One of our investors recently mentioned to me the difference between “orthogonal” and “linear” thinking.

By the former, I think of it as: multi-dimensional, creative, having disruptive potential. By the latter, I think of: logical, incremental, thoughtful (but almost obvious).

I think entrepreneurs are predominantly orthogonal thinkers. My partners and I often mention how entrepreneurs truly do see the world differently. They see the same pieces of information that the rest of the world does, but for some reason, they’re able to project further into the future and see potential that others cannot.

The challenge with backing entrepreneurs is that the orthogonal point of view can often create blind spots and irrational exuberance  So, as a VC, you have to work hard at enabling entrepreneurs to “go for it,” but at the same time, give advice as to when you think they’re going off the reservation.

Believe it or not, VCs have very little day-to-day power. We can influence people and situations, but we aren’t at the companies every day. Sure, we can give up on companies and force a shut down, or we can fire people (I call these the “nuclear options”).  But, you in practice rarely use those options without the entrepreneur’s consent. There needs to be a lot of trust there in the relationship.

It’s ironic, but venture capital means you have power but that you rarely use it. You really in the end have to let entrepreneurs do what they want. And, if they fail, you have to give a helpful ear and give them a hand. And, when they succeed, you hope they stay humble and hungry.

Today was our VC firm’s “annual meeting,” and it is one of my favorite days of the year. It’s an in-person meeting whereby we gather with our investors to update them on our companies.

I learn a lot at these meetings. We have investors who manage huge pools of capital, and some used to manage endowments at Yale, Notre Dame and Vanderbilt. Others invest on behalf of large retirement plans. It’s a sophisticated group.

Well, one of them shared with me a concept called “Business Love.” He said that the investment managers who tend to do the best for them are the ones with Business Love. I had no idea what he was talking about, and so, I asked him to elaborate.

Here’s what he meant:

• Members of those firms really respect and like each other. They’re very tight. In fact, they love each other
• They have a sense of mission. They want to make money, but that’s not the most important driving force
• How they treat each other spills over to how they treat their entrepreneurs and investors

Now, you may think of all this as hokey. But here’s this individual’s track record investing in VC and private equity managers: his performance is ranked #1 in the world, according to a third party. So, he’s got tons of street cred.

I think culture is a fascinating topic. We’ve always thought at Kepha that firm culture is everything, which is why we have Operating Principles. We wrote down our Principles to create a positive work environment, selfishly, for ourselves. We never expected it, though, to be a driver of superior financial results.

I’m going to think a lot about Business Love, and I’m going to look out for it at our companies. Pretty cool concept.

Tomorrow is one of my favorite days of the year. It’s the day of our firm’s “Annual Meeting.”  It’s when we get together with our investors and report on how we are doing.

Most VC firms do the same thing. We rent a meeting room at a hotel and give a presentation on how our investments are doing. Most VC meetings feature a portfolio company speaker, and a networking event with portfolio companies. We pretty much do the same thing.

The reason I like this day is that it’s always a pleasure to see our investors. It was very big of them to support a one-person VC firm in 2007, and now that we’ve raised two funds, they’ve bet on us twice. There’s always a genuine and supportive vibe in the group when we meet, and I’m so grateful to them for supporting us.

As I’ve written before, in a series of posts, VC is a trust business. It’s very moving personally to know that investors trust us with their capital. It’s very motivating to know that they bet on us as a start-up when the firm just got going.

So, tomorrow, is a special day for me. Our team here feels tremendous obligation to our investors. We want to do well and thank them with great financial results.

I often tell our portfolio company founders the following: at Kepha, we’re playing a 20-year game.

I think having a long time horizon affects what we do, why we do it, and how we behave. It sets a very high bar to which we aspire. It’s not always easy, and we don’t often hit those ideals. But, we certainly try to.

Here’s how a long time horizon affects how we work: we’re OK if entrepreneurs fail, as long as they don’t lie to us. We know that most VC-backed companies do poorly. With its 33% success rate, VC is a lot like baseball, as I’ve written in the past. It’s all about home runs. So, we’re OK if entrepreneurs “strike out.” But, what we want to do is have earned the right to work with them again.

In one example, we worked with an entrepreneur on two seed ideas, neither of which got anywhere. But, we introduced him to a third opportunity because we really believed in him. That one is now doing well. Eric and I identified this person as someone with whom we want to work for 20 years. The first two seeds failed because of the market and not because of any shortcomings in the entrepreneur.

Having a long-time horizon also encourages us to say the hard things, rather than keeping quiet and writing off an entrepreneur in our minds.

For example, I yesterday had a tough conversation with one of our founders. I told him that we thought his company’s progress seemed slow, but that we wanted to help. That tough topic led to a very honest and very valuable exchange. I said that since we wanted to work with him for another 20 years, we needed to tell him what we really thought. It ended up being a very awesome conversation, and I feel more aligned than ever with this start-up.

