Posts from stocks

Maybe They Do Understand Your Business

Farhad Manjoo has a piece in the NY Times discussing something we’ve been talking about ad nauseam here at AVC in the past year or two, namely that venture backed tech companies are waiting much longer to go public and in the process creating a “private IPO” market which in turn is increasingly putting huge valuations on a large number of venture backed companies, including a bunch of USV portfolio companies.

There is an unfortunate quote in Farhad’s post which suggests that the public markets are clueless:

If you can get $200 million from private sources, then yeah, I don’t want my company under the scrutiny of the unwashed masses who don’t understand my business

First, the public markets are not “unwashed masses.” They are full of very sophisticated investors who, I suspect, do understand these businesses very well.

It is true that Wall Street will not be tolerant of missed expectations. It is true that Wall Street may focus too much on short term numbers. It is true that you may not be able to control what numbers Wall Street decides to obsess over when it comes to valuing your company.

But I think tech sector is making a huge mistake in thinking that they know their companies and how to value them better than Wall Street. That kind of thinking is arrogance and pride comes before the fall.

Two Charts

What is the capital markets environment for startup tech companies?

I think these two charts tell most of the story:

median pre-money

Seed and Series A is more or less healthy. Series B is getting overheated. Series C and beyond has gone crazy.

public market trends

Public markets are rational. Tech stock performance has been strong but is driven by strong revenue growth and good business fundamentals generally speaking.

The disconnect is entirely between the late stage private markets and the public markets. That’s where things are unstable.

The Coming Change In Monetary Policy

Janet Yellen, the Chairman of the Federal Reserve, has been signaling to the financial markets that the Fed is going to raise rates towards the end of the year. If this happens, it will be the first time in nine years that the Fed has raised rates in the US. And it will be the end of an extraordinary period of near zero interest rates that resulted from the financial crisis of 2008. The near zero interest rate policy allowed banks and brokerage firms to replenish their balance sheets, work off their book of toxic assets, and regain their health. It also allowed the US economy to rebound from the effects of the financial crisis, it allowed homeowners to hold onto homes through difficult financial times, and it allowed businesses to borrow and raise capital at very attractive rates.

A side effect of this period of cheap money is that the tech sector, venture capital, and startups have enjoyed a valuation environment that has been extraordinarily friendly. I wrote about this in March of last year and said:

It is the combination of these two factors, which are really just one factor (cheap money/low rates), that is the root cause of the valuation environment we are in. And the answer to when/if it will end comes down to when/if the global economy starts growing more rapidly and sucking up the excess liquidity and policy makers start tightening up the easy money regime.

Yellen has also been signaling that the Fed does not plan to make rapid and large increases in rates. So the valuation environment in the tech and startup sector may not change quickly. But it will change. And so will the valuation environment in the stock market. This is because valuation multiples are inversely correlated to interest rates. When rates rise, valuation multiples fall.

So, I am going to watch the Fed’s moves and the market reaction with interest. This may have an impact on the venture capital market and startup valuations so it’s not something to ignore.

Video Of The Week: Dick Costolo at Re/code

I like how Dick answers the question about whether he’s going to be CEO of Twitter by the end of the year. It is about time that Twitter articulates how large their audience really is and why their usage numbers can’t be compared directly to Facebook, Snapchat, and Instagram.

Full disclosure, I own a lot of Twitter and am a big fan of the company and of Dick. I do not plan to be more critical of Twitter in the coming months.

The 40% Rule

I was catching up on Brad Feld’s blog this morning and saw that he had posted about the “40% rule” for SAAS companies.

I was at the same board meeting as Brad and came away similarly impressed by the simplicity of the rule and the logic behind it.

Here’s the 40% rule and it is aimed at SAAS companies:

Your annual revenue growth rate + your operating margin should equal 40%

So, if you are growing 100% year over year, you can lose money at a rate of 60% of your revenues

If you are growing 40% year over year, you should be breaking even

If you are growing 20% year over year, you should have 20% operating margins

If you are not growing, you should have 40% operating margins

If your business is declining 10% year over year, you should have 50% operating margins

I have never seen growth and profitability so nicely tied together in a simple rule like this. I’ve always felt intuitively that it’s OK to lose money if you are growing fast, and you must make money and increasing amounts of it as your growth slows. Now there’s a formula for that instinct. And I like that very much.

Thanks Brad for posting it.

Broken Cap Tables

A “cap table” is a schedule of all the shares outstanding for a specific company. Here’s an MBA Mondays post I wrote back in 2011 on the subject of cap tables. If you want to know how much of a company you own, a cap table is the best way to figure that out.

Cap tables are almost always prepared and kept in spreadsheets, usually excel, but also increasingly google sheets. And, it turns out, they are often wrong.

Henry Ward is the founder and CEO of a company that is aiming to fix that called eShares. Last month USV led a Series A round in eShares and my partner John Buttrick wrote a bit about that investment today on the USV blog.

The reason I tell you this is that yesterday Henry wrote a great post about broken cap tables that everyone in the startup world should read. Here are the four big takeaway’s from Henry’s post:

  1. Most cap tables are wrong
  2. Most investors don’t track their shares
  3. Note holders are often forgotten
  4. Employees suffer most

How does Henry know this? Well part of eShares’ business is converting cap tables from spreadsheets into their cloud based application and reconciling everything to make sure it is correct. They onboard about 100 companies a month right now and they see a ton of cap tables.

Tracking everyone’s ownership in companies is a perfect application for a cloud-based network of owners and issuers. If every company used a platform like eShares, and if all these platforms talked to each other, if there was a common identity standard, then as you move from one company to another over your career, collecting equity along the way, you could access and manage all of your ownership interests in a single dashboard.

