Building A Bust Proof Portfolio
I have no idea if we are headed for another bust. I sure hope not. But having lived through the 2000 bust with a portfolio that was not "bust proof", one of the things I think about all the time is how to build a "bust proof" portfolio.
And part of my thinking about this notion of a "bust proof portfolio" is driven by what happened with the Flatiron portfolio when the market broke. We had about 36 companies in the portfolio at that time, as we had exited about 21 companies before the market broke. Of those 36 companies, one third were out of business within 12 months, one third were sold during the "nuclear winter of 2001-2003", and one third made it through and are doing great. What was it about the ones that made it through? And what if you could construct a portfolio that had the characteristics of the companies that made it through and are doing great?
So here are the things that those "survivor" companies had in common:
- Lower burn rates
- Business models, revenues, and customers
- Good venture syndicates with real VC firms (as opposed to strategic investors, amateurs, new funds, etc)
- Realistic valuations (as opposed to valuations that could not be sustained when the market broke)
- Committed entrepreneurs who were in it for more than just money
- Long time horizons for everyone involved (entrepreneurs, investors, employees)
- Reasonable exit expectations
- Less capital raised and less preferences on top of the founders
I hope nobody takes this post as me saying that we’ve built a "bust proof portfolio" at Union Square Ventures. We may not have another bust, and if we do, we’ll find out then if that’s the case. What I am saying is that when you are taking the kinds of risks we take in the venture business, you really shouldn’t increase the risk profile beyond what is required.
I am seeing some things in the market now that concern me. Rising private company valuations (particularly in the Series B and Series C rounds) that may not be sustainable in a different market. The rise of strategic investors in the capital structures (we saw how quickly those investors bailed when times got tough). Increasing burn rates. Rising expectations on exit valuations.
I am pretty sure that we are not in for a rerun of 1998-2000 because there is a lot that is different now about Internet businesses and Internet investing. But I am also sure that there are lessons to be learned from the bubble that burst in 2000 and we should not forget them.