As VCs Move Upstream, Madrona Venture Labs Builds Its Own Startups

In recent years, venture capitalists have been investing earlier in promising entrepreneurs and startups, nurturing their ideas in incubators, and creating programs to select the best teams and accelerate their growth. Seattle-based Madrona Venture Group is going one step further with an effort to directly form and develop high-potential software startups—based on the ideas of the venture firm’s partners—and then recruit talented individuals from places like Amazon and Microsoft to build them.

Madrona Venture Labs is an attempt to systematize the firm’s past “ad hoc” efforts to incubate startup companies, says Greg Gottesman, a managing director at Madrona, one of the Northwest’s preeminent and long-tenured venture firms. “There’s a lot of VCs that are doing seed rounds, including Madrona,” he says. “This is even earlier than the seed round.”

Companies incubated at Madrona in the past were mostly brought in by outside entrepreneurs seeking investment from the firm, but also include the likes of, a marketplace for pet boarding services that Gottesman founded out of a Startup Weekend event.

Madrona lifted the lid on its Labs project this week with the unveiling of its first spinout company, Spare5, based on an idea conceived by serial entrepreneur and former Madrona entrepreneur in residence Joe Heitzeberg and Gottesman. Today the venture firm widely announced the effort, begun in spring of this year.

Here’s how this top-down innovation model is supposed to work: Gottesman and Heitzeberg lead a seven-person team (pictured at top) consisting of experienced software developers and designers, paid from Madrona Venture Group’s current investment fund. They’re tasked with the heavy lifting of validating a business idea—usually something with a billion-dollar-plus potential market, enabled by big technology themes such as mobile, cloud computing, and machine learning. They work for three to six months to create a product or service, and attempt to attract paying customers. If the nascent company has gained traction, the firm recruits a CEO with relevant experience and other early employees to take it forward, and helps find additional venture financing. If it doesn’t show promise, they kill it and move on to the next idea.

In the case of Spare5, which pays people to complete tasks for businesses like tagging e-commerce photos, Madrona recruited Matt Bencke, erstwhile senior vice president at Getty Images, as CEO. It helped raise a $3.25 million seed investment from New Enterprise Associates, Foundry Group, and, of course, Madrona itself.

The Spare5 team also includes Urbanspoon co-founder Patrick O’Donnell, former TeachStreet chief technology officer and Amazon senior engineer Daryn Nakhuda, and Feedburner co-founder Matt Shobe.

Chris DeVore, general partner of Northwest-focused early-stage investor Founders’ Co-op, describes himself as a “founder-centric investor” who is “skeptical of ‘top down’ innovation efforts.”

That said, Madrona appears to be off to a good start, DeVore says in an e-mail. “I know many of the guys associated with Spare5 and it’s a very strong team, so they’re clearly attracting great talent to the program,” he says.

That’s a key focus of Madrona Venture Labs. Heitzeberg says Seattle’s twin technology giants bring in talent from around the world, many of whom are entrepreneurial in nature and aspire to have their own companies, but are loath to trade the security and good pay of a job at Amazon or Microsoft for the risk and toil of a startup.

It’s a common lament in the Seattle startup community that too few Microsoft and Amazon employees leave to become entrepreneurs and angel investors.

“To do a startup on your own means giving up all of that, working for zero for up to a year, and then maybe you get a little seed [investment], and then you can take a cut-rate salary for another year,” Heitzeberg says, adding, “Some of us have survived on that model, because we have very loving spouses.”

Madrona hopes to pry some people loose from Seattle’s technology giants by handing them the keys to a startup that’s revved up and ready to drive.

madrona-venture-labs-logo“Labs brings an idea with traction, paying customers, a working product, and leverage to get financing right away, so that a would-be entrepreneur at Amazon with a proven track record can parachute in and be effective from day one [and] grow the company to the next level,” Heitzeberg says. “So that’s a huge differentiator in the world of startups and in terms of what you can do in Seattle, even if you look at things like Techstars Seattle.”