This is a service that is incredibly useful to startups and angel investors and VCs. But as Henry outlines at the end of his post, it will ultimately help employees the most. And, as we have discussed here before, employee equity is certainly more broken than cap tables are. Fixing that is a worthy mission for a startup and that is what Henry and his team intend to do.

Revenue Multiples And Growth

When you say “the stock is trading at 20x revenues” people rightly shake their head and say “that is nuts.” I got a lot of tweets like that in reaction to my comments about the Uber valuation in the LeWeb breakfast chat.

However, what people fail to realize is these things happen in a moment in time and that stocks won’t trade at 20x revenues forever.

Let’s take a fictional company that has $1bn in revenues in 2014 and goes public at $20bn, 20x revenues. Let’s say it will double revenues in 2015, then grow 60% in 2016, and 40% in 2017, and 30% in 2018.

So here are the revenue numbers

Yr/Yr %100%60%40%30%

So, let’s now look at profits, since valuations are ultimately a function of profits, not revenues.

Let’s say this fictional company is breakeven in 2014, but expects to make 10% EBITDA margins in 2015, growing to 25% EBITDA margins by 2018. So here are the EBITDA numbers that fall out of that.

EBITDA Margin0%10%15%20%25%

Let’s say this fictional company’s stock will go up 10% a year each year until 2018. So the valuation goes from $20bn today to $29bn over five years.

Yr/Yr Growth10%10%10%10%

So here are the Revenue and EBITDA multiples that fall out of this thought exercise

EBITDA Muiltple110.050.429.720.1
Revenue Multiple20.

The point of all of these numbers is to show that if a company can grow very quickly over a five year period, and become highly profitable, the stock can perform well and the multiples can come down to earth pretty quickly.

That is a bunch of “ifs”, but every once in a while this actually happens. It happened with Google which now trades at 5-6x revenues, and it is happening with Facebook which is in the middle of this kind of a story. So my point is 20x revenues is a huge number, but every once in a while, a company actually deserves it.

For anyone who wants to dig into the numbers a bit more, here’s a link to the google sheet that I built as I wrote this post.

The AVC Community Is An Optimistic Bunch

The results of the poll we ran on Friday are interesting:

poll results

62% of AVC readers think the NASDAQ will be flat to up 10% in six months. That means continuing the steady march upwards that it has been on for six years.

6.5% of AVC readers think the NASDAQ will be up big (>30% in the next six months). That would be a blowout. Hard to imagine how that could happen but there are some among us who can.

32% of AVC readers think the NASDAQ will be lower in six months with half of them thinking it will be down a bit (10%) and the other half of them thinking it will be down big.

I will say that I’m in the latter camp. I can’t recall if I voted for 4000 or 3500. I did not vote for below 3000. I hope I’m wrong to be honest. We’ve got plenty of assets that are in some way or form tied to the markets and I’d prefer not to see them go down. But I am mentally prepared for it.

Fearful Friday: When Will This Bull Market End?

We are going to do a variation on Fun Friday today. We are going to discuss the near future of the public stock markets, particularly the NASDAQ, where so many of the tech stocks trade.

Here’s a chart of the NASDAQ over the past six years.

NADAQ chart

What you see is a big run upwards since the last downturn (and the election of Obama). He’s been great for the stock markets. If you had bought the NASDAQ on his inauguration on Jan 20th, 2009, you’d have tripled your money in six years. A 3x in 6 years is a 20% compound annual return. Whatever you might think of the President, he surely has been great for wall street.

But I am not really interested in the rear view mirror. What I am curious about is when this bull market will end.

I’ve posited on this blog that rising interest rates will eventually suck the wind out of our sails and bring stocks and valuations back to earth. But we could get a break before that happens. Ebola could start spreading in the US, ISIS could take all of Iraq and Syria, Putin could take the Ukraine and then start thinking about the Baltics. Or something else could happen.

We could do this via the comments section, and I am sure we will discuss this there, but I’ve created a poll so that we can easily see where the sentiment of the AVC readership is on this issue. So please vote away and add any color you’d like in the comments.

Devices vs Cloud

Yesterday, on stage at an event hosted by our portfolio company Disqus, it was suggested that I was “trolling Apple” with the comments I made at TechCrunch Disrupt. I explained that I was not trolling anyone and that I attempted to honestly answer a question about the changes afoot in technology. I think there is a fundamental and important distinction between a device focused strategy and a cloud focused strategy.

Carlos Kirjner is an analyst at AB Bernstein who covers Internet companies. I was reading his analysis of Larry Page’s letter to shareholders this morning (the analysis is not a public document and I cannot link to it).

In Carlos’ analysis, he wrote this:

We believe … Larry Page’s discussion about the new mobile, multi-screen world …. is really about the importance of cloud services in that world. This is by no means a trivial statement and we believe goes against a more device centric model favoured, we believe, by Apple.

Many interpreted my comments as anti-Apple and pro-Google and I guess they were. But I was attempting to make a larger point. Which is that a device centric strategy is not a winning strategy in my mind. The big gains from technology in the coming years will come from things like machine learning and collective intelligence. Hardware and operating systems are important but to some extent a commodity at this stage of the game in mobile. Yes, we will see more sensors, better screens, better battery life, and more and more technology packed into these mobile devices. But I don’t think any one company has a lock on all of the device level innovation and I worry that one company, Google, is developing a very large and sustainable advantage in machine learning and collective intelligence that will be hard for anyone to compete with.

So when I look at which top technology company is best positioned for the next decade as I see it unfolding, well that’s an easy answer in my mind and that’s the answer I gave.