Posts from VC & Technology

What Can It Be Worth?

The thing I always think about when making an investment is not what it is worth, but what can it be worth. To determine what something is worth, you can look at comps (which I posted about here), or you can let the market tell you what it is worth by running a process.  But the really interesting number is not what it is worth today, but what it can be worth.

For this, you need to use your imagination. When we invested in Twitter, we had to imagine that hundreds of millions of people around the globe would use Twitter to find out what was going on, and that Twitter would be able to build an advertising business around that behavior that would result billions of dollars of annual revenue, and that Twitter would be able to generate positive cash flow on that revenue, and that the public markets would welcome Twitter and value it as a multiple of those revenues and that operating cash flow. We did imagine that, although to be honest, we did not imagine as big of a success as evidenced by the fact that we stopped investing in Twitter after three rounds, which was a mistake that, in part, led to the creation of our Opportunity Fund.

So when valuing a venture stage opportunity, you have to imagine the product can scale to be used by many more people, or companies, or both, than are using it now. For that exercise, you need to study the product, the roadmap, and the use cases and be sure that your imagination is possible and not delusional. You also need to figure out what an annual revenue per user (ARPU) might be and apply that to the potential size of the market. Then you need to study the economics of the business and figure out how much of that potential revenue might flow to the bottom line.

Finally, you need to figure out how the market might value that cash flow. That’s where a comps analysis might be valuable. But you have to factor in that the market might not be valuing companies when you exit in the same way they are now.

After you figure out what it might be worth, you need to discount that back by 3x, or 5x, or even 10x, to discount for the risk that none of this might happen.

When you do all of this work, in today’s environment, it’s hard to make an investment. Because often the math doesn’t work. Which tells me that many people aren’t doing this work.

Rinse And Repeat

I’d like to call out a really great blog post (and talk) my colleague Nick Grossman delivered last week. He called it Venture Capital vs Community Capital, but to me its about the endless cycle of domination and disruption that plays out in the tech sector. This bit from the post rings so true to me:

So there’s the pattern: tech companies build dominant market positions, then open technologies emerge which erode the the tech companies’ lock on power (this is sometimes an organized rebellion against this corporate power, and is sometime more of a happy accident).  These open technologies then in turn become the platform upon which the next generation of venture-backed companies is built.  And so on and so on; rinse and repeat.

So, all that is to say: this is not a new thing.  And that seeing this as part of a pattern can help us understand what to make of it, and where the next opportunities could emerge.

Nick wrote the post and did the presentation for the OuiShareFest, an international gathering of folks interested in the peer economy. Nick starts out noting that the early enthusiasm for the peer economy has moderated with the understanding that a few large platforms have emerged and have come to dominate the sector.

Nick’s presentation and post, therefore, was a reaction to those emotions and a reminder that what goes around comes around eventually. That is certainly what I have observed in the thirty plus years I’ve been working in tech. Rinse and repeat. Same as it ever was.

What VC Can Learn From Private Equity

It is friday and that usually means a fun friday or a feature friday but I’m stuck on a plane flying back from a week on the west coast and have the time and inclination for a longer post. So we will return to our regularly scheduled friday programming next week.

I spent a week in Europe a few weeks ago with our friend Eric who is a managing partner in a private equity firm. We talked a lot about his business and our business that week and I’ve been ruminating on it since. I’ve also had the pleasure of working on a board of one of our portfolio companies with a private equity investor who is making a few minority investments. I’ve been able to learn a fair bit from watching how he thinks about investments and works on them. Finally, the first venture capital firm I helped start, Flatiron Partners, was backed by and initially housed inside a private equity firm, Chase Capital Partners, and Jerry and I learned a lot from attending their weekly investment meetings and listening to them talk about their business.

Venture Capital and Private Equity are very different investment disciplines. Both are purchasing stock in privately held businesses with the hope that you can sell the stock at higher prices in a merger/sale transaction or a public offering. Both involve investors taking board seats to monitor and manage their investment. That is about where the similarity ends. I’ve seen venture capital firms morph into private equity firms over time so there are clearly some skills that translate from one investment discipline to the other. But even so, I think they are fundamentally different investment disciplines and here are some of the biggest contrasts:

1/ Private equity is control investing. Venture Capital is minority investing.

2/ Private equity can’t afford to lose money on an investment. Venture Capital requires it.

3/ Private equity generates leverage from financial engineering. Venture Capital generates leverage from technology driven disruption and the opportunities that presents.

So what can Venture Capital learn from Private Equity? Here are a few things that have struck me as I’ve thought about it over the past few weeks.