Of course, the CEO who is handed a neatly packaged, ready-to-grow startup should expect a smaller equity stake than a founder who took the risk and the pay cut to build something from scratch. Just how much less Madrona wouldn’t specify, saying only that the spinout companies will be structured “in a way that is meaningful for the CEO and the founding team that is recruited to take the company forward.”

Another twist to what Madrona is doing with Labs is the explicit focus on ideas from within the firm and its network.

“One hundred percent internally developed,” Heitzeberg says of the ideas Madrona Venture Labs plans to develop. Gottesman hedges that a bit, adding that ideas from entrepreneurs Madrona has worked with before will also be considered. “We’re not set in stone on the right, perfect way to do this,” he says.

This reflects a shift in venture investing as firms that used to count on their partners’ networks to ensure proprietary “deal flow” have more competition for investment opportunities. Firms are moving to early stage investments in pre-commercial ventures to ensure access to later rounds, to build deeper relationships with entrepreneurs, and to learn about new markets. Some, as in the case of Madrona Venture Labs, are also turning to venture creation—forming new businesses themselves.

“The VCs of today are increasingly credible as operators and often have successful entrepreneurs within the ranks of their general partners,” says Ted Zoller, director of the Center for Entrepreneurial Studies at University of North Carolina at Chapel Hill, in an e-mail. “I think VC is swinging back to the entrepreneurial culture that gave it its birth in the age of silicon.”

Many venture capital firms have set up incubators with similar goals to Madrona’s, though they all have different approaches. Examples include Flagship VentureLabs; the General Catalyst Hatch Fund; and the technology side of Atlas Venture, which has unveiled plans for a startup incubator in Boston. Others, such as Polaris Partners, have scaled back their incubator efforts. And still others choose to support startups through outside accelerators and incubators, as was the case with Y Combinator and several top-flight firms, such as Andreessen Horowitz, that until recently served as limited partners. (Y Combinator announced an end to that practice earlier this year, in part to reduce consternation among other VCs.)

Gottesman says he’s not seen the explicit focus on forming companies from partner-spawned ideas at other venture firms before. Zoller, also a senior fellow at the Kauffman Foundation, agrees that it is “somewhat unique.” Gottesman likens Labs instead to stand-alone innovation shops such as betaworks in New York City or Ivy Softworks, another new effort in Seattle. (Similar projects in Boston include Redstar and Blade.)

“These types of efforts are definitely more common today than even three years ago,” says Josh Lerner, chair of the entrepreneurial management unit at Harvard Business School, in an e-mail. “There are increasing efforts to corporatize the production of start-up firms.”

Taken as a whole, the track record of accelerators and incubators thus far is short and inconclusive, according to research from Susan Cohen at University of Richmond and Yael Hochberg at the National Bureau of Economic Research. They note that there remains considerable confusion about what constitutes an accelerator (usually a short-duration, competitive, cohort-based program including mentorship and investment) versus an incubator (less competitive, longer stays, often non-profit, and focused on local economic development).

Today, you can add to that mix a proliferation of innovation studios, labs, workshops, and foundries—or whatever the term du jour may be—either independent or affiliated with venture capital firms.

They’re all part of an ongoing race to create innovative, high-growth companies and, for investors, to capture them as early as possible when the potential for outsize returns is greatest.

“We’re not interested in hitting singles,” Gottesman says.

Madrona, which turns 20 next year, will continue to incubate startup companies from outside entrepreneurs as it always has. Asked why this was the right time to begin the Labs effort, Gottesman pointed to his and Heitzeberg’s enthusiasm for the effort, and the potential for returns to the firm, which has a stake in every Labs spinout company, as well as the opportunity to invest alongside other firms as the Labs companies grow.

“We feel like we’ve got a good shot at building meaningful companies using this model, and the proof will be in the pudding,” Gottesman says.

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