globally and needed millions of dollars for that footprint, in the medium term, we really don’t need a lot of outside investment.
So I wonder if you could just address that and think about when it makes sense. There may be times where VCs want to invest, but maybe the entrepreneur should hold back a little bit.
Oh, I think it’s a very good question. And there’s an answer for it.
If you are thinking in a narrower sense, a more localized sense. If you were opening up a beauty parlor, I would say, “What do you need venture capital for? Go to your friends and relatives and angels and get a few dollars to help you start.” If you wanted to open up a chain of beauty salons all over the country and you had a new technology or a new concept, I would say, “You better make sure you’ve got financing that’ll carry you there.”
I think, if you’re gonna take venture money, you have to be prepared for certain, not restrictions, but. .. you’re gonna have to be organized. You’re gonna have to end up having a board. You’re gonna have to end up having good accounting systems. You’re gonna have to have legal agreements. You’re gonna have to act in a more formalized manner.
I was mentioning Africa before. There’s a big struggle going on, but it’s happening. They’re totally unused to having accounting. They all keep double books. That’s a very common thing in a lot of countries, to keep double books. They have cash accounting and, they don’t want to go to gap accounting.
I think if you’re gonna take venture money, other things go with it. And you have to be willing to put together a real business plan, a budget. All those things are uncomfortable for a lot of people, certainly at an early stage. So I think you have to mentally say, “If I’m gonna take venture capital, a lot comes along with it.” Unless you’re really thinking in expansion mode. ..
I had a friend of mine many years ago who came to me. He was an art dealer, and he wanted to start an art service in London. He was in New York and was moving back to London, and he wanted to raise, I don’t know, a quarter million dollars. And I said to him, “I think you’re crazy. What you should do is sell two, three, four paintings, take the profits. You’ll so regret being in a service business like an art dealer and having me own 25% of your business. It will come, it will be a very unhappy relationship.”
He took my advice. He’s a hugely successful dealer today. He loves to tell everybody that my advice is what kept him 100% of his business.
So I think if you have that kind of a service business, people forget some of the best financing is from your suppliers and your customers. It’s a great indication that you’re any good. If you’re gonna start a business and you can get your suppliers to give you six months credit? If your customer will pay you in advance? Those are techniques of how to build a business without having to raise capital or get to a certain point where you then can raise capital at a much higher valuation.
Venture Capital as a Catalyst for Economic Transformation
Audience member (23:32):
Japan is going through a period of transformation with disasters and prolonged recession and political stagnation. Can venture capitalists play a part in actually transforming an economy on a large scale, do you think?
Actually, Yoshi and I were just talking about that a few minutes ago before we started. The answer is yes. I think that entrepreneurship is critical. The whole startup environment is critical to society today.
New York is a good example. If you had gone into New York five years ago, and you had a technology meeting. .. if you got twenty people, I would be surprised. There’s now something called the New York Tech Meetup, and they meet once every month, the first Tuesday of the month at seven o’clock. There are a thousand people. A thousand.
New York is boiling with startups, and it feeds on itself because, remember, every startup, once it gets financed, the next day, it increases employment. As opposed to a buyout firm where, the next day, they’re improving productivity by laying off people. So the venture business, and I mean, I’m not trying to get credit for it, but startups in general and having an ecosystem. .. startup expansion increases employment.
Ultimately, those companies that are successful, like a Google or Facebook, spawn other startups. And so I think it’s critical to have a vibrant startup community. And I don’t don’t know how active it is in Tokyo now, but I can tell you that we are in New York and Los Angeles, and both places are exploding with new business formation, incubators, accelerators, and Meetups.
I dunno if you know what Meetup is, but there’s a business called Meetups. You can form a Meetup. You could do one here because the technology is online. There’s a company called Meetup.com, and you can form a Meetup for people who make labels for meetings. And all of a sudden, it goes on the internet, we’re gonna meet on Wednesday night, and surprise! Twenty people will show up.
There’s a Meetup for everything today. People who make hangers, people who make beverages, but mostly technology people. That’s the kind of community you wanna encourage. People are talking to each other and exchanging ideas and forming new businesses.
New York and Los Angeles are very hot today. Silicon Valley will always remain the hottest. New York right now has an RFP out to form a new high-tech university. I happen to be on the committee that’s going to review the applications. But there are people from universities all over the world trying to start up a university in New York, from scratch, have to finance and everything, which is designed to encourage the ecosystem.
