Forbes/Wolfe Emerging Tech Report
Kevin Kinsella is the founder of Avalon Ventures. He has specialized in the formation, financing and/or development of more than 100 early- stage companies, including: Athena Neurosciences (acquired by Elan plc [ELN]); Onyx Pharmaceuticals [ONXX]; Sequana Therapeutics (merged with Arris to form AXYS Pharmaceuticals, acquired by Celera Genomics [CRA]); Vertex Pharmaceuticals [VRTX]; Synaptics [SYNA]; Vocera Communications [VCRA]; Sytera Ophthalmics (acquired by Sirion Therapeutics); Amira Pharmaceuticals (acquired by BMS); Anaptys- Bio; Cardeas Pharma and Juliet Marine Systems. Kinsella was the founding chairman of Athena Neurosciences, Aurora Biosciences, Landmark Graphics, NeoRx, Onyx Pharmaceuticals, Synaptics, Vertex Pharmaceuticals, X-Ceptor and Sequana Therapeutics.
Kinsella is a graduate of the Massachusetts Institute of Technology with a Bachelor of Science degree in management, with minors in electrical engineering and political science. He holds a Master of Arts degree in international relations from the Johns Hopkins School of Advanced International Studies and conducted post-graduate work in political economy on a Rotary International Fellowship at the University of Stockholm, Sweden.
Kinsella is the largest individual producer of the Tony Award-winning hit Broadway musical, Jersey Boys, and the partner of Rhino Records (Time Warner) in producing the Grammy Award-winning Jersey Boys Original Cast Recording. Kinsella is a member of the Council on Foreign Relations and a member of the Broadway League (Tony voter). He founded Kinsella Estates Winery (Healdsburg, California), which produces the highest rated premium Dry Creek Valley cabernet sauvignon. His collection of California Plein Air art, housed at the Kinsella Library in La Jolla, is among the best in the world.
How did you get started as a venture capitalist?
I wasn’t ready to get a real job after school so I took off around the world. I did everything from teaching algebra in Beirut, to studying political economy at the University of Stockholm, to advising the Peruvian government on cultivating quinoa. At age 30 I returned home to figure out what to do with my life, and was asked to help MIT begin a $225 million capital campaign. Over the course of the campaign I had the wonderful opportunity to meet some of the early venture capital entrepreneurs, I’d guess you’d call them—people like Tom Perkins at Kleiner Perkins. I was at that period in my life where I was doing template matching, and I just loved talking to these individuals about what they did. On one hand it had all that wonderful technology dilettantism about it—using a technical base to be able to come to grips with new ideas. You also had the chance to vary your interests, because you weren’t just involved with one company. And then of course, if you placed your bets right, you could make a lot of money without a lot of heavy lifting—high cleverness with low capital. I just loved that. So once the campaign goal was fully in sight, I moved to the West Coast with $250 in my pocket and my Ford Pinto to become a venture capitalist.
What was your first success?
Prior to starting Avalon I created 2 companies, Spectragraphics and Landmark Graphics. Landmark was the first to process geophysical seismic data into a display of the Earth’s subsurface, with anticlines that might have pockets of oil or gas. It went public and was later acquired by Halliburton [HAL] for a half a billion dollars.
As someone who’s been in this business a long time, what are some common misconceptions about the venture industry?
Some think this is a process-oriented business that can be studied, or learned through weekend courses. Fundamentally, it’s an art, best learned as an apprentice. But there’s also no substitute for developing your own scar tissue as an operating manager, because you need to know the problems all entrepreneurs face.
I’m now working on a book called On Venture Capital, which aims to demythologize and debug some of the constraining theories about this industry. Most books on venture capital drone on about things like term sheets, which are fairly simple concepts. The most important thing is to be on the same page with the entre- preneur, because you either win together or lose together.
Does a successful venture capitalist need to have the same outlook and mindset of a great entrepreneur?
At Avalon, each of our partners has been an operator. Each has founded, built and sold businesses, and has taken them public. We look for ideas that are outside the box, and that requires great tolerance of personalities that may not be congruent. As you get older, the entrepreneurs seem to get younger, so you have to stay young at heart and be able to relate—to get down and dirty, go into the labs at Stanford and MIT, talk to people and find out what the hottest ideas are. You can’t just sit in your corner view office and have the world come to you—you’ve got to go out and find it.
