Posts from VC & Technology

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.

Loyalists vs Mercenaries

One of the things that entrepreneurs, founders, and CEOs obsess over is holding onto their team. When I propose some sort of difficult decision to a CEO, I am often met with the response “the team will freak out and we will lose them.” And I understand where this emotion comes from. You spend so much of your time recruiting, training, and managing a team and getting them into a place where they can execute for you and you can’t imagine having some of all of them walk out the door. Neither can I to be honest.

But teams come in all flavors. There are highly loyal teams that can withstand almost anything and remain steadfastly behind their leader. And there are teams that are entirely mercenary and will walk out without thinking twice about it. I once saw an entire team walk out on a founder. That company survived it, remarkably.

I’ve been thinking a lot about the factors that go into determining whether your team skews loyalist vs mercenary and what you might be able to do about it. Here are some of the most important factors:

1) Leadership. At the end of the day, people are loyal to a leader they believe in. Leading is not managing. Although it is impossible to lead if there is no management. But leading is that special thing. It is charisma, it is strength, it is communication, it is vision, it is listening, it is being there, it is calm, it is connecting, it is trust, faith, and belief. The best founders are great leaders. They may be shitty managers which means they need to find managers to help them. But they are great leaders. One of the things we look for in founders is leadership. If we want to follow them, we believe that others will too.

2) Mission. People are loyal to a mission. I’ve seen super talented people walk away from compensation packages 2-3x what they currently make because they believe in what they are working on and think it will make a difference in their lives and the lives of others. This is why investing in mission driven companies can produce great financial returns. Mission driven companies have something most companies don’t have. They have “why” that keeps the team together through difficult times and when the compensation isn’t close to “market”.

3) Values and Culture. My friend Matt wrote a post about Values and Culture the other day. I read it and responded “values are the house and culture is the furniture”. He thought that was about right. People want to work in a place that feels right to them. They need to feel comfortable at work. In the way that a welcoming home with comfortable furniture is pleasant to be in, a company with good values and culture is pleasant to work in.

4) Location. I spent the past week in europe. In Berlin, Paris, Istanbul, Vienna, and Ljubljana. These are very different talent markets that the bay area or NYC. In the Bay Area and NYC, your employees are constantly getting hammered to leave for more cash, more equity, more upside, more responsibility, and eventually it leads to them becoming mercenaries. It is incredibly hard to hold onto a team in the Bay Area and NYC. If you are building your company in Ljubljana, Waterloo, Des Moines, Pittsburgh, Detroit, or Indianapolis, you have a way better chance of building a company full of loyalists than if you are building it in the Bay Area or NYC.

If you mess up any of these dynamics, you can easily turn your team from loyalists to mercenaries. Changing leadership is the most common one. Almost every time I have seen a founder leave and be replaced by a new CEO, I have witnessed a significant exodus of talent from the company. It is better if the new CEO comes from within, but even then I have witnessed a significant exodus of talent. When the CEO comes in from the outside, it is almost always much worse.

If you move your team from Philadelphia to NYC or from Des Moines to the Bay Area, expect more turnover. Expect to turn loyalists into mercenaries. These talent starved locations create mercenaries. It’s the nature of the beast.

So what can you do to build a company full of loyalists instead of a company full of mercenaries? First you must lead. If you think you are a good leader, get better. If you think you are a great leader, you can get better. Get coaching and focus on becoming the best leader you can be.

Second, build a mission driven company. Make sure you are doing something that matters. If all you are doing is trying to make money for yourself, then all your employees will try to do is make money for themselves.

Third, invest in values and culture. Matt’s post is a good starting place for some tips on how to do that.  Build a welcoming home and put comfortable furniture in it. I mean that metaphorically of course. But the office does matter too.

Finally, think about being somewhere other than the Bay Area or NYC. Yes, they are great places to start companies, find talent, and get investment. But they are also places where others start companies, get investment, and find your talent. It’s a ratrace, a treadmill, and it’s grueling. If you can avoid it, you owe it to yourself to try.

There are many reasons why the startup sector feels stretched to me. But possibly the most significant one of all is the increasing amount of mercenary behavior I am witnessing in it these days. Hopefully this post will help you avoid that as much as possible. It’s hard these days.

