Mark asked me to come on his TV show before leaving LA and I did that last week. It is an hour long broad ranging conversation about the venture capital and startup business.
Posts from VC & Technology
Insite is a great program that connects graduate students at leading universities to the startup community around them. It started in NYC and has been connecting graduate students at NYU and Columbia to the NYC startup community for well over a decade. It is now active in other startup communities around the US.
They raise money each year for their NYC programs with a bowling event called Kingpins. Startup companies and VC firms buy lanes and half lanes and the result is a fun night of eating, drinking, and bowling. The startups and VCs mingle with the Insite fellows and all sorts of good things happen.
This year’s event is Monday, April 13th, from 6pm to 9pm, at Chelsea Piers. Half lanes are $1000 and full lanes are $1800. If you are a VC firm and want to support the local community, Insite, and meet startups, you should buy a full lane. If you are a startup and want to drink beer with VCs, think about a half lane. If you are just a regular community member and want to joint the fun, you can buy a single ticket for $150.
The details and tickets are here.
I’ve known Jason Calacanis for twenty years. We met when he was in his early 20s and I was in my early 30s. A lot has happened in those twenty years and Jason and I sat down to talk about that at his Launch Festival last week in San Francisco. It’s a long talk, almost 60mins, with no Q&A from the audience. We cover a lot of territory and I was as candid as can be with Jason. I think this chat reveals a lot about where my head is at right now, which is a credit to Jason and our long friendship.
As I was reading Josh Kopelman‘s excellent post on the seed boom and Series A bust, I got thinking of some words of wisdom Mike Arrington once shared with me. He said “numbers always ruin a good story.”
What Mike meant by this is you can raise a seed (or Series A) on a story. But at some point, you will have numbers; users, user growth, revenues, and revenue growth. You will also have a burn rate. And those numbers will become the thing you are judged on and your nice story will be “ruined” by the numbers.
Now this is not always true. You might be one of the few entrepreneurs on a real rocket ship and your numbers will be your friend. If that is true, raise while the numbers are great. Because they might not always be.
But, particularly at the Series A stage which Josh’s post is all about, the numbers aren’t always so great. And your story will conflict with the numbers. And so you’ll have to change the story to reflect the numbers. Because you can’t change the numbers to reflect the story you really want to tell.
It’s a painful experience. But as Josh explains, it’s like skinning your knee as a child. Painful but necessary.
My partner Albert wrote this a few weeks ago. Since then I have met with a number of founders who are most certainly headed for this problem. As valuations are extended and it feels very late in this cycle, I feel that the risk of this happening to entrepreneurs is quite high now.
In the current valuation environment many entrepreneurs seem to believe that only two numbers matter in a financing: the amount of the raise and the dilution. This leads them to buy into the idea that more money for the same dilution is always strictly better. Combined with a lot of money being available from investors this is resulting in Series A rounds of $10 million and more.
What could possibly go wrong? The number everyone seems to be forgetting about is the post-money valuation. It is a crucial number though as long as a company is not yet financed to profitability. It determines how far the company needs to come to be able to raise money again. It needs to build enough value so that the next round of fundraising can be at or ideally above the current post money valuation.
If you do a Series A with a $50 million post-money, it means you have to build something that people will consider to be worth $50 million when you next raise money. Now if your company hits a great growth trajectory and the financing environment stays as it is then great. But if either of those two conditions are not met you will find yourself in the post money trap.
Again, you can get caught in this trap in two different scenarios. The first one is that you hit a bump in the road. Users or revenues or whatever the most relevant metric for your business wind up not growing as fast as you think or worse yet hitting a temporary plateau, possibly even a small setback just as you need to raise more money. The second one is that the external financing environment adjusts for instance because the stock market drops 20%. Then even if you hit all your milestones, suddenly that may no longer let you clear the hurdle you set for yourself.
Some founders seem to ignore this logic entirely. Others come back and say “but we will have that much more money to and hence time to clear the hurdle.” That too, however, is faulty logic. It reminds me a lot of the problem of getting rockets into space. The simplistic answer would seem to be: just add more fuel. The problem though is that fuel too weighs something which now needs to be lifted into space. Your burn rate is pretty much the same thing. Unless you are super disciplined on how you spend the money you will have a higher burn rate the more you raise which makes subsequent funding harder (instead of easier).