The Rise of Social Impact Investing
Yoshito Hori (27:08):
The next question: Venture capital industries are being diversified by having incubator accelerators. And there’s an impact investment method which is now you quite common. What do you think about that?
You happened to ask someone who knows something about that. I know a great deal about it. It’s called “social impact investing,” and it’s a very active new movement.
It’s been around for several years, but in the last year, through the Clinton Global Initiative Program and through the Rockefeller Foundation and a whole bunch of people, they now have brought together. There’s a global social impact group that has about a hundred members. You’re aware of it, I assume. And the head happens to be a friend of mine.
It really is designed to encourage nonprofit organizations or philanthropists to make investments in businesses around the world. Not so much in the United States, but somewhat. But really in the developing world for social, not just purely financial impact.
So they’re making bed nets to prevent malaria in Africa. They’re doing water systems to improve clean water. The obvious areas: education, water, health. So they’re encouraging people to form companies to be helpful to society. They’re revenue-producing businesses, but they’re less focused on getting very rich, and more on doing something good for society.
There’s a fund called the Acumen Fund. You may have heard of it, it’s run by Jacqueline Novogratz. There are many funds being started like that. It’s a new concept. We don’t know the ultimate result, but they’ve gotten together now and formed a group of people who exchange ideas.
Where does the capital come from? How do they raise capital, and what is the expectation for return?
Well, they’re getting them from philanthropists. They’re getting them from people like Jeff Bezos. Or from Jeff Skoll from eBay. Or other very big philanthropists. They’re getting them also from institutions who are getting socially conscious. There’s pressure that says, “You have this big fund of money. You should give a little bit for social impact investing.”
So it’s a fund, but they say that the return will not be expected.
Yeah, exactly. It’s a fund. So they’re getting people maybe, even pension funds or for-profit investors who say, “Take a little bit and do some good with it.”
Okay. That’s a good idea.
The Role of Risk in Venture Capital Investing
Audience member (30:44):
My question’s very general. You mentioned about being disciplined, interpreted as “don’t gamble.” And also “be prepared for adversity,” meaning “have a reasonable expectation for the outcomes.”
But you never mentioned the word “risk.” So I just wonder if the venture capital business is a risky business, or is there any way to cultivate or expand your personal capacity to accept or tolerate calculated risk?
Well, I think you’re always trying to mitigate risk, but it’s a business. I mean, you know, without a risk, you don’t have reward. I mean, we all know that. You can buy treasury bonds—or you used to be able to buy treasury bonds and not take any risk. Some countries there’s a little more risk than others, but theoretically, that’s why you buy treasury bonds with a ten basis points yield.
Venture capital is on the high end of the risk spectrum. Let’s be realistic.
In the private equity business, my sense is that they don’t expect to lose money on anything. They don’t expect to have bankruptcy. They do, but they invest with the idea that they’ll have zero losses. Venture capitalists understand that you’re gonna lose some of the companies. We’ve, we’ve sold twelve companies so far. Four lost, and eight had profits. I think our loss ratio will probably be very good, which is about 20%. I think that’s very good. Most firms would be higher than that.
You can mitigate risk by making sure you’re adequately financed, that you’ve got talented people running it, that you understand the market, that you understand the technology developing the product. Those are all steps you take to get a winner. You know, all the things I was talking about. Get a team that’s worked well together before, that knows the business, understands the economics of it.
All that helps to mitigate the risk.
Closing Remarks for Alan Patricof
Yoshito Hori (33:05):
Thank you very much, Alan. It’s been a pleasure having you make a presentation on venture capitalism. I have asked Alan to make this presentation simply because we’d like to learn. The best way to learn would be for Alan to speak about how to become a great venture capitalist.
Thank you. I just remember the first time, we (Yoshi and I) visited New York to make a presentation for the joint venture by Apax GLOBIS. That was seven years ago. And at that time, Alan did some research to open up the Asian—I mean Japanese—office for venture capital. And there were lots of offers. Bank-operated venture capital, security firms, large venture capital. But he took us to be his joint venture partner.
And we asked him, “Why us?” And he said, “I’d like to work with entrepreneurs, not an organization or big firm.” And he always, picks great talent. Great talent to be, not already great. We’d like to continue to pick up good talent to be, and take risks, work with them, and build up future great companies. That’s what we’ve learned for over thirty, forty years from him.
There are lots of venture capitalists in Japan, and we would like to continue to help Japanese companies to go global. That is our promise for the next thirty years.