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What Makes a Good Venture Capitalist?

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Michael Arrington, editor of the popular tech startup news site, TechCrunch has decided to shift gears and become a venture capitalist (VC).

Debates on journalistic ethics aside, is it that easy to become a VC?

Marc Andreessen, founder of the leading venture firm, Andreessen-Horowitz Ventures, once said, "In California, you need a license to drive a car or buy a gun, but not to be a venture capitalist." Even the local barber has to pass a State Board Exam, and get a license to cut hair. Being a VC calls for two distinct abilities: raise money from institutional investors (called limited partners) and invest it in a portfolio of companies -- the Facebook, Twitter, Zynga's -- to generate obscene returns. Sounds deceptively easy! Not quite. Here are a few characteristics of successful venture capitalists:

Can you raise money? According to the National VC Association (NVCA), venture firms shrunk from over 1023 in 2005 to 791 in 2010. In other words, institutional investors are not handing out money as fast as they once did. Ten years ago, during 1999-2000, venture funds raised $100 billion. In 2010, only 157 venture funds raised $12.3 billion -- the lowest in the past seven years. Despite this apparent slowdown, for best-in-class VCs, raising money is a quick in-and-out 90 day process, while the rest of the wannabees spend 18 months or more raising capital. Institutional investors are being very selective. Venture funds that can demonstrate a compelling strategy are welcome. For the rest, Darwin prevails.

Can you find the future 'greats'? Just as every newborn baby looks beautiful, every startup looks like a great investment opportunity. In any year, VCs invest about $15 billion in some 2,000 companies. So how many rise above the noise? I interviewed Terry McGuire, who founded Polaris Ventures, a VC of 25 years and Chairman Emeritus of NVCA, for my upcoming book. He recalled that he met with every start-up with a sense of wonder. "You really can do that?" he would say. Over the years, his success came from a fine balance: "You have to believe that the world can change...be optimistic, and at the same time, be realistic and guarded, not romantic." Frank Caufield, Partner at Kleiner Perkins Caufield & Byers told me over an informal lunch that a VC's job is to decide if the CEO's vision is really a vision or a hallucination."It all boils down to judgment," he pointed out. Good VCs welcome every entrepreneur with healthy skepticism.

Can you generate returns? Getting into great startups is only half the equation. Getting your money back, ideally with a large multiple, is the other half. The single metric of success in this business is called IRR -- internal rate of return. According to Thomson Reuters, the median return for a VC over a 20 year period ending Septemeber, 2010 was 12.1 percent. Speaking to an audience at Stanford, Marc Andreessen once said that only 30-40 firms generate returns, while the vast majority of VCs break your heart. Indeed! The top quartile of VCs generated 40.3 percent over the same period.

Like Arrington, Michael Moritz of Sequoia Capital was a former journalist, so was Stewart Alsop of New Enterprise Associates (NEA), a leading VC firm. Moritz became hugely successful. Alsop described his own success as not being in the "God" category, and eventually left NEA. There is no formula for making successful investments. How many are truly successful in generating venture-like returns is anyone's guess. C. Richard Kramlich, founder of NEA, once remarked in an interview with Gary Rivlin of the New York Times that "Below the surface there's a huge amount of turnover."

In between finding the good opportunities and exits is a fair amount of turmoil. Dick Kramlich, in an interview with Mauree Jane Perry, said "Good instinct, well honed by experience makes a good venture capitalist. The most difficult part is dealing with uncertainty. This uncertainty, combined with the opportunity of interacting with bright entrepreneurial minds (and making money) attracts one and all to the business of VC. Michael Moritz of Sequoia Capital was quoted in Aspatore Books saying, "Every day is composed of a hundred soap operas--it's an exhilarating place to live and work." Speaking about being a venture capitalist, Steve Jobs is a bit harsher - he was quoted in Return to the Little Kingdom: How Apple and Steve Jobs Changed the World "sounds like a bullshit job to me." That book was authored by none other than uber VC Michael Moritz of Sequoia Capital. Touche indeed!