1/ Many venture capitalists and venture capital firms go “along for the ride” with the entrepreneur and don’t do much to change the trajectory of the investment. Some VCs don’t even take board seats on their investments. There is a lot of talk about “value add” from VCs but often that is just for show during the process of winning the deal. The number of VCs who actually add a lot of value to their investments is much smaller than you would think. Private equity, on the other hand, is all about adding value to the business. For one thing, the private equity firm owns the business. If the business gets messed up, it’s on them and nobody else. The buck stops there at the partners desk. This mindset is refreshing for me to witness. The level of care and attentiveness to the business is very high in the private equity business. The firms and partners that are good in private equity are fantastic operators and game changers for the companies they work for/on. After my week with Eric, I made a mental note to do more of that for our companies. It’s powerful.

It is easy to cop out and say “well we don’t control the business. we don’t have the ability to change management if we want to. we don’t want to get sucked into operating the companies we invest in.” And I agree with all of that. But you don’t need to control a business to be able to meaningfully impact its management team, its strategy, and its operations. I believe if you are trusted by management, if you are there for them when they need you (and when they think they don’t), and if you have done the work to truly understand the business, the team, the market, and the opportunity, that you can by force of intellect and will have a very substantial impact on the business. I want to do more of that with my time and energy and I think all VCs should do that.

2/ Private equity firms don’t normally invest in syndicates. A single firm makes the investment and takes responsibility for making it work. This one is not so cut and dried for me as the first observation. Syndicates, when they are functional and small, are quite powerful. But many times syndicates are large, unwieldy, and dysfunctional. And then there is a ton of finger pointing, or worse, abdicating responsibility to another director. For the CEO, there is often a question of who to listen to, what to do with conflicting direction from the investors, and how to manage this unwieldy mess. The beauty of one firm calling all the shots makes me jealous of the private equity world at times. It is helpful for everyone to know who is the boss and who is making the calls. Venture capital syndicates and board often suffer from a lack of that clarity and if you have a weak or inexperienced CEO, it is a really bad combination.

3/ Private equity firms make the call when to sell. In VC, entrepreneurs will make the call when they are in charge or the board will when they are not. In any case, a VC firm is rarely in a position to make the call on when to sell. Marc Andreessen makes the claim in the recent Tad Friend profile of him in The New Yorker that Accel wanted to sell Facebook to Yahoo! for $1bn but Mark Zuckerberg really didn’t want to (and that Marc Andreessen urged him not to). I’m not sure if that is accurate or revisionist history (which the startup sector is full of), but in any case it is sometimes for the best that the VC firm doesn’t make the call on when to sell. A lot of big independent public companies would not exist if VCs made the call on when to sell. However, that is really only true when the investment is a breakout success. There are many venture portfolios (ours included) full of good but not great companies that would be best sold to a consolidator so that everyone, the entrepreneurs, the employees, and the investors can move on to other things. That doesn’t happen as much in VC because no one person can make this call all by themselves.

4/ Private equity firms are great at digging into the business and figuring out what is broken and how to fix it. We don’t do so much of that in the VC business. For one, the CEOs feel that we are being disruptive when we do that. And also, VC firms don’t normally have the armies of associates and junior partners who do that work in private equity firms. I’ve watched a private equity partner engage in a minority growth investment and I am impressed by the insights they can provide the management when allowed to do a deep dive on the business. VCs often lose interest as a company grows and turns into a big operating company, when this kind of “consulting” work is most valuable, whereas private equity gets its juices flowing on these sorts of situations.

I’ve come to realize that I need to be more attentive to this phase of a company’s development because our returns mostly come from the big breakout companies and if we can help make them 2-3x more valuable (as a private equity firm would seek to do), that can drive our returns on these big winners from 50x to 150x. And that’s a huge difference. So while I don’t see myself equipping myself with an army of analysts and consultants and doing deep dives on our biggest companies, I do see myself trying to ask harder questions and force more instrumentation into the businesses so that the boards I am on can add more value.

The main thing I’ve come away with from this several week long rumination on private equity is the value of having very clear lines of responsibility, crisp decision making, clarity of who is calling the shots, and, mostly, a deep feeling of ownership and responsibility for the businesses we invest in. It’s not possible for one VC partner to do this for more than about eight to ten companies, and most VCs take on way more portfolio companies than that in an effort to scale their businesses and get to better economics. But I think we can learn a lot from what works so well in private equity. I think we can borrow some of their tactics to produce better outcomes for the entrepreneurs we back and the companies they create.

The No Stack Startup

There’s been a lot of discussion in recent years that the “full stack approach” is the future of startups. My friend Chris Dixon articulated the reasons for going “full stack” very well in this post from last year. But like many things, the best approaches are at both ends of the spectrum. Either go “full stack” or go “no stack.”