Another, less common, founder objection is: well, if necessary we will just do a down round. This ignores that down rounds are incredibly hard to do. For reasons of founder, employee and investor psychology they rarely happen. And if they do they are often damaging to the company. So when you are in the post-money trap you have largely made your company non-financeable entirely.
Finally, this situation is highly asymmetric from the point of view of funds versus companies. First, funds have portfolios, so some deals with dangerously high post money valuations can be offset — if one is disciplined — with others that are more attractive. Second, when investing in preferred there is a lot of downside protection built in that’s not available to the common shares. Hence a simple test to see just how far you are stretching into is to ask investors (and better yet yourself) how much common they (you) would buy right now and at what price.
I said something on stage at Launch yesterday that I’d like to elaborate on:
— Red Clay (@redclayco) March 4, 2015
I do not mean that your investment isn’t important and I do not mean that making money isn’t the focus of a venture capital firm and a venture capital investor. Both are absolutely true.
However, I believe if you are invested in a startup at an early stage that goes on to become a “great company”, that your investment is going to work out fabulously well.
So I think that putting all of your energy into helping the entrepreneur and the team around them build a great company is the best way to accomplish generating great returns on investment.
Venture capital is one of those asset classes where you can impact your investment. And the best VCs do that very well. I’ve studied the great VCs and how they conduct themselves. And what I have seen is that this focus on the company first and everything else second is what separates the best ones from the rest.
Most people that are in the VC and startup sector know that USV likes to invest in networks. And most of the networks we invest in are consumer facing networks of people. Peer to peer services, if you will. The list is long and full of brand name consumer networks. So it would be understandable if people assumed that we do not invest in the enterprise sector. That, however, would be a wrong assumption.
We’ve been looking for enterprise networks to invest in since we got started and we are finding more and more in recent years. There is a particular type of enterprise network that we particularly like and I want to talk about that today.
Businesses, particularly large ones, build up large groups of suppliers. These suppliers can be other businesses or in some cases individuals. And these suppliers also supply other businesses. The totally of this ecosystem of businesses and their suppliers is a large network and there are many businesses that are built up around making these networks work more efficiently. And these businesses benefit from network effects.
I am going to talk about three of our portfolio companies that do this as a way to demonstrate how this model works.
C2FO is a network of businesses and their suppliers that solves a working capital problem for the suppliers and provides a better return on capital to large enterprises. Here is how it works: C2FO has a sales force that calls on large enterprises and shows them how they can use their capital to earn a better return while solving a working capital problem for their suppliers. They bring these large enterprises onto their platform and, using C2FO, they recruit their supplier base onto the platform. They also bring all the accounts payable for the large enterprise onto the platform. Once the network and the payables are on the platform, the suppliers can bid for accelerated payment of their receivables. When these bids are accepted by the large enterprise, the suppliers get their cash more quickly and the large enterprise earns a return on the form of a discount on their accounts payable. C2FO takes a small transaction fee for facilitating this market.
Work Market is a network of businesses and their freelance workforce. Work Market’s salesforce calls on these large enterprises and explains how they can manage their freelance workforce directly and more efficiently. These enterprises come onto the Work Market platform and then, using Work Market, invite all of their freelance workers onto the platform. They then issue all of their freelance work orders on the Work Market system, manage the work, and pay for the work, all on Work Market. Work Market takes a transaction fee for facilitating this and many of Work Market’s customers convert to a monthly SAAS subscription once they have all of their freelance work on the platform.
Crowdrise is a network of non-profits, the events they participate in, and the people who fundraise for them. Crowdrise’s salesforce calls on these events and the large non-profits who participate in them. When a large event, like the Boston Marathon, comes onto Crowdrise, they invite all the non-profits that participate in their event onto the platform. These non-profits then invite all the individuals who raise money for them onto the platform. These events and non-profits run campaigns on Crowdrise, often tied to the big events, and Crowdrise takes a small fee for facilitating this market.
I hope you all see the similarities between these three very different companies. There are several but the one I’d like to focus on is the “they invite all the ….. onto the platform”. This recruiting function is a very powerful way to build a network from the top down. And once these networks are built, they are hard to unwind.