Profits vs Growth

One of the things I’ve always struggled with as an investor in high growth tech companies is the tension between getting profitable vs growing more quickly. It has become a central tenet of tech growth investing (in both the public and private markets) that growth is more valuable than profitability and you can always focus on profits once you have “captured the market.” This leads to behaviors like investing heavily in sales and marketing to increase the growth rates of a business beyond what it can grow at “organically.”

A few months ago, I blogged about a formula I came across at a board meeting a while back that says your year over year growth rate plus your pre-tax operating margins need to be at least forty percent. Meaning you can grow at 100% per year and have operating margins of -60%. Or you can have flat growth and have 40% operating margins. Or you can grow at 20% per year and have 20% operating margins. There is no magic to the forty percent target, but I do like establishing some relationship between acceptable levels of profitability (or losses) and growth. Too many times I have seen companies invest in growth for growth sake without having any constraints or sanity checks on that investment and the losses that result from that investment.

We have worked with/invested in a few super high quality companies over the past decade that did not make this tradeoff. They got profitable early on in the life of their company and then were able to use their profits to reinvest in the business and continue to grow at very high year over year growth rates without having to burn money and raise capital. Indeed.com is probably the best example of this group but we have had a number of them and they are all special companies that I have enormous respect for.

These experiences lead me to question the orthodoxy in the world of technology that says if you are not investing heavily in growth (and losing money), then you are not maximizing the potential value of your business over the long haul. It doesn’t have to be that way. Now maybe you need to have a very special company that has real structural competitive advantages in the marketplace to avoid this tradeoff. Or maybe you just need to be a really sharp and experienced business person to be able to do this (that’s how I would describe Paul and Rony, the founders of Indeed.com, for example).

I also think the profit motive, generating more revenues each year than the expenses you are spending to do that, is a really valuable constraint on a management team. It forces them to think creatively and logically about the investments they want to make. It roots out bad investments in people, product, sales, marketing, and elsewhere in the business and helps to maintain a lean and mean highly functioning organization. If you don’t need to make money because there is plenty of capital available to fund your losses and you are “investing in growth”, then you can also avoid making the hard decisions that focus an organization and insure a high quality team where everyone is pulling their weight.

I don’t want to come off as a positive cash flow freak. It is our business to invest in companies to allow them to run operating losses in order to get a product in market, grow the business and team, and create value for the founders, management, and shareholders. Most of our portfolio companies lose money and we are used to reading income statements with lots of red on them and staring at runway calculations showing when the money runs out.

But I’m a bit sick and tired of the objective of every operating plan I see is to get the business to a point where it can raise money at a much higher price. That’s nice and it’s how the VC/startup game is played. But at some point I’d prefer to see an operating plan that has the objective of getting to sustainable profitability. And I do mean sustainable.

Because, as I said earlier, some of the very best companies we have worked with at USV got profitable early on in their life and maintained profitability while revenues grew100% year over year for a number of years. It can be done. Maybe the reason that many entrepreneurs don’t think it can be done is nobody is telling them it can. So I’m doing that.

Technology In Istanbul

The Gotham Gal and I are winding up a four day weekend in Istanbul. She likes to blog about the places we go and things we do so if you want to read about all that visit her blog. I expect the posts on her blog will be all about Istanbul for the next few days.

There is something about the uptake of technology in Turkey that is somewhat unique. Facebook blew up in Turkey fairly early in its international phase. Foursquare’s Swarm is so popular in Turkey that you would think the product was started here. We’ve seen similar stories in other USV portfolio companies and also companies that have pitched us. So one of the things I’ve been looking at while we’ve been here are clues to the behaviors that make this happen.

The most obvious thing you see is the almost total obsession with mobile phones. Everyone has one and everyone is using them. You might think using mobile phones during meals or conversations is rampant in the US, but in Turkey it is way more rampant. It is clearly the social norm to be on your phone at the same time you are hanging out with other people.

It also seems that the phones are cheap and there also seem to be a number of wireless carriers active in the market. We got good data service everywhere we went in Istanbul. The speeds were great and the data was reliable and abundant. Phones and prepaid cards are sold everywhere. I haven’t looked deeply at any reports on this but on the surface it seems that the wireless industry (carriers and handsets) have done a good job of competing vigorously and bringing price points down and service quality up. Maybe the US could learn a thing or two from Turkey.

