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The Benchmark in Venture Capital

Benchmark Capital is a venture capital firm that focuses on start-up investments and technology-driven companies. The Fool's Tim Beyers recently had the opportunity to interview Bill Gurley, a general partner at Benchmark. See what Bill had to say about his due diligence process, the ideal start-up, and which part of the technology industry to avoid.

TMF: One of the great myths of growth investing is that only value investors act conservatively. But some of the most conservative investors we know also happen to be venture capitalists. Tell us, Bill, what does your due diligence process look like? 

BG: I think this is a great point, in that I do consider my investment style to be rooted in financial conservatism. "Contrarian" would be another word with which I associate. As we invest in very-early-stage opportunities, our due diligence process is very intimate. We spend time with the entrepreneur and get a read on their individual skills. We personally do reference calls, and market calls. We don't even have associates, because we want to hear the information first-hand. Lastly, we incorporate what the "market" is doing in our analysis. If 10 other guys are likely to be doing the same thing, it's not for us.

TMF: What does the ideal start-up look like? Would The Knot (Nasdaq: KNOT  ) , which is a company that you've invested in and is one of our own Rule Breakers stock recommendations, be a good example?

BG: Benchmark did not invest in The Knot, but I did as an investor at Hummer Winblad (where I worked before Benchmark). Simply put, the ideal start-up has network effects. They are talked about frequently, but scarcely observed in real practice. Yet they do exist. You want the competitive advantage to strengthen over time. eBay (Nasdaq: EBAY  ) had this. Open-source companies like Red Hat (NYSE: RHT  ) and MySQL have this. And I would argue that Open Table, Linden Lab (Second Life), and Yelp all have this.

TMF: You're one of the lead investors in Linden Lab, the creators of Second Life. That business appears to have taken off like few others. Did you foresee Linden having this much success?

BG: It wouldn't be fair to say I foresaw quite this much success. Back when we invested, we did openly discuss the leverage and network effects that exist when a product is 100% user-generated content. Moreover, when you put a financial engine on it and other people can make money, you have a very strong "competitive moat." Last month, over 40,000 in-world entrepreneurs made a profit net of fees to Linden Lab. How many platform plays have enabled that amount of financial success for its participants? Microsoft (Nasdaq: MSFT  ) , eBay, Apple (Nasdaq: AAPL  ) , who else? Macromedia? It's a short list.

TMF: How do you know when a start-up is destined for failure?

BG: Over the past 10 years, I have seen several "near-death" companies find a way to change their strategy and reach remarkable financial success. As such, I am much more suspect of "declaring the patient dead" than I would have been earlier in my career. I suspect when the team loses all hope, it's hard to continue. But I will try to convince them otherwise!

TMF: If it were possible to short an entire sector of the technology industry, what would it be? Or, put differently, what sorts of businesses are guaranteed not to make your power lunch list?

BG: As venture capitalists, we favor businesses with IP leverage. On the margin, the last unit of production should be way more profitable than the first. At the peak of financial cycles, venture capitalists forget this (it is happening now), and they fund professional service companies, network operators, and more recently things like fuel manufacturers. These investments on the whole will be disappointing.

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Tim Beyers

Tim Beyers first began writing for the Fool in 2003. Today, he's an analyst for Motley Fool Rule Breakers and Motley Fool Supernova. At, he covers disruptive ideas in technology and entertainment, though you'll most often find him writing and talking about the business of comics. Find him online at or send email to For more insights, follow Tim on Google+ and Twitter.

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