We don’t see many consumer networks built top down, but we do see a lot of enterprise networks built top down. And we are seeing more and more of them. It is also possible to build enterprise networks bottoms up (Dropbox is a good example of that). That’s the interesting thing about enterprise networks. You can build them top down or bottoms up. And we invest in both kinds of enterprise networks.
The top down enterprise network is a growing part of the USV portfolio. We like this approach to building an enterprise software business and it does not suffer from the “dentist office software” problem. Which is a very good thing.
Back in the early days of this blog I had a series called VC Cliche Of The Week. I’m not sure how long I ran it but I did eventually run out of material and phased it out. In continuation of yesterday’s good vibes and with yet another shoutout to Bliss, here’s a reblog of one from March 2006:
The father of this weekly series, the guy who taught me at least half of the cliches I know, is a guy named Bliss McCrum. He and his partner Milt Pappas taught me the venture capital business from 1986 to 1996 when I worked with them at their firm, Euclid Partners.
One of my favorite cliches from Bliss is a rising tide lifts all boats.
Whenever things seemed too good at a portfolio company, in the stock market, the economy, or somewhere else, Bliss would quip, “well you know that a rising tide lifts all boats“.
It was his way of saying “don’t mistake a good market for a good business”. The insinuation was always that the tide would come back in and so would the boats. And you had to be prepared to make things work in tough times as well as good times.
And we are in good times in the venture business, the internet business, and for the most part, the US economy. Consumer confidence hasn’t been this strong since before the Iraq war. The Fed has raised rates 15 times and may not be done, signalling that the economy remains stronger than they’d like it. Venture money is flowing freely in Silicon Valley and China and in many parts of the developed or developing world. Advertising dollars continue to move from offline media to online media and that is one rising tide that is certainly lifting all boats.
But we know these good times will come to an end at some point. Are we in 1998 as Caterina suggests and have another year or two before the good times end? Who knows? I don’t expect this run of good times to play out like the last one anyway.
The best we can do is prepare our companies to withstand a business environment that is less friendly. Companies need a business model, they need a seasoned and well constructed team, and they need patient and experienced financial partners. With these ingredients, hard work, and some luck, you can survive a downturn.
Some of the best companies I’ve ever worked with were funded at the height of the last bubble and they are doing great now. So it doesn’t really matter when you start a company, but it does matter that you can make it through tough times. Because right now we have a rising tide that is lifting all boats and that won’t last forever.
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.
I was reading William’s post on the potential crash in the Bitcoin sector this morning and I thought of Carlota Perez. Longtime readers of this blog will know that I am a huge fan of Carlota’s work, her research around technology revolutions and financial capital, and her book about all of that.
In 2011, I got to interview her on stage at the Web 2.0 expo, which was one of the highlights of my career.
For those that are not familiar with Carlota’s work, she studied all of the major technological revolutions since the industrial revolution and how they were impacted by and how they impacted the capital markets. What she found was that there are two phases of every technological revolution, the installation phase when the technology comes into the market and the infrastructure is built (rails for the railroads, assembly lines for the cars, server and network infrastructure for the internet) and the deployment phase when the technology is broadly adopted by society (the development of the western part of the US in the railroad era, the creation of suburbs, shopping malls, and fast food in the auto era, and the adoption of iPhones, Facebook, and ridesharing in the internet/mobile era).
And the “turning point” between the two phases is almost always marked by a financial crash and recovery. See the chart below from Carlota’s book:
I’m not going to guess if we’ve seen the “collapse phase” of the Bitcoin technological revolution, or if we are in it, or if it is coming. But if Bitcoin and Blockchain is going to be a meaningful technological revolution, and I think it will be, then we are going to move from the installation phase to the deployment phase at some point and there will be a major financial break point that happens along the way.
What is less clear to me is whether this “collapse” will be seen in the price of Bitcoin, the health of the overall Bitcoin and Blockchain sector and the companies in it, or possibly the broader capital markets (VC, public equity, etc). It seems to me that the first is very likely, the second is also likely, and the third is less likely.
In any case, as my friend Tom Evslin like to say “nothing great has ever been accomplished without irrational exuberance”. And the Carlota Perez corollary to that is “nothing important happens without crashes”.
And the lesson I’ve learned in my career is to invest into the post crash cycle. When you do that, and do it intelligently, you are rewarded greatly.