My partners Andy and Albert have been writing about the no stack approach this past week and it is the topic of the week at usv.com.

At USV we have never been excited by the full stack approach. It is well suited to investors who have unlimited amounts of capital to invest and a need to put all that cash to work. We aren’t that kind of investor. We like low capital requirements and low burn rates and extremely high rates of return on invested capital. So no stack seems like it will suit us well.

Our partner Brad said in an internal email about this today, “We need to think through defensibility, margin sustainability, and not having control of some infrastructure.” So that’s what we are doing now. And if anyone would like to weigh in on this, the comments here at AVC is a good place as is the usv.com topic of the week conversation.

Survata

We’ve been using a tool at USV recently that I like. It is called Survata and it allows to you to create a survey and then target it at whatever number of completes you want. You can target it to respondents in 17 countries “by age, gender, geography, and custom attributes.”

It is helpful for us to get a sense of what is going on in a market quickly. We generally go for thousands of completes and we get results within three to seven days. We have been paying between $1 and $2 per complete which, for us, is not a lot to get some answers quickly.

I am sure there are many services out there that do something like this. It’s not particularly difficult to offer a service like this. But the Survata user experience is simple, easy, fast, and affordable. We like it and are using frequently. I thought I’d share that with all of you.

My CNBC Appearance

I spoke at Techcrunch Disrupt yesterday and several media outlets had crews there. I was asked to speak to a few of them and I said yes. I was on CNBC and ABC News yesterday morning. To my knowledge the ABC News clip is not yet up. But CNBC put up three clips that I believe, in their totality, make up my entire appearance. So here they are in order and sorry about the pre-roll videos in front of all three. I looked for a single clip for the entire interview but could not find it.

eShares

This post is self serving to some degree as USV is an investor in eShares. But in the world of VC and startups there isn’t much that is more broken than cap table management. eShares fixes that by putting the entire cap table online and allowing your company to issue new shares and options directly from the platform. It’s kind of like writing checks directly from your accounting system. Everything gets recorded and there are no missing stock certs or broken promises.

I explained this to one of our portfolio companies last fall around the time we made our investment in eShares. One of the co-founders replied via email “we don’t need that, our cap table is all in a single spreadsheet.” A month or two later, as we were doing a round of financing, when the lawyers were doing their diligence, it came out that our cap table spreadsheet was missing some shares that had been issued but not recorded. I had a good laugh at that because it is always the case that something is not recorded. A perfect cap table is very rare, unless you are using a tool like eShares.

The VCs and angel investors aren’t hurt so much by this because our investments are large and mistakes made on our shares are easily caught. Employees are the ones who have the most to gain from eShares because they are the ones whose issuances are most often missed or not properly recorded on a cap table and these mistakes can go on for a long time before being caught. This causes issues in terms of exercise price changes and tax issues for the employee.

If you are starting a company, do yourself a favor and start building your cap table day one on eShares. If you have been managing your cap table in a spreadsheet for years and are tired of doing it that way, talk to eShares. They will help you “port” your cap table to their system. That’s part of the onboarding service they provide. And then you can start issuing shares the way you’d imagine it would be done in 2015. The way most companies is doing it is circa 1900. I’m serious about that.

If you want to learn more about eShares, contact them here.

The Rich Get Richer

The 2014 numbers for the VC category are out and it was a huge year, almost $50bn in total VC funding.

the rich get richer

But look at the numbers for “deals” vs the numbers for “dollars”.

In 2014, there were 4,356 deals vs 4,193 deals in 2013, an increase of 3.8% year over year.

In 2014, VCs invested $48.3bn, compared to $29.9bn in 2013, an increase of 61.5%.

Basically, the average deal size went from $7mm in 2013 to $11mm in 2014. But averages don’t really tell the whole story.

What is going on is that the late stage market is going crazy. There was a $100mm+ deal on average every month in 2014 and the late stage market made up 1/3 of all deals.

VCs are all about what is happening now and are not focusing as much on what will happen in five to ten years (the seed/early stage markets).

None of this should be news to those who are paying close attention. Round sizes have gone up and burn rates have gone up, but so much of this is limited to a hundred or a couple hundred companies. The rest of the market is more or less where it has been for years. The rich are getting richer. The middle class is stagnant. And the people who can’t raise a round still can’t. Only the top end of the market has really changed over the past five years.

Kind of like the entire economy, isn’t it?

Video Of The Week: How To Build An Investment Thesis

My friend Pedro Torres-Picon gave a good talk a couple weeks ago at the Pre Money Conference on “How To Build An Investment Thesis”. This is a topic we’ve discussed a lot around here so it’s familiar territory but Pedro does a good job of explaining it with some quotes from yours truly and others.