Harvard Business School Working Knowledg e Archive

Done Deals: Venture Capitalists Tell Their Story: Featured HBS McGuire

2/5/2001
All too often, the mantra of venture capitalism boils down to "get in, get big, sell out." Polaris Venture Partners bucked convention, believing that creative vision counted just as much as—if not more than—aggressive profit motive. "Venture capital firms have become … obsessed with the idea of a billion-dollar company," says managing partner Terrance McGuire (HBS MBA '85), who would rather fund small technology businesses with killer ideas. "If you build good companies, you will be paid for your hard work."
Terrance McGuire

Excerpted from the book Done Deals, edited by Udayan Gupta, Harvard Business School Press

Expect venture capital to look a lot different in the years ahead. To be sure, there'll be more venture capitalists, more competition, and more scrutiny; the need for differentiation will never be greater. Venture funds, especially those that are newly formed, will have to establish an identity for themselves that goes beyond that of other capital providers.

Newly formed funds such as Benchmark and Polaris have been among the first to quickly articulate a position for themselves and set about establishing it. Polaris, with partners based on the East and the West Coasts, and with a wealth of experienced investors and entrepreneurs, has positioned itself as a fund with a nationwide reach and a philosophy that brings together the best of the two coasts—the financial discipline of the East with the technological adventurousness of the West. And like Accel, another small fund that now is acclaimed as one of the "hot funds," Polaris has created a network of successful entrepreneurs and industry experts who can provide a quick read on changing technology and business strategies.

Since its founding in 1996, Polaris has shown that small funds can also deliver significant financial returns, especially if they are willing to be creative in their investment style. Polaris's early successes—Classifieds2000, Allaire, Exchange.com—have come from investments in ventures and entrepreneurs that others had neglected or ignored. But perhaps its—and the industry's—most remarkable success came at the end of 1999, when Akamai Technologies, an Internet technology firm that allows for rapid transmission of Web data, went public. The $8 million investment Polaris made in April was worth over $2 billion by the end of the year.

Polaris partners Arnold, Flint, and McGuire aren't newcomers to venture capital or to entrepreneurship. They've all served apprenticeships at other funds and in other contexts. But their backgrounds and their reasons for starting their own fund serve as clear reminders that venture capital is just as exciting today as it has been in the past, and that the industry continues to attract a remarkable mix of backgrounds and practitioners.

The Genesis of Polaris
Strategy
An Investment Blueprint
Partnerships
Billion-Dollar Deals

McGuire: I got the bug to be a venture capitalist in a very unique way. When I left college in 1978, I was fortunate enough to win a Thomas Watson Fellowship, which gave me the chance to live in a different culture before pursuing a career. The fellowship provided year-long support to live on the west coast of County Donegal, Ireland, an area where Irish Gaelic was—and still is—the first language.

Donegal's remoteness and relative poverty is both a curse and a blessing. The Irish language still lives because the English and the Anglo-Irish never made a serious attempt to colonize Donegal's beautiful, yet infertile land. To illustrate how removed it is, back in 1969 many of the locals doubted that men had actually landed on the moon because the lunar terrain they saw on TV so closely resembled the landscape where they lived.

I found myself in a place known as the Donegal Gaeltacht—so designated by the Irish government because it is one of the few areas where the indigenous language survives. My project was to learn to speak Gaelic and study the one or two remaining Seanachie, or elderly storytellers, who were the last surviving link to Ireland's great oral tradition.

Donegal's remoteness preserved the native tongue, but also compelled its young people to leave in search of employment. For more than 100 years, many of the young men and women left to find work in Dublin, Glasgow, or New York. When they left, they carried with them the energy and sense of purpose every community needs to remain vibrant. When Donegalmen returned to the Gaeltacht, they often had every intention of raising their children to speak Gaelic in order to help preserve native traditions. But their children often preferred to speak the English they learned in Great Britain or the United States. Their need to find work had the unintended effect of eroding their cultural traditions. Obviously, jobs were needed to keep people in the Gaeltacht in the first place.

But not just any kind of jobs—the best opportunities would be those that could harness Donegal's unique culture and history. I left the Gaeltacht convinced that the way to save this island of Irish tradition was to work in the area of new ventures, that I might one day return to help put in place the very infrastructure needed to create a sustainable and thriving economy. I returned to the United States and to Dartmouth College and pursued a degree in engineering. Following Dartmouth, I became the first employee of a start-up software company. My academic and experiential journey led me to the Harvard Business School, where I discovered this great field known as venture capital—and, I thought, Donegal's solution.

