Advice for Building a 100-Year Firm
Building a VC firm that will stand the test of time requires immense skill, foresight, knowledge, determination, sacrifice, and a little bit of luck. Throughout the month of June, we’ve learned from 6 powerhouse investors who have built enduring, legacy firms. We’ve explored the highs and lows of building a firm, the lessons they learned, and what they would change if they did it all again.
Wrapping up Season 2 of the Kauffman Fellows Podcast, Code welcomes Chuck Newhall, Co-Founder & Retired General Partner at New Enterprise Associates (NEA), and Harry Gruner, Managing Partner at JMI Equity, to share their experiences successfully building long-lasting firms and offer their advice for those who are currently in the early stages of building firms.
This season of the Kauffman Fellows Podcast is produced in partnership with Mighty Capital. Together, we unravel what truly makes a great VC investor.
NEA Co-Founder, Chuck Newhall, on Building a 100-Year Firm
Chuck Newhall, Co-Founder & Retired General Partner, New Enterprise Associates (NEA), joins Code to share how NEA attracted and retained superstar investors, how they grew the size of their funds, and the mistakes they made along the way.
On the decisions you make to build a 100-year firm
A spirit and culture of sharing carry and alignment helped Newhall build an enduring firm.
“You have to build an exceptional team, which means you give up your carried interest to partners that are joining. By NEA 3, the founders only had 30% of the carried interest. 70% was given to attract people. We attracted superstars. I have many thoughts on the merits of that, but by doing it, we created a very long-term orientation. Initially, the partnership was flat. All general partners had an equal carry.
We then moved to giving the managing general partner a premium of 20%. We started having billion-dollar outcomes. So, we had to include a bonus paid in stock or cash at the time of the realization of the gains, going to the partner that sat on the company’s board, which in hindsight was a big mistake. It should have gone predominantly to the partner that sat on the board, but also to the person that originated the deal as well as people who made a significant contribution.”
On how they structured the firm
An enduring firm learns and adapts as it evolves.
“We initially had a vesting schedule of 12 years. Then one of our partners, who came from T. Rowe Price, said that’s ridiculous. It has to be four years. Against my objections, it was made four years. It was a catastrophe. We ended up giving half the capital gains in the first five partnerships to people who had left the firm — because we moved them out… So, it went back to the 12-year vesting schedule. That changes people’s behavior.
We had a philosophy that each generation that runs the firm should make more than the previous generation, which was reflected by how we divided the carry. Later on, we created a management company, which was people who’ve been with the firm for 20 years. The loss of whom would be disastrous for the firm. They got 16% of the carry of that entity, plus a small percentage of the fee. The management company became unwieldy because we decided to put a value on it. Then, the existing members of the management company would buy out the retirees. The management company's debt was a disaster. By the fourth generation, the young people would be assuming billions of dollars of debt.
Scott Sandell got an outside investor to buy 20% of the firm, which was, in essence, the management company. Now, they’ve gone to giving retiring partners a continuing interest. We wanted to make partnership incentives since the reserve. You build a partnership, you liquidate it, and you go on. It’s not a loan. We wanted to turn a partnership into a corporation. By doing the management company, we gave the founding partners, the early partners, and the later partners a chance to have profit centers in the firm and its ongoing form.
On how they assess partner performance
Assessing the performance of partners isn’t a short-term game.
“We do it qualitatively, but you really can’t assess performance until about year seven. You have to start generating real gains. For startup businesses, that takes a long time.”
On moving from $100–300M funds to billion-dollar funds
When they saw too much money being left on the table, Newhall and his partners adjusted their approach to raise larger funds.
“We had a real Board of Directors, consisting of our largest limited partners. They had to review our salaries and hire and fire decisions. They eventually removed that, which I felt was a big mistake because everybody needs a board to provide governance, advice, and help. Our board was invaluable.
We had been making some bad mistakes. We participated in the A and B rounds and forgoing the C, D, and E rounds. We should have invested when we had a good company in the C, D, and E rounds. Instead of getting a gain of $30 million, we would have gotten a gain of $500 million. We needed to evolve from a startup firm, retain our focus on startups, but develop real competence in venture growth equity, which are the C, D, E, and F rounds, which we did. To do that, we had to have big funds.”
JMI Equity Founder and Managing GP, Harry Gruner, on Advice for Building a Long-Term Firm
In Code Cubitt’s final episode as guest host, he welcomes JMI Equity’s Founder and Managing GP, Harry Gruner. With over 30 years of experience working in and with software companies, Harry offers insight into building an investment thesis that grows with you, getting started in VC, and persevering through the tough times.
On developing a thesis with long-term legs
Gruner and his partners knew that Silicon Valley didn’t have a monopoly on smart entrepreneurs.
“As software development, computer science programs, and academic programs have gotten more robust, others have extrapolated a lot of the plumbing. We used to spend most of our R&D dollars on stuff customers would never see. Now, a lot of that’s done for you. If entrepreneurs understand workflows, trends, and how transactions move in an industry, they’re better situated and can get a product to market for less money. We spend our time with a lot of those types of folks.”
On advice to young entrepreneurs who want to get into venture capital
Gruner had some prescient advice for young VCs or those looking to get into the business.
“Start with whatever it takes to build a track record and build your muscles. Then do a good job. The capital will find you. The advice I also give is, that you’re always working on the next fund. As you fundraise for this fund, you’re telling people what you’re going to do.
There aren’t that many folks who will invest in a new fund with folks who have a limited track record. So, tell them what you’re going to do and then keep showing up. Over time, we’ve worn people down, where we just keep showing up and have performed the way we told them we would. We’re always thinking about that next fund. Always bringing people along, always calling on them, and trying to provide some insight.”
On building a firm for the long-term
Sticking with the grind and keeping a growth mindset will help you endure.
“The best way to be a good investor is to be brilliant. The second best way is to go work for someone who’s brilliant. I didn’t have the beneficiary of the former, and my colleagues didn’t have the benefit of the latter. We had to keep figuring it out and putting one foot in front of the other and getting better.
There’s no magic to this. If you keep showing up, learning your lessons, and incrementally getting better every day, 1,000 little things just keep pushing and getting better. You can build a career doing it. However, I stand by that. Going to work for Warren Buffett would be a better way to do that. To be Warren Buffett would be a better way than the path we’ve chosen, but we didn’t have that luxury.”
On words of wisdom for aspiring fund managers and GPs
Success requires a certain amount of ‘sticktoitiveness’ for young VCs.
“There’s a certain perseverance that’s been important in the soul of our place. Part of that is always thinking about the firm’s future and not putting the firm at risk. We can make an impact investment, a bad hire, or a mistake, but we’re always moving the firm forward in a measured way. We’re not putting the firm at existential risk. If you do that, keep showing up, and you’ve decided you’re going to get better every day, that has worked for us.
We were not the big macro, new thing folks. That wasn’t our thing. We decided what we were and kept getting better at it. We have been fortunate, which probably has more to do with it than anything. Starting when the market was low, interest rates were high, and software was small. Now it’s big. We kept showing up for a period of time with the wind at our back.”