The firm will invest money from the fund, officially called Founders Fund II, in 15 to 20 early-stage startups.
The San Francisco firm has made a point of giving power to entrepreneurs in ways that many competing firms don’t. In its view, this focus is fixing the venture business model.
Specifically, it will continue its practice of offering start-up founders Series FF stock, that can be converted to preferred stock during following rounds of funding (more on FF stock, here). Preferred stock can let founders sell a portion of their stock while still running their companies. The firm also says it gives entrepreneurs additional voting power, to help them maintain direct control of their companies as additional investors are brought on board.
The first Founders Fund was $50 million from personal investments, and from select individuals. This time around, the money comes from institutional investors. In an interview Monday at their office at the Presidio, the firm’s partners said the investors had all requested confidentiality. The Wall Street Journal reports one institutional investor was Stanford University’s endowment arm — a backer of other Silicon Valley venture firms.
The Founders Fund managing partners are some of the younger investors in the Valley. They include two of many PayPal co-founders, Luke Nosek and Ken Howery (ages 32), former PayPal chief executive and hedge fund investor Peter Thiel (age 40) and iconoclast entrepreneur Sean Parker (age 28, pictured – our coverage of him joining the fund, here). The partners see themselves as bringing venture capital back to its roots.
The Journal article says some institutional investors were skeptical of the partners and passed on the opportunity to put in money. Parker confirmed that the fund-raising process turned out to be more time consuming than the firm had expected. But he also said limited partners had invested because their model — namely, a venture firm run by founders with experience — was needed in the industry. The firm originally sought to raise $150 million, but ended up raising $220 million.
Early Silicon Valley venture capitalists were entrepreneurs who made their money and wanted to invest in the next generation, Parker said. These days, as The Founders Fund partners put it, many VCs are investment bankers and MBAs who don’t have experience actually founding successful companies. [Update: An astute reader points out below that some of the earliest venture capitalists, including some of the best of them, were not entrepreneurs. This is true. However, there’s also no denying that the “institutionalization” of venture capital in the late 1990s, which saw many funds grow to $1 billion in size, and having 8 or more partners, ushered in an era of the low-risk “career path” to VC, which hadn’t existed in the early days.]
The resulting problem, as Parker says, is that entrepreneurs often know how to run their companies better than investors do, but are prevented from doing what they think is best. One example he gives is Friendster, which faced crucial “scaling” problems as it grew, several years ago. The load on Friendster’s servers, caused by the expanding number of calculations it was performing, was tremendous (see our discussion of the company’s graph server problem). That company’s venture backers couldn’t imagine a Silicon Valley tech company having scaling as its biggest problem, and they ignored its founder’s pleas for a greater focus on solving the problem immediately. Partly as a result of continuing site performance problems, users gradually left to other social networking sites.
Parker has learned such lessons first-hand. He helped found formative music-sharing service Napster and contact aggregator Plaxo, and was the president of Facebook during its early years. As many in the Valley know, Parker has had a long and turbulent history with established investors, especially Michael Moritz of Sequoia and other VCs who served on the board of Plaxo. He was also a friend of Friendster chief executive Jonathan Abrams, and witnessed through that relationship how even a company like Friendster, with a large lead in the social networking sector, and backed by the two big-name VC firms, Kleiner Perkins and Benchmark, could lose its way.
After surviving Plaxo and watching Friendster disintegrate, Parker took an uncommon approach to bootstrapping Facebook. When the company needed capital to build out its infrastructure in order to match its exploding growth, Parker obtained $250,000 in debt, which prevented him and the other early Facebook employees from having their stock diluted.
Then, Thiel stepped in with $500,000 — Facebook’s first angel investor.
Current Founders Fund investments include leading social network Facebook (via Thiel’s investment, from what we understand), along with widget-maker Slide, online genealogy mapper Geni, search engine Powerset, web analytics company Quantcast, and land-line calling service Ooma.
The Founders Fund may spend similarly small amounts of money on early stage companies, the partners say — whatever the startup needs. It will focus on what it knows best: Consumer internet companies, including social networking applications, especially in the US. However, the partners stress that they are “contrarian” to investment trends and will put money into any team they believe in, anywhere in the world, across industries.
Update: The Journal reports that the firm’s first fund, raised in 2005, had a “return of 23 percent net of fees,” which we’ll assume means a 23 percent “internal rate of return,” since that is the venture capital industry norm for measuring fund returns. This means it has earned 23 percent each year since investment began, which is much more than industry average. Investments typically take years to yield profits, and so most funds yield a negative IRR until their third year. We’re confirming that the WSJ meant IRR.