Posts from VC & Technology

Timing

There is a big difference between being right about something and being right about when something will happen.

Sadly, to profit from being right you either have to get the timing right or you have to hang in there until the timing is right. The latter can be incredibly painful and most investors don’t have the stomach for it.

This is particularly true of short positions. It is not enough to know that something is going to blow up. You have to know how, why, and when.

On long positions, like venture capital investments, you do have the ability to buy time but it requires a lot of conviction and patience and the carrying costs can negatively impact the returns.

Which is why the best venture capital investments are always the right idea at the right time by the right team.

I remember watching streaming video over a 14.4 modem in 1997. Ten years later YouTube nailed that opportunity. Right place. Right time.

A lot of venture capital investors ask “what can go right” instead of “what can go wrong” and that is exactly the right mindset in VC investing. But you also have to ask “when will it happen and why?”

Taking Money “Off The Table”

One of the hardest things in managing a venture capital portfolio is managing your big winners. A big winner can dwarf the rest of the entire portfolio and you end up sitting on enormous paper profits that you can’t get liquid on. I realize that this seems like a great problem to have, and it is, but it is still a challenging situation.

We faced it in Twitter in 2010/2011/2012, in the years before Twitter went public (which happened in the fall of 2013). We had bought 15% of Twitter for $3.75mm in the first VC round in 2007 and though we had been diluted down a bit in subsequent rounds, we had a very large position that was worth in the neighborhood of $1bn by 2011. Our entire fund was $125mm and so we were sitting on a position that was worth 8x the entire fund. It was a wonderful situation in many ways but I was nervous that macro events or a setback at Twitter could go against us and the position would go down in value, possibly significantly.

The way we managed this issue is we sold a portion of our position in two secondary transactions and in connection with those sales, I stepped off the board, making room for an independent director who would be helpful as the Company scaled and got ready to go public. We sold about 30% of our position in those two secondary transactions for about $250mm and returned 2x the entire fund to our investors.

That allowed us to “chill out” and hold the balance until the IPO, which had a customary 180 day post IPO lockup. After the lockup came off, we distributed the balance of the position, returning another ~$700mm to our investors.

Though we sold stock in the secondary transactions at lower values than the eventual IPO, I have never regretted doing that and believe that it was the right thing for us to do for many reasons.

We have done similar things in many other situations including Zynga, Lending Club, MongoDB, and a number of other investments. We typically seek to liquidate somewhere between 10% and 30% of our position in these pre-IPO liquidity transactions. Doing so allows us to hold onto the balance while de-risking the entire investment.

I was reminded of this topic when I saw the news that Benchmark, First Round, and Menlo sold between 15% and 50% of their positions in Uber to SOFTBANK. I think they all acted rationally and responsibly in doing that. It does not mean that SOFTBANK is making a mistake purchasing the shares. There are many reasons to believe that SOFTBANK made a good deal. But if you look at First Round, for example, they have a position worth $2bn or more at the $50bn valuation of the SOFTBANK tender. I don’t know the exact details, but I believe First Round’s fund that holds Uber is less than $100mm. So they returned something like 8x the entire fund and still hold the majority of their position. That was “well played” in my book. Same with Benchmark. Same with Menlo.

Taking money off the table is smart portfolio management. It is very different from selling your entire position, which could be brilliant but is equally likely to be a mistake. Selling a portion of your position, returning a multiple or two (or eight) of the fund, and holding on to the balance works out for you no matter which way the position goes in the future. If the position blows up, you got a lot out and booked a huge gain. If the position goes up significantly, you make even more money on the part of the investment you retained. If it goes sideway, you got a little bit out early. It is a win/win/win pretty much every way you look at it.

Which takes me to crypto (naturally). If you are sitting on 20x, 50x, 100x your money on a crypto investment, it would not be a mistake to sell 10%, 20% or even 30% of your position. Selling 25% of your position on an investment that is up 50x is booking a 12.5x on the entire investment, while allowing you to keep 75% of it going. I know that many crypto holders think that selling anything is a mistake. And it might be. Or it might not be. You just don’t know.

What Is Going To Happen In 2018

This is a post that I am struggling to write. I really have no idea what is going to happen in 2018.