Having a long time horizon can make for tough situations, but it’s how I want to live my life.

Fred Wilson has another awesome post today about how hard it is to create real companies.  He wrote:

I have said many times that early stage VC is a lot like baseball, if you get a hit one out of every three times, you are headed to the hall of fame. And if I look back over my career, and also over the track records of the firms and funds I have helped manage, that is pretty much the hit rate I have seen.

It’s a very honest post, and something we in VC know. Most of our companies do not produce great returns, and that’s true for all, including VC super-stars.

Here are sobering data from Cambridge Associates. It shows IT & digital media start-ups from 2001 to 2011 and their multiples.  Yup, over 60% of them don’t return capital. They’re losses. Just 7% of companies generate >5x returns.

Fred’s comments and this data match what I’ve heard from many of our investors: the “loss ratios” for the good and bad VCs are the same. The difference between the groups is that the good ones have some super-winners.

So, VC is not about minimizing losses. It is about working with great entrepreneurs who can overcome obstacles and, in the end, create real businesses. In other words, you have to be really “go for it.” If not, your returns will suck.

Similarly, entrepreneurship is also hard. Creating real companies is usually a grind. It’s one thing to build a cool product. It’s another thing to build a real company.

There really is no free lunch.

Another busy day today.

One of my morning meetings was with an entrepreneur I know. I read his materials before he arrived and sent him an email saying we were unlikely to be a funding source, as we don’t know that space (selling hardware through waste management companies to hospitals). But, I said I was happy to meet him.

As I’ve written in the past, I try to give a clear answer when I meet with an entrepreneur. In this case, I frankly had reservations. He is someone I know and was referred to me by someone whom I know very well. I was worried about insulting him or our mutual friend.

The first few minutes, he did what most good entrepreneurs do: he tried to convince me otherwise. I heard him out, but again, told him we weren’t a fit. And, then, something magical happened. The conversation became very personal and very real. Once he got out of “sell mode” and I got out of “buy mode,” we had a very authentic discussion.

Also, we brainstormed about some options, and I think we ended up with some interesting ideas regarding next steps for him. He also shared some touching stories about his son, as well as a summer gig he did in Poland in 1974, during which he met the future Pope John Paul II, back when he was a largely unknown guy.

So, it was a good meeting.

I continue to get queries from people on “How to Get a VC Job.” I always tell them that it’s tough to enter the business, given that the industry is consolidating. Most folks continue to want to try, and I understand that.

But, here’s a picture that I think does say a thousand words. We’ve all heard that fewer VC dollars are being raised, but I saw this chart a few days ago, and it really caught my eye:

In short, less money raised means less management fee with which firms can hire people (see “How Are VC Paid?”). In some cases, it means that firms shrink. There’s not enough money to keep everyone. So, while it might be possible to enter an industry while many are leaving, it’s tough.

If you want to be a VC, I don’t want to burst your bubble. But, consider having a Plan B.

I often chuckle when I read articles about “successful” entrepreneurs and their multi-billion-dollar exits. It seems so easy in these news pieces: a good idea, superior execution, and everything falls into place. Geniuses snap their fingers. Fortunes follow.

The reality, in my experience, is different. There can many heartbreaks, pivots, layoffs, and divorces. There are usually many sleepless nights and a deep anxiety that roils your guts.

I follow some of the New England Patriots on Twitter. I noticed a few of them would Tweet: #RiseAndGrind. I’ve read that Head Coach Bill Belichick expects mental toughness in his players. He wants the team to improve bit by bit, day by day, and on each day.

He “cold calls” players in team meetings and asks them about opponents. You have to be ready or look stupid. You have to be hungry to do well in that environment. There aren’t many moments of downtime as a New England Patriot. Once a game is over, even after a resounding victory, it’s on to the next opponent.

Similarly, I think entrepreneurs and VCs have to be willing to “rise and grind.” Work hard. Don’t get too high or too low. Sacrifice.

My business partner, Eric Hjerpe, and I have spoken about this many times. We believe that doing well for our investors and entrepreneurs is about doing the little things every day. Putting in our hours, whether the day looks promising or terrible. Being consistent and honest. Being mentally tough.

And, hopefully, with good luck, we’ll make them all proud of us.

I’ve met many entrepreneurs.  Two who impress everybody are Sravish Sridhar and Rob May.

Given that, the New England VC Asssociation has asked them to lead the “Coffee Connect with a VC” series. As I’ve written previously, I think there’s a huge need for entrepreneurs and VCs to get together for regular, open/inclusive, and meaningful discussions. We VCs at times have a bad rap, and sometimes, it’s warranted.