How is Avalon different from other venture firms?
We are a partnership-only fund. We do not have senior vice presidents, principals or any of the bureaucracy that happens when piles of money came into the venture business. The first touch and the last touch that any entrepreneur has with us is with a partner who is a decision maker. The fast turnover of technology today has forced a change on larger, more bureaucratic venture funds. We cannot have a three-month cycle before an entrepreneur finally gets to meet the partners, while they’re working their way up the chain of associates. The deal is long gone by then. We’ve never had associates, and therefore we don’t have to con- tend with that problem. We also try to stick to early stage deals where we can peel off small amounts of money. If the company meets their marks, they get more. The valuations that we pay are modest but fair. One side effect of the excessive capital that’s come into this industry is that we’ll see deals priced not by their in- trinsic value or the value of the founders’ resumes, but priced by the availability of capital.
What do you mean?
I read about syndicates forming to create $40 million investments in early stage companies. That just leaves me flabbergasted because it’s not imaginable to do that with any company I’m aware of in the technology space. You always have to reserve at least 15 – 20% of the company for founders, key advisors and future employees—otherwise there is no incentive to work hard. So if you work the equation backwards and say $40 million ultimately buys 15% of the business, you arrive at some unbelievably large valuation, which doesn’t make any sense. As a result, we absolutely avoid getting involved in situations where deals are priced based on the availability of capital and not by the intrinsic worth of the idea and the people.
Does that imply that you invest where capital is scarce?
Right. Great ideas are not products of committees; they’re not lying around on the street for anyone (including large corporations) to pick up and use. We look for unique opportunities where the entrepreneurs are not the polished Harvard Business School types, but are compellingly intelligent, creative, and don’t dance to everyone’s standard tune. We seek out the quirky ideas, because the price hasn’t gotten ridiculous.
How do you diligence companies that are essentially just conceptual ideas?
My partner Rich Levandov once enunciated that “due diligence is what you do when you don’t want to do a deal.” It has to be a gut feel. In fact, if you could even possibly do a five- year projection for the business, then clearly it’s not a new industry, because otherwise the data would not be available. For example, when we invested in Zynga, the market did not exist for social media games, nor did the concept of virtual goods for these games. The idea that people would buy into the so-called “freemium” model just had not occurred to people and it required very different metrics and a new way of thinking about gaming. If you had hired McKinsey to do a long-term projection, it would be completely bollocks because there were no reference points. We like deals with no reference points because they’re so novel and creative that the usual suspects won’t have a point of view.
You mention the word “creative” frequently. Why do you think creativity is such an important trait in the startup world?
It’s the only thing that distinguishes a great deal from the hoi polloi of plain old ordinary deals. True creativity is not a new algorithm that will permit you to X, Y or Z to be clever or interesting. True creativity means creating an entirely new market—it’s got to have the potential to generate big dollars at the other end.
What are some of the mental models you have formed over time to help distill the characteristics of what makes a really great idea?
Essentially, uniqueness. I don’t want to hear about the third coming of some deal that’s already out there. It’s just not interesting and it’s unlikely to get traction in competition, unless you have some special sauce that the other entrenched player doesn’t have—as was the case when Google knocked Yahoo off its pedestal. Yahoo was the first major search engine, but not today, right? Generally we approach those notions with enormous skepticism, because we recognize it’s very difficult to kick the dominant player off the playing field.
We also love emerging technologies. We look for areas that don’t have footprints; like untracked snow where we can carve our own path with the company. Otherwise, we don’t stick to a roadmap. There’s no textbook or formula for a successful startup. It doesn’t work that way. Out of a million businesses started in the U.S. in a given year, 990,000 of them fail. Of the remaining 10,000, some will bump along for a while and then fail, and the few standouts will have enduring traction and power and will go on to great things. Obviously those are the ones we’re looking for, but the odds are not in our favor so we need to be smart and careful and clever.
What do you consider most important: market selection, team selection or technology selection?
The team is the most important, and market is probably next important—which the team will figure out, because they are smart people, right? Let me share some of our current think- ing: consumer Internet startups leave us cold, because most just slice and dice pieces of a fi- nite pie. We seek new tools to radically revolutionize what goes on in enterprise, with customers willing to pay bigger bucks and to pay maintenance fees on software. The whole enterprise model is different. The up-cycle is certainly a lot longer than the consumer sector, but once established, you’ve got more longevity than in the faddish world of consumer culture.