  • Will the crypto markets continue in their bull cycle? I have no clue. I was showing my daughter’s friend an app that helps people save and invest and he said to me “I don’t need that, I just buy some ETH every week.” I said “that’s a good plan until it isn’t.” I just don’t know when buying crypto will stop being a good idea. It was a great idea in 2017.
  • Will the economy extend its eight year expansion? I have no clue. The longest post WWII economic expansion was 10 years from 1991 to 2001. Can this one beat that one? Maybe. Will this one also burst over the collapse of another tech bubble? Maybe. But again, I have no idea when that might come.
  • Will the corporate tax cuts that are coming from Trump’s tax bill lead to increased hiring and investments, or will companies simply hoard that cash or pay it out in dividends? Likely a bit of both. But I think Wall Street has largely priced in the increased earnings so I’m not sure the tax bill will be a boon for the stock market in 2018.
  • Will the current Internet oligopoly (Amazon, Apple, Facebook, Google) continue to take share from the rest of the sector, or will one or more start to falter? I’d like to see the latter, but I suspect it will be more of the former.
  • Will the rise of massive growth funds (SOFTBANK, Sequoia, etc) lead to the best and brightest tech companies delaying IPOs even longer? The logical answer is yes, but I think the answer may be no. We see an increasing desire of founders in our portfolio to take their companies public.
  • Will the tech backlash that I wrote about yesterday continue to escalate? Yes.
  • Will we see more gender and racial diversity in tech? Yes.
  • Will Trump be President at the end of 2018. Yes.
  • Will the GOP lose control of Congress in the midterm elections. Yes.
  • Will we avoid war with North Korea? I sure hope so.

So there you have it. Ten questions. A few predictions. A lot of unknowns. That is how I am going into 2018.

Happy New Year Everyone.

What Happened In 2017

As has become my practice, I celebrate the end of a year and the start of a new one here at AVC with back to back posts focusing on what happened and then thinking about what might happen.

Today, we focus on what happened in 2017.

Crypto:

I went back and looked at my predictions for 2017 and I completely whiffed on the breakout year for crypto. I did not even mention it in my post on New Year’s Day 2017.

Maybe I got tired of predicting a breakout year for crypto as I had mentioned it in my 2015 and 2016 predictions, but whatever the cause, I completely missed the biggest story of the year in tech.

If you look at the Carlota Perez technology surge cycle chart, which is a framework I like to use when thinking about new technologies, you will see that a frenzy develops when a new technology enters the material phase of the installation period. The frenzy funds the installation of the technology.

2017 is the year when crypto/blockchain entered the frenzy phase. Over $3.7bn was raised by various crypto teams/projects to build out the infrastructure of Internet 3.0 (the decentralized Internet). To put that number into context, that is about equal to the total seed/angel investment in the US in 2017. Clearly, not all of that money will be used well, maybe very little of it will be used well. But, like the late 90s frenzy in Internet 1.0 (the dialup Internet) provided the capital to build out the broadband infrastructure that was necessary for Internet 2.0 (the broadband/mobile Internet), the frenzy in the crypto/blockchain sector will provide the capital to build out the infrastructure for the decentralized Internet.

And we need that infrastructure badly. Transaction clearing times on public, open, scaled blockchains (BTC and ETH, for example) remind me of the 14.4 dialup period of the Internet. You can get a taste of what things will be like, but you can’t really use the technology yet. It just doesn’t work at scale. But it will and the money that is getting invested via the frenzy we are in is going to make that happen.

This is the biggest story in tech in 2017 because transitions from Internet 1.0 to Internet 2.0 to Internet 3.0 cause tremendous opportunity and tremendous disruption. Not all of the big companies of the dialup phase (Yahoo, AOL, Amazon, eBay) made a healthy transition into the mobile/broadband phase. And not all of the big companies of the broadband/mobile phase (Apple, Google, Facebook, Amazon) will make a healthy transition into the decentralized phase. Some will, some won’t.

In the venture business, you wait for these moments to come because they are where the big opportunities are. And the next big one is coming. That is incredibly exciting and is why we have these ridiculous valuations on technologies that barely/don’t work.

The Beginning Of The End Of White Male Dominance:

The big story of 2017 in the US was the beginning of the end of white male dominance. This is not a tech story, per se, but the tech sector was impacted by it. We saw numerous top VCs and tech CEOs leave their firms and companies over behavior that was finally outed and deemed unacceptable.

I think the trigger for this was the election of Donald Trump as President of the US in late 2016. He is the epitome of white male dominance. An unapologetic (actually braggart) groper in chief. I think it took something as horrible as the election of such an awful human being to shock the US into deciding that we could not allow this behavior any more. Courageous women such as Susan Fowler, Ellen Pao, and many others came forward and talked publicly about their struggles with behavior that we now deem unacceptable. I am not suggesting that Trump’s election caused Fowler, Pao, or any other woman to come forward, they did so out of their own courage and outrage. But I am suggesting that Trump’s election was the turning point on this issue from which there is no going back. It took Nixon to go to China and it took Trump to end white male dominance.