My smattering of Gaelic didn't fail me when the time came to find my first job in venture capital. At that time, entry-level positions in venture capital were just as scarce as they are today. Fortunately, I had been elected president of the HBS Venture Capital Club, which opened a few doors. However, even my combined engineering and MBA degrees didn't guarantee a slot. My lucky break came during an interview with Golder Thoma & Cressey, a Chicago venture capital partnership and one of the few venture firms recruiting on campus.

My initial interview was conducted by Jon von Schlegell, an associate with the firm who would soon become a partner. The interview was going well, if not spectacularly, when Jon blurted out, "An bfhuil se fluic, amach?" This is Gaelic for "Is it very wet outside?" I responded, "Ta, ta se fluic angus fuar amach—it is wet and cold outside." Jon, too, had studied Irish one summer in Dublin. We hit it off. He went on to champion my candidacy and subsequent job offer from GTC. So off to Chicago I went.

Eventually, I returned to Boston and for seven years worked with Burr Egan Deleage. During my last year with the firm, several partners left to found venture capital funds of their own. We, too, decided to take the entrepreneurial plunge.

Launching our own venture firm gave us an opportunity to use the advice we had given to many of our clients. We had to convince investors to share our vision of what Polaris Venture Partners could become. We've taken substantial risks to ensure the success of our company. If I didn't have compassion for entrepreneurs before starting on this adventure, I certainly have it now.

I'm fortunate—I work with great partners and we share a common vision of our firm's mission and purpose. An essential component of that mission—the belief that supporting the entrepreneur is one of the keys to a successful venture—was vital to our founding in 1996, and has proved to be esssential to the great success and sense of achievement we are experiencing now.

Flint: I was a litigator with Testa Hurwitz & Thibeault, the major venture capital law firm on the East Coast. It was there that I came to know about the venture business, which seemed much more interesting and attractive to me than being a lawyer!

My background is pretty eclectic. I worked in the film industry briefly, and was involved with several well-known projects. I was also an investigator and researcher for the Watergate Special Prosecution Force's impeachment inquiry staff, which was an arm of the House Judiciary Committee.

Watergate was the best and worst thing ever to happen to me. On the positive side, I had a tremendously educational experience working with some truly exceptional people on the impeachment inquiry staff. Bill Weld, who later became governor of Massachusetts, was a staff member, as was Hillary Rodham Clinton. I learned a lot about the need for intellectual rigor, how to investigate and evaluate, and how to make appropriate judgments about people. At the same time, my time on the Watergate staff was also detrimental because it was difficult to discover anything else in my career that could replicate that level of excitement and interest.

After my time with the Watergate Committee, I went to work for a Wall Street law firm, where I became involved with the IBM antitrust litigation. This was my first exposure to computers, software, and the related technology issues.

I was one of the many young lawyers working on the IBM case. My first assignment was to prepare the direct examination of Digital Equipment Corporation as a witness for IBM. IBM sent us to Armonk, New York, for a month, where we were taught the basics of technology and capital markets. Ironically, the preparation for this case led me to my present career, because DEC was backed by General Doriot, founder of the legendary venture firm American Research and Development. I fell in love with the idea of creating and championing new companies.

While at Testa Hurwitz, I had discovered that I liked creating business solutions, instead of litigating business problems. For two years, I continued to practice law as I attempted to enter the venture business. Bill Egan and I had worked together on one deal. Finally, I went to him and said: "Look, I can do this. I'm willing to take a huge risk and I'll work for nothing." Here was an offer he could not refuse. For three or four months I worked for Bill, free of charge.

Honestly, I would be very skeptical about hiring a lawyer for the venture business. However, I wasn't a typical lawyer. Really, I wasn't! I view myself as eclectic and entrepreneurial. I wanted to use the experience investigating people, products, and markets that I had gained from my work as an attorney and as a member of the House Judiciary staff. Part of my strength has been my good fortune to work with people of great ability and achievement. In addition to working with Bill Weld and Hillary Clinton, I also had the opportunity to work with John Landis, the well-known director, on his first feature film. Through these experiences I became convinced that venture capital was about identifying great people with exceptional talent and putting good teams together. In our industry the most important capital is human capital. This philosophy certainly propels us at Polaris.