Can you share your thoughts specific to investing in biotechnology?
I recently spoke with a pharmaceutical guy who asked what I thought of the current crop of biotech companies. I said, “I hate them all, until proven otherwise.” The pendulum has gotten completely out of whack in terms of the appropriate level of risk for clinical medicines. The ecosystem is being destroyed because the pharmaceutical companies are effectively saying “you swashbuckling venture capitalists should be taking all the risk,” but then they’re not rewarding companies for that risk. Even if you are successful in generating good phase II data, they offer you a deal to get your money back up-front and then upside on the come on the back end. How can any venture capitalist go back to their Limited Partners to raise money on the notion that their successful returns are just getting their money back? It’s preposterous, and two-thirds of health care-fo- cused venture funds are now out of business.
And now the pharma companies have finally realized there are no phase II assets left worth a bucket of spit, and they need to get something going in the discovery stage. But guess what?
They’ve already fired their R&D staff because they were so unproductive and the business development people—through their predatory practices—were basically raping and pillaging all the biotech companies and their venture backers as they cut a swath through biotech land proving how clever they were. I think they’ve now hit the panic button so we’re having several discussions with pharma companies about returning to the old system.
Would you predict that biotech might actually return to being an exciting sector for VC?
We don’t have a template anymore. We avoid discovery-stage deals like the plague. In the old days, technical risk was the biggest concern. Will it work? Is the target drug-able? Will the tox data be sufficiently innocuous? We have more tools today where we can tip the cards in advance so we’re less likely to pursue something that will get kicked out in phase III (although it still happens). Today, the risks are more financial than technical. The time-to-market is so long that it goes beyond the length of your 10-year fund. What’s the point of that?
What biotech companies have you invested in?
We created a company called Aratana, which deals in companion animal health. There are more dogs and cats in the U.S. than children, by far. People want healthy animals and since insurance is rare, pet owners pay out of pocket, so there are no payment issues. And it’s not too difficult to get medicines approved for animals; in many cases it’s governed by the USDA as opposed to the FDA so you can fast-track these products. This company will probably go public later this year.
Another example: we provided funding for a clever antibiotic technology at Scripps. We had one guy running the company, working hand in glove with the scientist-entrepreneur. We’re now within weeks of selling that small company to a major pharma firm. Because we kept it small, and own most of the company as the only financier, this will be a big win for us.
If you look at the statistics over the course of last year, the average price paid for a tech company was $103 million and $130 million for a biotech company. The challenge in this
business is to make money at the averages, in terms of the amount of the company you own and the valuations that you paid. If you can’t do that, then you’re in the Hail Mary business.
How do you avoid being in the Hail Mary business?
The Hail Mary business is like Las Vegas. We’re making thoughtful investments, so we require great discipline. You can’t control your exits—the value you get on exit depends on many things, including luck and timing and competition.
However, you can control your entrances. You have total control over the valuation that you’re willing to invest at, when you go into a company, and we are enormously disciplined at that. I’ve seen great opportunities that we would have loved to invest in, except the valuation got crazy. If we can’t see the path to the exit, we won’t do it. Part of our discipline is to ensure that the going-in price will make us money on the exit, without relying on the Hail Mary billion dollar return. The basic notion of venture capitalism is to leverage big cleverness with small capital, not small cleverness with big capital.
You are also an investor in the Broadway show, Jersey Boys. How do you compare show business to the venture business? Both are high risk, and in both cases, you have to go with your gut. I first saw the show in technical rehearsal in October 2004 at the La Jolla Playhouse. By the end of the first act, I was scrambling to find the director. I told him, “I’ve got to invest in this show—this is the best Broadway show I’ve ever seen!” He told me I might lose all my money (like most people who invest in Broadway). I loved hearing that because people in our business are rarely completely honest about risk. We always hear about how we’ll double our money overnight or get 10X in 18 months, etc. I signed on for $400,000, as a personal investment. A few months before the open- ing, after a very successful run at La Jolla, an- other investor pulled out a million dollars. That was a million dollars gone from a seven and three-quarter million dollars budget! The director called me in a panic, and I said, “Okay, I’ll take it all!” I became the show’s largest investor, and it’s been so successful that it’s been like winning a lottery ticket. ET