Andreessen Horowitz (a16z) is a venture capital company launched sometime in 2009. Over the years, it has moved into the VC industry's top ranks for its ability to invest in Silicon Valley's most promising startups. This case study analysis delves into the company's history and the motivation and strategy of its co-founders. This study seeks to answer the question of whether or not a16z's development was influenced by its novel organization structure. It also is aimed at determining whether a16z should increase its scale over the succeeding years.
Thomas R. Eisenmann; Liz Kind
Harvard Business Review (814060-PDF-ENG)
January 30, 2014
Case questions answered:
Case study questions answered in the first and second solutions:
- Was venture capital an attractive industry to enter in 2009? What entrepreneurial opportunity did Andreessen Horowitz see?
- “To succeed as a VC, you have to do three things really well: source, pick, and win” (case, p. 8). What does a traditional VC firm do to source, pick, and win? How does a16z approach these key success factors differently than other VC firms?
- If you were a first-time founder of a tech startup seeking Series A investors, would you find a16z’s value proposition attractive?
- Is a16z’s big investment in its operating team likely to yield a positive return? Should other top-tier VC firms copy this approach?
- Evaluate the following a16z organizational policies and practices:
a) criteria for hiring General Partners; b) compensation approach for GPs; and c) co-founders’ governance rights. How important will each be to the firm’s success?
- Should a16z seek to double its assets under management over the next two years? If you support rapid expansion, would you diversify into other sectors (e.g., life sciences, cleantech) and/or geographies (e.g., China, New York)?
- To understand the potential financial impact of doubling assets under management, estimate a16z’s “steady-state” annual revenue and its costs before GP compensation using the following simplifying assumptions:
i) a16z raises a new $1.5 billion fund every 3.33 years (a typical frequency for a VC firm); fund life averages 10 years. So, in steady-state, a16z would have $4.5 billion in total committed capital—1.7x its current scale—and would invest $450 million per year.ii) Across its entire portfolio, exit proceeds average 2.5-3.0x capital invested, consistent with successful VC funds’ performance.iii) Management fees equal 2.5% of committed capital, and carry equals 25% of capital gains. Ignore thresholds that boost the carry to 30% and the fact that management fees on parallel funds are paid on invested rather than committed capital.iv) To calculate costs, estimate the average annual cash compensation per non-GP employee. Then, increase that figure to reflect additional expenses for benefits, rent, travel, professional services, etc.Finally, estimate the number of non-GP employees a16z would require to support a 1.7x increase in scale to $4.5 billion in committed capital. Note that a16z currently has 74 non-GP employees, 43 of whom are operating team professionals.
Case study questions answered in the third solution:
- What opportunity does Andreessen Horowitz see in the venture investing industry? To succeed as a VC, you have to do three things well: source, pick, and win. How does a16z approach these key success factors differently than other VC firms?
- Is the value proposition of a16z attractive to first-time founders? Explain why or why not.
- Is a16z’s investment in their operating team likely to yield positive returns? Explain.
a.) You will need to calculate the typical cost of the operating team and how much revenue a16z generates using the figures provided in the case. You may assume a typical employee costs a16z $300,000 per year. - Should a16z seek to double its assets under management over the next 2 years? Should they seek to diversify into other sectors or other markets (such as China or New York)?
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Andreessen Horowitz Case Answers
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Question 1: Was venture capital an attractive industry to enter in 2009? What entrepreneurial opportunity did Andreessen Horowitz see?
Overall, the Venture Capital industry was not very attractive in 2009. Due to lowered costs for launching internet start-ups, the industry became disruptive and decreased the need for Series A funding. In relation to that, potential targets preferred to remain private longer than the usual VC cycle of seven years, which led to restricted liquidity for VC firms.
Representing a highly fragmented industry where the lion’s share of high returns was constantly split between only a few strong individual firms also didn’t constitute the attractiveness of the industry. The level of competitiveness was even further increased by the rise of alternative funding methods such as crowdfunding, incubators, and angel investors.
Lastly, VCs attracted lower returns in comparison to S&P500 in recent years. Yet, a16z saw in these flaws the opportunity to enter with a differentiated approach and fulfill their own imaginations, being previously inspired by negative conceptions about VCs by former customers. To exemplify, in comparison to traditional VC, their new VC business model was supposed to focus more on operating support or to have founders remain in the firm rather than replace them with external CEOs.
Generally speaking, in 2009, after the financial crisis, potential valuations were demonstrated to be lower. This led to more conservative prices being paid for firms and hence offered Andreessen Horowitz the opportunity to eventually get higher returns when the market was able to recover.
Question 2: “To succeed as a VC, you have to do three things really well: source, pick, and win” (case, p. 8). What does a traditional VC firm do to source, pick, and win? How does a 16z approach these key success factors differently than other VC firms?
Firstly, next to referrals, proactive self-generations, and quantitative sourcing, a VC firm’s network is the major origin of its sourcing activities. For the picking process, factors such as the nature of the entrepreneurial team, the attractiveness of the industry, and the product are relevant.
Moreover, in the picking stage, majority votes among GPs are usually required. Lastly, with regard to ‘winning,’ all expertise in traditional VC firms usually comes from the VC company itself rather than from a network of external partners.
Moving to the factors that a16z does differently than traditional VC firms, a16z applies a retrospective approach with regard to sourcing. On a monthly basis, the company reviews deals that were sourced by its top-tier competitors, and for those deals that it did not source, the company firstly questions why these deals were not sourced and, secondly, whether this was the right decision.
Furthermore, the fact that a16z has applied extensive marketing efforts should give the firm access to additional companies that an ordinary VC firm without a clear marketing function would likely miss.
With regards to picking, a16z, in contrast to traditional VCs, does not require majority votes among GPs and…
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