We also found wifi to be offered in most venues in Istanbul. I have been using WifiMap (which I blogged about a few weeks ago) and you can get wifi in almost every place you walk into around town. So for people on mobile data plans who want to offload to wifi when possible, Istanbul is a good place to do that.

Turkey also seems economically quite vibrant so most people apparently have the means to afford the basics (phone and mobile data) and yet they are not developed enough that they made massive investments in the last generation internet infrastructure (desktops, laptops, wired internet, etc). So it’s a place where social, mobile, local, messaging can take off as well as anywhere in the word and doesn’t necessarily have other older solutions to these needs.

Here is a slide I found on the Internet that is from early 2014:

turkey slide

Mobile penetration in Turkey was 84% in early 2014, likely higher now, and that is about the world average. But given the size of Turkey, the total mobile population was 68mm in early 2014, as big as many european countries.

So Turkey is a place where technology, particularly mobile, has taken off. It’s a big market and one that seems to adopt things early on. It’s a good market to pay attention to when you think about international strategies and it is also likely a good place to start companies that focus on mobile products and services.

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.

Kozmo

Yesterday was a bright sunny day on the east end of long island. So the Gotham Gal wanted a hat to shield the sun from her face and pulled out this gem from one of our closets.

jo in kozmo hat

For those that don’t know, that’s a Kozmo.com logo on the hat. Kozmo shut down in early 2001 and has been gone for over fourteen years. But I still see bike messengers riding around NYC with their messenger bags. It turns out the schwag is often more durable than the company. In this case, that has absolutely been true.

My prior venture capital firm provided much of the early capital to Kozmo and we wrote off something like $25mm or $30mm when it went up in flames.

On the way back from lunch, the Gotham Gal turned to me and said “Kozmo was way ahead of its time.” I woke up thinking about that this morning. It’s true.

Kozmo pioneered the idea of same hour delivery in 1998, fifteen years before its time. Kozmo pioneered the idea of raising and spending hundreds of millions of dollars a year long before it became fashionable, even normal to do so. Kozmo nailed the practice of scaling while your unit economics are upside down. They took that practice into almost twenty markets before the capital markets turned on them and there wasn’t money available to incinerate anymore.

I hope it all turns out differently this time. There are many reasons to hope and expect that it will. But for now, I see a lot of similarities out there in the delivery space to what Kozmo was doing, long before it was common.

I have a lot to be thankful for from Kozmo. I’ve got hats and messenger bags. But more than that, I’ve got scars. I wear them every day.

The Buffalo Bet

Last year I went up to Buffalo and talked to their startup community and got a tour of the emerging startup community there. I was impressed by what I saw. Like many cities around the country, Buffalo is betting on tech and tech startups to give their economy a boost.

Part of this bet is the $5mm startup challenge called 43North. I wrote about this last year and it is happening again.

43North is the world’s largest business idea competition. Once again they are awarding $5 million in cash, in the form of a $1 million grand prize, six $500,000 prizes and four $250,000 prizes. Winners also receive space in the 43North incubator, mentorship and access to START-UP NY, which allows companies to operate free of New York State taxes for 10 years.

The competition is open to applicants ages 18 and over from anywhere around the world, in any industry, with a few exceptions, like bricks-and-mortar retail and hospitality. It is free to apply and the first round application is a high-level business summary that takes 20-30 minutes to complete. Applications are due at www.43north.org by June 24.

Last year’s winners hailed from places like Taiwan, Miami, Brooklyn, Toronto and Atlanta and had businesses ranging from biotech to a virtual fitting room. All 11 winners are located in Buffalo and most of them in an incubator facility located in the heart of the Buffalo Niagara Medical Campus in free space with services, classes, training, support and mentors.

This is all part of NY State Governor Andrew Cuomo’s Buffalo Billion, a huge investment in Buffalo, which once was the 8th largest city in the US. The decline of the manufacturing and related transportation businesses in the midwest in the 20th century changed all of that. But we are in a new era, one defined by technology, and Buffalo wants a part of that. If you want to be part of that resurgence and get some much needed capital for your business too, check out 43North.

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.