Pharos Capital Group's managing partners and co-founders, Michael W. Devlin and Doctor Robert Crants agreed to take my questions on the subject of the venture capital world in 2006, the Web 2.0 environment and investment in web technologies. Mike & Bob are both veterans of the VC industry and currently have investments in companies like SmartDM, Travel Holdings, NetSize and more. drow names
Mike blogs at Mike Devlin on Private Equity and Bob runs Bob Crants Pulls Back the Private Equity Curtain.
My goals with this article were to delve more deeply into the macro-trends in the investment and web technology worlds and see how the people funding these companies think about web as a platform and Internet investment.
Rand: Mike & Robert, thanks for participating; I know that both of you have a lot to share. Let’s talk first about your background and what brought you to the VC field – were there any traits, connections, smart moves or strengths that you feel helped get you to this position? If someone’s dream is to enter the VC field, what advice would you give them?
Bob: I began investing at a young age and truly enjoyed watching the ups and downs of the stock market. Fortunately I made as many bad trades as I made good ones so that I learned with my own money the importance of managing risk. I studied economics at Princeton University, then joined Goldman Sachs in the Special Investments Group which designed and marketed a wide array of alternative investments including private equity.
I developed a passion for the private equity market through my experiences at Goldman and ultimately decided to take what I learned and apply it to the creation of a new firm dedicated to managing private equity investments.
The traits that are required to be successful in the private equity market from my perspective, are patience, quantitative skills, understanding of risk, and probably most importantly a hint of entrepreneurialism. If you cant think like a CEO and understand the challenges associated with building a business, it is going to be hard for you to be successful.
For a college student interested in the field of private equity, my suggestion would be to find a firm that has a team of people that you will enjoy being around and whose opinions you respect. The private equity field is quite interactive and involves long hours, lots of travel and quite a number of stressful times. If you are not around people that you like and respect, this lifestyle will be too much for most people. If you are surrounded by people you like and respect, private equity can be a great and rewarding business.
Mike: I took a more circuitous path into the VC field than Bob. After graduating from Yale, I was selected to teach at the Chinese University of Hong Kong as part of the Yale-China Program. Hong Kong to me was and still is the epitome of entrepreneurship, where most people dream of starting their own business and successful entrepreneurs are celebrities. I was exposed to this world (and one very different than that of the University) through a Chinese family I met that was in the vanguard of setting up manufacturing facilities in mainland China.
After 3 years in Asia, I decided to come back to the US and went to Duke Law School that had an interesting China related program in which I participated. I also started a small import business with the Soviet Union while at Duke. Next, I joined a big Wall Street firm, Davis Polk & Wardwell and learned about securities and merger transactions. I never wanted to be a lawyer, but a family friend had recommended this path with the assertion that unlike most parts of the world the nexus between business and law in the US makes it important to know something about the law.
I think he was right, even though it was painful working at a law firm. After my law experience, I went to work at a start up group at Goldman Sachs and learned the fundamentals of value investing in both the public and private markets. That's where I met Bob and after some time working together, we decided to start our own business. The smartest move we made that helped our company succeed was setting up in Nashville and Dallas. There was scarcity value in what we were doing and there are lots of good companies (particularly in health care) in these under served markets.
Regarding advice about the VC field:
Invest in the Stock Market
The experience of investing in public companies is not directly analogous, but it is a pretty good proxy. Comparing business plans, assessing management and understanding competition in a particular sector will be helpful experience.
Read A lot
You never know where your next investment idea or theme will come from, but it will likely not be completely original. Reading lots of regional and national business oriented publications is helpful, but so is reading other non business oriented publications in which you have an interest.
I remember Roy Zuckerberg, the former head of Goldman Sach Equity Division, once mentioning in a speech that one of the things he looked for in potential hires was a demonstrated interest in collecting things. He didn't care if it was baseball cards or 20th Century art. Collecting is at its core, weighing relative value and allocating capital. That is a discipline that is extremely important as a VC. After all, your job is to allocate a finite amount of capital in companies that will grow in value over time.
Rand: Can you describe your current venture – Pharos Funds – what is the goal of that firm and where are the primary areas of investment? What do you feel are some of the most interesting or notable elements about the fund?
Bob: Pharos is a private equity firm that makes $5-$20MM investments in companies involved in Health Care, Business Services or Technology. We are value-added style investors and invest primarily in underserved markets. We are always willing to look a little harder, or work a little harder to find deals that we believe will generate attractive returns for our LPs.
Mike: The goal of Pharos simply put is to return more capital to our institutional LPs than they gave us in the shortest amount of time possible. We intend to accomplish this by investing in health care (broadly defined....services, devices, diagnostics), business services (companies that focus on making other companies more competitive) and applied technology (has both a product and a defined market).
A notable element about Pharos is that we focus intently on markets that have been traditionally under served. This can include companies in states that my friends on both coasts call "fly over country" that have less VC competition or entrepreneurs who have traditionally been overlooked by institutional VC investors (minorities and women led companies).
Rand: Let’s move to the history of VC and the Internet. What elements do you feel were primarily responsible for the events surrounding the bubble and crash? Do you think that real lessons were learned during that time, or are we going to experience similar ups and downs in the future? Are we in the early stages of a new web bubble right now?
Bob: Virtually all bubbles are based on successes, and the internet bubble was no exception. As the public markets embraced the unlimited potential of the internet, exits became easier for private companies and returns to venture capital firms became larger. These outsized returns triggered easier fund-raising efforts, more money to be invested and encouraged entrepreneurs to take on more risk in order to shoot for the big payday.
However, as more and more money was raised for deals, and risk tolerances were relaxed, valuations became unsustainable, and the market was ripe for disappointment.
In the case of the internet bubble of 2000, many business received funding that never should have, but lots of good businesses delivered unprecedented growth that simply couldn’t keep up with unrealistic expectations. As investors became disappointed, stocks were sold, prices fell, the IPO and M&A market closed, and many private equity professionals looked at their portfolios with a critical eye really for the first time.
Needless to say, not everyone liked what they saw. As for today, the huge successes of some internet exits, including Google and Skype and MySpace/Intermix, have lead more private equity firms to look at intenet based business models more closely. Within our markets however, the hype is not anything like in 2000, and private equity firms are treading cautiously and trying not to make the same mistakes again. Similarly, earnings, profits and cash flows, remain part of virtually every discussion with private companies today, whether internet based or not. This grounding should keep the market more reasonable and balanced.
Mike: The causes of the Internet bubble and crash will be debated forever, but I think you would have to put on the list:
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