Trading Deals, A Lost Art?
Bijan wrote a good post yesterday called We Gotta Do A Deal Together in which he outlined the common practice of VC's showing each other investment opportunities. That's how I got to know Bijan. He showed us Tumblr. And we reciprocated with Twitter where we serve on the board together. We have five investments in common with Bijan and his partners at Spark Capital, including Bug Labs where my partner Brad first started working with Bijan and his partners three and a half years ago.
So that's a success story in the world of VC deal sharing. But I think this practice is becoming a lost art. When I got started in the venture business in the mid 80s, this was a very big part of how the business worked. VCs would work in packs, called syndicates, and they'd trade deals back and forth all the time. When you had a deal to syndicate, you'd ask your partners "who do we owe one to right now?"
It still happens but there are bunch of reasons why it happens less. Let's start with the healthy reasons it isn't happening as much.
1) Entrepreneurs have all the cards now. They typically control who invests in their companies and they pick the VCs they want to work with. There is a lot more knowledge out there about VCs, which ones are good to work with and which ones are not. We cannot tell an entrepreneur to take money from Bijan and his partners at Spark. We can suggest it, and sometimes they choose to do that. But it is the entrepreneur's call these days, not ours. That's a good thing.
2) VCs are working harder than ever to figure out what are the most attractive investment opportunities. The best VCs go out into the market and figure it out. They don't sit back in their offices waiting for the calls from their friends in the business horse trading deals with each other. That is also a good thing.
But there are some not so good things at work here too.
1) There is too much money in the venture business. Many VC firms want to make large investments and obtain large ownerships. It is very hard to build syndicates these days. It used to be that the first round would be for 40% of the company, with two firms splitting it. We see most first round deals for 20-25% of the company these days. That is very good for the entrepreneur but not good for syndicates. It is more common to see a VC firm to do the entire first round by themselves or with angels, than to see two firms splitting a first round.
2) The markups between the first and second rounds in the best deals can be large. So if we turn to our friends in the VC business and say, "here's a good deal, but you have to pay three times what we paid less than a year ago", they are not always going to look at that as a favor. They might think we are taking advantage of our friendship not facilitating it.
We are thinking about several follow on financings in our portfolio right now. And as we walk through the options with the entrepreneurs, I am often tempted to do the round ourselves (or with our syndicate partners if we have them). If we can make a deal with the entrepreneur that both parties are comfortable with, we keep the team focused on the business and off the road. We keep the company from educating other VCs about how good the opportunity is and less likely to fund a competitor. And we can build a larger position in the company for ourselves and our investors.
We are not the only VCs who are thinking this way. This "do it ourselves" approach has been prevalent in the VC business for over a decade and is gaining even more adoption as VCs figure out how to make money in the new environment we all face.
I don't want to give the wrong impression with this post. Our firm, Union Square Ventures, has and will continue to syndicate deals with other venture firms. If you go through our portfolio, you'll see that we have VCs as co-investors in 22 our 29 announced investments. In the others, we have angels as co-investors. We like to invest with others and continue to try to do that as much as we can. But I feel like we are doing it less than before and I feel like we'll do it less going forward unless something changes in our business or the venture business as a whole.