Arnold: I've been involved in the technology industry since 1982. My first job was at Atari during the period when it was the fastest-growing company in the world. Atari was moving so fast that I had a new job and a new boss every three months. I left Atari in the fall of 1983, after the company had crashed and was attempting to recover.

When I left Atari, I didn't expect to remain in the technology arena, but I was recruited by Lucasfilm Ltd. to run their games and entertainment group. The group began as a research and development project that collaborated with Atari to build games based on the kinds of creative impulses that George Lucas had in his movies and that Industrial Light and Magic demonstrated in their special effects. I ran Lucasfilm's games and entertainment group from 1984 to 1991.

We evolved into LucasArts Entertainment Company, which became one of the top three privately held software companies in this emerging industry.

In those days, we were developing software for PCs rather than the video game platform. We developed a number of very innovative products, including "Lucasfilm's Habitat," the first multi-player graphically animated online adventure game. The game was a joint venture between LucasArts Entertainment and Quantum Computer Services, the forerunner to AOL.

I left Lucasfilm in 1991, when Bill Gates recruited me to run his private company, Continuum Productions, now known as Corbis. Continuum's mission was to figure out how to build what we called at the time "navigable information systems." The goal was to make a broad array of images and information—and eventually sound—available to users as an integrated and easy-to-use database. My first focused encounter with the venture industry came during this time, when Jon Flint, then at Burr Egan Deleage, asked me to consider becoming CEO of one of his portfolio companies.

My conversations with Jon gave me an understanding of vision and the goals of his company. Even though I didn't take the position with Jon's portfolio company, I became intrigued by the workings of the venture capital industry, and the opportunity to help create the future—something we were doing at Continuum.

There were many similarities between venture capital and my work at Lucasfilm and Continuum. At each company we looked forward into new and emerging markets, trying to figure out where the interesting business opportunities would be. Then we worked to build a team of talented people, and then with that team we worked to build a business that addressed those markets. In conversation with Jon and his partners at Burr Egan Deleage, I could see how they were doing similar things with a range of companies, and I found that I really liked the notion of "inventing the future" across a portfolio of early-stage, leading-edge companies.

Around this time I went to work at Microsoft as vice president of broadband applications. While my work with Microsoft was very rewarding, I found myself still drawn to this idea of creating new ventures. I had enjoyed a number of opportunities to be a pioneer in new technologies and new markets; yet, I still wanted to build something of my own. To me, that was a greater challenge than improving the performance of an already successful company. So, I left Microsoft and joined Jon at Burr Egan Deleage as a special advisor. When we formed Polaris, I finally completed the transition from running emerging software companies to venture capital.

The Genesis of Polaris

Arnold: My friendship with Jon and Terry grew during my time with Burr Egan Deleage. We talked about the flood of opportunities in the information technology and medical sectors, and how great it would be if we could create a small team of entrepreneurs that could harness these opportunities. We all realized that it would be extraordinarily satisfying to build and champion companies, work with creative, passionate people, and invent devices and processes that change the way people live. Each of us had experienced this somewhat through our work. But the thought of uniting all of these goals under a new company was inspiring to all three of us.

Flint: We started Polaris because the venture capital business is a great business. We had a lot of fun and success at Burr Egan Deleage. Terry, Steve, and I thought we could create even more opportunity and satisfaction by doing the same thing ourselves.

We wanted to do what Bill Egan, Craig Burr, and Jean Deleage accomplished when they spun Burr Egan Deleage out from TA Associates in the 1970s. Like most entrepreneurs, we wanted our own sandbox. We wanted to have the fun of creating our own brand, finding our own office space, and growing our own organization.

We believed that our approach to the business was unique. We observed that medical technology and information technology were converging. We predicted that platform shifts with the Internet would create a bonanza of opportunities for entrepreneurs who had innovative ideas—and who would need capital to make their ideas a reality. We thought our backgrounds would be highly beneficial in this environment.

Each of us was a generalist, without deep technological knowledge. Terry and I had been investors for more than twelve years. We had invested in medical, service, and pharmaceutical companies. We had invested on the IT side, in media, and in broadcasting. We felt our breadth of understanding and diversity of experience in these markets would prove helpful when investing in portfolio companies.