So, we did a pilot test of three Coffee Connect meetings. A seed project. Here’s how we described it:

You. A VC. Entrepreneurial peers. A free-flow discussion on raising funding and growing your tech./life-sciences company. Open and inclusive. At Voltage Coffee in Cambridge.

We sent surveys after every meeting and were psyched that both VCs and entrepreneurs really liked the get-togethers. So, we want to leave the “seed” stage and continue to the next level.

Moreover, we think that entrepreneurs themselves need to lead these events.  We VCs can help support, but something “for entrepreneurs and by entrepreneurs” is much more meaning and sustainable.

So, we asked Rob and Sravish to lead the program, and we’re so glad they said yes.

If you’re interested in learning more, click here and consider opting into the group. Rob and Sravish are great folks doing great things.

I read Terry Francona’s new book. He is the ex-Red Sox Manager, who took the team to two World Series titles and, at long last, “reversed the curse.”

If you like baseball, it is a fun insider’s view into how a professional sports team is run. If you like following companies, it’s also an example of how success can breed the seeds of future destruction.

In the case of the Red Sox, going from zeroes to heroes made them a huge national brand, and, with that, came temptations to grow the business. The owners made decisions to maximize revenues, which at times dis-respected the Manager and the players. Ultimately, dysfunction set in, trust was broken, and people walked away from each other.

As a VC, I think the incentives in that situation were mis-aligned. Managers and players are paid salary and performance bonuses. They don’t have equity in the team. Team owners, on the other hand, want to maximize revenues to increase the value of their team. It’s what equity-ownership does to you.

Running a sports team is like running an airline: there are huge fixed costs (staffing a ball park, employing coaches, chartering jets, paying players, etc.) and the variable costs are pretty low.

So, every incremental dollar you get in revenue is largely profit. And, if every dollar of profit comes with it a valuation multiple of 10x (an example), you’ve now dramatically increased the value of your team. If you own the team, every dollar matters as a result. Owners aren’t bad people when they chase revenue growth. They’re responding to incentives.

So, in the case of the Red Sox, traveling to Japan and back for exhibition games was great for revenue, but it took a terrible toll on the players who then had to start their season jet-lagged and tired. Squeezing in home games after rain delays guaranteed revenue, but it wreaked havoc on the players’ mental and physical health.

Now, I don’t think aligned incentives are the panacea to all problems. But, it sure does help focus a conversation and helps align behavior. Common incentives mean that what’s good for the owners is also good for players.

One reason I like being a VC is this: there’s not a lot of room for fluff. The whole team (founders, employees, and investors) is trying to create value and do what’s right for the start-up. For the most part, there’s alignment.

It really simplifies life.

One of my morning meetings today was with a CFO, who is looking for his next gig. He has headed up finance for quite a few start-ups.

He recounted one such company, in the 1998/1999 time frame. It went public. Revenue was $1 million. Its market cap was $2.2 billion. “Those were the days!” he and I said.

When I look back at that time, it’s hard to believe that it actually happened. It was a weird period during which the cost of capital was negative; in other words, the more money a company raised, borrowed and spent, the higher its valuation in the public and private markets. It was all about go-go growth.

What’s odd is that all of us involved (investors, entrepreneurs, bankers, lawyers, etc.) didn’t think it was weird during that time. It was hard to know, while you’re in it, that you’re in a Bubble. “This time it’s different,” we all thought (or hoped). It’s easy to spot bubble-like conditions afterwards, but when you’re living in the moment, it feels absolutely normal.

I write this because another morning meeting I had was with an entrepreneur, whom I like and respect greatly. This person commented that business-to-business (B2B) start-ups were “in favor” again, but she wondered whether the crowds can be right.

I don’t know whether a space is “hot” or “cold” is relevant to entrepreneurship, for by the time you switch your capabilities to that “hot” sector, it may be too late. The market, IMO, seems much more guardrail-to-guardrail these days.

So, at our VC firm, we don’t time the markets. When B2B was out of favor, we continued to steadily plug away, investing in companies such as VoltDB and Paradigm4. When Internet consumer was “down” during an advertising recession, we invested in OwnerIQ.

We just want to work with great people on awesome ideas that matter.

Like many VCs, I’ve long admired Fred Wilson and what he and his team at USV have built. I think his post today is very important, which is why I’d like to highlight it.

Fred is writing about recently-announced data from the National Venture Capital Association and a comment from NVCA President Mark Heesen:

The venture capital fundraising environment has settled into a ‘new normal’ which is characterized by a barbell structure of larger funds which are stage and industry agnostic on one end, and smaller, early stage, industry or region specific funds on the other.

Fred captures, IMO, really important implications to entrepreneurs of this “new normal”:

There are a ton of options out there for early stage funding. And if you get to the stage where you need a growth round from a big fund, there are plenty of options for that too. But if you are looking for a Series B round to help you grow from early revenue status to true growth status, you are going to find that challenging….