McGuire: As a venture capitalist, you live in an entrepreneurial environment. We, too, became infected with the need to create. Founding Polaris empowered each of us to build a firm that embodies our philosophy, goals, and passion.

I took great comfort in the fact that we had a core partnership. Jon and I had worked together for many years, and together we had had the chance to work with Steve for three years. When I helped create Polaris I wasn't simply an individual walking out to start a new and untested fund. I was part of a group that had been successful and would continue to be successful.

Arnold: We never questioned whether Polaris was the right thing to do or whether or not we would be successful. Our question was: What level of success would Polaris achieve? Market conditions would greatly influence the level of success we would enjoy. But we all agreed that the momentum to establish a partnership was there.

Strategy

Flint: At the core of Polaris's strategy is the requirement that we be great partners to entrepreneurs. When you back and support great people, wonderful things often result. This approach to partnership was in direct contrast to the prevailing view of venture capital. The venture industry had developed a bad reputation. On the West Coast, the tendency was to micromanage companies. People complained that venture capitalists did not stick with things for the long term, and that they did not build company cultures. On the East Coast, venture capital had the reputation of being too financially oriented.

We wanted to unite the best attributes of the East and West Coasts. Of course, we also wanted to provide outstanding returns on investment. And we could do this by creating long, loyal relationships with the entrepreneurs who created and ran the companies within our portfolio.

Steve was our West Coast guy, located in Seattle. Having run LucasArts with George Lucas and then Bill Gates's private company, he was experienced in the more creative way of business typical on the West Coast. As we established our other founding office in Boston, our goal was to unite the traditional financial and corporate discipline of the East Coast with the entrepreneurial, innovative traditions of West Coast firms. We felt that it would be fun to create Polaris and bring in talented young people and mentor them, just as we had been mentored. Polaris would also be a home to experienced entrepreneurs and venture capitalists.

Our strategy is also based on seeking diversity within the portfolio. At a time when most of the other players were leaving the practice of investing in medical technologies, we felt that the new paradigms that were occurring in the information technology domain were also occurring in the medical arena. Perhaps the public markets were not captivated by the medical business, but these things run in cycles. In 1990, for example, Burr Egan Deleage was told to get out of the IT business for its fifth-generation fund. Of course it did not take that advice, and the returns for that fund from its IT investments just blew the roof off. Those IT investments in highly successful companies such as Powersoft and Premisys returned five times their original cost, because the investments were made at a time when prices were very discounted.

Arnold: We believe that supporting entrepreneurs and their ideas is the best model for creating value. In a nutshell, that's how Polaris works. Today, there is a real edge to the competitive aspect of the venture business. There's a lot of money around and events move very quickly. Syndications and teamwork among VCs are occurring less frequently. Yet, everyone is still looking to establish a relationship with the great entrepreneur.

An Investment Blueprint

Flint: When we went out to raise our first fund as Polaris, we told our investors we'd do what we had been doing for fifteen years—get into our companies early, complete an array of seed deals, and support a lot of entrepreneurs who were working out of their garages. And we're doing just that. For example, in Polaris II, we are either the lead or co-investor in every deal. Often we are the sole institutional investor, and Polaris is usually the first venture capital firm. We are extremely active investors. We want to build companies. Allaire is a good example of our philosophy in action. When we first met with Allaire's staff, we found a group of fourteen twenty-five- and twenty-six-year-olds with a great idea. We gave then the choice of moving to Boston or the Silicon Valley. Thirteen of them chose Boston—which was the right decision, because the talent pool there was right for what they wanted to do.

We found their office space, accountants, and lawyers. We recruited their CFO and their vice presidents of development, marketing, and professional services. We created a board of directors. We used a recruiter to retain Allaire's CEO. Four months into our work with Allaire, we helped them raise $10 million—at four times the value we originally paid. Together with Allaire, we created a company with a $2 billion dollar valuation in less than two years time.

Arnold: Sometimes venture capitalists push their portfolio companies to go for the gold, when maybe the silver is a great outcome. A good venture partner establishes a realistic picture of the marketplace for their entrepreneur.

Classifieds2000 is a good example of establishing a realistic model of success for the VC and the entrepreneur. Classifieds2000 is a provider of classified advertising on the Internet. They grew very quickly and had a very important strategic place in the market. But it was evident to the entrepreneur and to us that there were a lot of giants who were coming into that part of the marketplace.