The truth is early stage investors are often asked to be the funders of last resort for the “in between” stage…. So choose your early stage investors well. Make sure they are willing to see you through the in between phase if need be. Because they will probably need to.

Fred’s post made me wonder if the “high volume” seeding strategy can continue given the above realities. As I’ve written in the past, roughly put, there are two VC strategies for early-stage: 1. The “high volume and broad reach” model, where you invest in one round in many companies, and 2. The “low volume and high commitment” approach, whereby a partner invests in one to two new companies a year and “reserves” capital in the fund for future financings for those companies.

IMO, strategy #1 of doing 20 to 50 to 100 investments a year as a firm works best in a rising-tide market. When the market is flush, it’s easier to find a new firm to price the following round and add money to the company. When markets stall, the “insiders” (the existing investors) are asked to do that. And, if your strategy has meant doing a lot of investments and allocating few dollars to each company, it can mean a VC firm may get washed out or the companies themselves may run out of cash.

At Kepha, we follow strategy #2: we budget to invest in each of our companies’ financings. In this type of market, I’m particularly glad we do so.

I took a bad fall while skiing during the winter holidays. I should know better than to keep up with my speedy and nimble children, who ski so effortlessly and with insane speed.

Days later, I’m in a lot of pain. My usual bad back pills aren’t helping at all, and I wake up often at night due to back spasms.

So, I turned to Facebook and Twitter and asked whether anyone has tried acupuncture. Very quickly, many suggestions and opinions came in. I’m touched that people would take the time to give such good advice, with offers to provide the names of various care providers.

Tomorrow, I will see an acupuncturist for the first time. And, I’m grateful to all of my Twitter followers and Facebook friends.

I caught up today with a friend who has been a VC for a long time in NYC.  He has been in the business since the 1990s and is now doing angel investing.  He has a great track record.

Now, I don’t know NYC.  We look at things based there and are open to investing in the area, but we’ve not yet found our first opportunity.  I asked him about what the funding environment was like down there.  I expected a rosy and optimistic view.  A lot of VC money has been pouring into NYC. I instead heard a bearish view.

His paraphrased comments:

• A huge number of seed funds and angels
• But, very few people who can lead a Series A round

Regarding the latter comment, he thinks there’s a dearth of folks with time and capital:

• A number of firms outside of NYC are flying in, but aren’t much of a factor these days, as they’re slowing down their investment pace
• Many of the luminary VCs based in NYC are already filled up with board seats and are spending most of their time investing elsewhere.  So, they live in NYC but they’re investing mostly in other states

So, my friend continues to focus on seed investments.  He also thinks there are great opportunity in finding “seed extensions”: a company needs a few quarters more of runway to hit more milestones, but my friend gets to invest at the same price as the original seed round.

I wonder if this POV is what you’re seeing in NYC.  With a long-term view, I’m optimistic for NYC–some great fundamental trends there for innovation.  But this current snapshot isn’t what I was expecting to hear.

I guess the “Series A crunch” virus is spreading (here’s a great post by Dan Primack on that).

An entrepreneur last week called me: he met many times with a VC, who kept saying over and over he really wanted to invest.  Then, suddenly, nothing. The VC wouldn’t return his calls or emails.

In another recent situation, a different entrepreneur had many meetings with another VC.  After many weeks, the VC passed on the financing, saying the company didn’t have enough revenue.  That entrepreneur was very frustrated.  Why, he wonders, did the VC pass based on something that would have been obvious in the first meeting?

The short answer is you’ll never know why a VC doesn’t engage or invest.  So, stop stressing about it. It is Bill Belichick-ean to say, but just turn the page and move on.

I wrote a blog series on “How to Raise VC Money,” and in one post about handling VC due diligence, I listed some reasons why a VC passes:

• The VC took the meeting as a favor and was never interested in investing
• He doesn’t believe in your space
• He is on too many Boards and is holding out for a later-stage investment
• He is secretly thinking of leaving his firm
• That VC has limited power to influence his partnership
• He wants to see if other VCs show up and validate your idea for him
• He reference-checked you with someone he knows—and, it was negative
• His partners really didn’t like the idea
• He is a new VC– the senior partner supervising him isn’t interested

My own personal view is this: I’m really busy, the entrepreneur is even busier, and so, I try to pass quickly.  I often do it in the first meeting. Or, when I get an email requesting a meeting, I often decline if the start-up isn’t in one of our core investment themes or sweet spot.

I endeavor to move things in and out of our pipeline quickly, and in the process, give entrepreneurs clear feedback.  Admittedly, it sucks when entrepreneurs get defensive with any feedback I give.  In those situations, I just dis-engage.

But, I’d rather disappoint people quickly than really disappoint them later.