As other major players in the Internet industry awoke to the opportunity, it became clear that a small, independent company might have a hard time growing in the years ahead without the right partner. So we talked to a number of possible partners, and found one where there was a great fit and the opportunity to accelerate Classifieds2000 to the next level of its development. We sold the company to Excite. We were in that investment for less than a year, and it was a success for everybody.

McGuire: Working with Advanced Inhalation Research (AIR), we re-invented the model for investing in medical companies. AIR developed a proprietary system for delivering drugs by breathing dry powder into the lungs. We co-founded the company and invested at every stage of development. Although we are a large fund now, we still make strategic early-stage investments in increments of $250,000. We call this cradle-to-altar support life-cycle investing.

The biggest challenge in the medical arena, however, is to find a product that can generate commercial sales sooner rather than later. The market isn't patient with interesting biology that needs a decade to develop into a commercial product. Companies like AIR with more immediate technology are able to generate commercial sales quickly. AIR wasn't going to require $20, $30, or $40 million in equity to move the company forward. What it needed was a good partner to help with the heavy lifting. I worked very actively with the two founders of the company in the areas of business development and in the process of negotiating the deals. I had the capability to talk with our corporate partners and tell them that I was not prepared to accept their offer. We would accept the right deal, or no deal at all. We didn't need their money at any cost. Having the necessary capital allowed us to be selective. We had created a company without a huge burn rate that possessed great science and attracted corporate interest. Being a strong partner was what made the difference.

Partnerships

McGuire: This idea of being successful by growing great companies is the fundamental idea we communicate to our entrepreneurs and investors. We begin a relationship by inviting entrepreneurs to perform as much due diligence on our firm as we would on theirs. They understand our idea of partnership and how a strong relationship between the VC and the entrepreneur adds value. In fact, this kind of understanding between Polaris and entrepreneurs is at the foundation of a good working relationship. Their confidence in our commitment to their enterprise helps build the value of the company.

Our philosophy is that we want to create companies that will change the world. This is one of our core values and is evident with every company in our portfolio.

Flint: We have probably thought more about how to build an enduring organization than anyone in this industry should have. We strive to surround ourselves with people more accomplished than ourselves. Because we have been able to recruit some great talent into Polaris, Terry, Steve, and I joke that we aren't sure if we could land a job with Polaris anymore!

Arnold: Are there limits to our investment strategy? I believe that we have to be careful not to overcommit to too many companies. We aren't limited simply by money, but by the number of deals we as a group or as individuals can accommodate wisely. Different companies need different kinds of resources, depending where they are within their life cycle. Companies undergoing their initial stages of development often need significant time and attention, while other companies later in their life cycle may need much less. Some companies may be developing information or medical technology. They may need to pass a certain threshold before they are deemed credible enterprises. We observe and see which companies require our expertise and at what level of their development our involvement is useful. Ideally, when a company matures, it should possess an experienced management team. As a company achieves this stage of development, our involvement often becomes more episodic.

We scan the horizon for challenges and opportunities. We then offer our entrepreneurs our perspective on the challenges or opportunities that may impact their company and try to advise and coach them on ways to marshal their resources, so each situation is resolved in the most advantageous manner.

We have always told our limited partners that we will substantially outperform the market. Each of us has lived through market cycles, and we realize that if you build great companies, your efforts will be rewarded. We believe that if we work with the entrepreneur and build a great company, excellent returns will follow. AIR is a great example. We didn't expect to sell the company. But the technology was right, the environment was right, and we found a strong partner and buyer in Alkermes.

Billion-Dollar Deals

McGuire: There is a fear in the entrepreneurial community that every venture capital deal must possess a billion-dollar valuation. We have built billion-dollar companies and we are delighted with them. However, we've also been invested in opportunities where we've approached an entrepreneur and said: "This is the time to sell. You won't have a billion-dollar company, but you will have a company valued in the hundreds of millions."

We have entrepreneurs who ask us: "Does this have to be a billion-dollar company?" Their fear is that venture capital firms have become so obsessed with the idea of a billion-dollar company that they don't know when it is prudent and advisable to sell the company for something less. One entrepreneur we met with was particularly concerned that we would just drive for the billion-dollar mark, with nothing in between being an acceptable valuation.

Our philosophy is simple: If you build good companies, guided by the vision and goals of the entrepreneur, you will be paid for your hard work.

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