The big change in the US is that women now feel empowered, maybe even obligated, to come forward and tell their stories. And they are telling them. And bad behavior is being outed and long overdue changes are happening.

Women and minorities are also signing up in droves to do public service, to run for office, to start companies, to start VC firms, to lead our society. And they will.

Like the frenzy in crypto, this frenzy in outing bad behavior, is seeding fundamental changes in our society. I am certain that we will see more equity in positions of power for all women and minorities in the coming years.

The Tech Backlash:

Although I did not get much right in my 2017 predictions, I got this one right. It was easy. You could see it coming from miles away. Tech is the new Wall Street, full of ultra rich out of touch people who have too much power and not enough empathy. Erin Griffith nailed it in her Wired piece from a few weeks ago.

Add to that context the fact that the big tech platforms, Facebook, Google, and Twitter, were used to hack the 2016 election, and you get the backlash. I think we are seeing the start of something that has a lot of legs. Human beings don’t want to be controlled by machines. And we are increasingly being controlled by machines. We are addicted to our phones, fed information by algorithms we don’t understand, at risk of losing our jobs to robots. This is likely to be the narrative of the next thirty years.

How do we cope with this? My platform would be:

  1. Computer literacy for everyone. That means making sure that everyone is able to go into GitHub and read the code that increasingly controls our lives and understand what it does and how it works.
  2. Open source vs closed source software so we can see how the algorithms that control our lives work.
  3. Personal data sovereignty so that we control our data and provision it via API keys, etc to the digital services we use.
  4. A social safety net that includes health care for everyone that allows for a peaceful radical transformation of what work is in the 21st century.

2017 brought us many other interesting things, but these three stories dominated the macro environment in tech this year. And they are related to each other in the sense that each is a reaction to power structures that are increasingly unsustainable.

I will talk tomorrow about the future, a future that is equally fraught with fear and hope. We are in the midst of massive societal change and how we manage this change will determine how easily and safely we make this transition into an information driven existence.

The Second Quartile

As I have written about here on AVC many times, early stage venture portfolios produce a wide range of outcomes. A few investments produce the vast majority of the returns while many investments return nothing. Managing a portfolio with power law dynamics is a challenge.

At USV, we tend to make 20-25 investments per early stage fund.

The best four to five investments per fund will usually produce greater than 80% of the total returns of a fund (the top quartile). This is where you might imagine that we spend all of our time, but the truth is that these investments generally go well and while we certainly do everything we can to help these companies, they often do not demand a lot of our time. When they do require a lot of our time, it tends to be situational.

There will be roughly ten investments per fund that will return maybe 5% of the fund (the third and fourth quartile). We spend a lot of time on these investments and it is difficult work that I have written a lot about over the years. The time and money we spend on these investments is not rational but we do it anyway.

And then there is the second quartile that will produce roughly 15% of the returns of the fund.

I find that it is this cohort of investments that is the most challenging to manage. The companies in the second quartile are usually very good companies but they lack the explosive value generation characteristics of the top quartile. They tend to have a harder time attracting top talent and financing their businesses at attractive valuations. We often do insider-led rounds for companies in the second quartile as the venture industry is hard wired to invest in the top quartile, particularly the later stage/growth investor community.

But there is a lot of value in the second quartile. The exits in the second quartile tend to be in the $100mm to $500mm range which is not a small amount of value to anyone other than a VC managing a billion dollar fund. The founders and management teams that are building these companies stand to make a lot of money if they execute the opportunity well. And an early stage VC can make a lot of money too. At USV, we tend to own between low to middle teens and twenty percent of our portfolio companies at exit, so the proceeds at exit to us of an investment in the second quartile cohort can be $50mm or more. A few of those and that is the difference between a 3x fund and a 5x fund for us. So managing the second quartile is super important.

But the second quartile will try your patience and your conviction. These investments often take longer to realize. And you will have to take endless calls from friends in the VC passing on the investment for all sorts of good reasons, but always come down to “it’s just not exciting enough to us.” You will have to talk your management team off the ledge countless times. You will work harder to recruit new talent. You will put more money into them than you want to. You will struggle to get the business profitable. You will wonder if you have lost your objectivity.

And then one day, you will get an offer from a buyer to acquire the company for hundreds of millions of dollars. And then all of that effort and conviction will have been worth it.

The tech sector’s obsession with the billion dollar companies emerging from startup land is irritating to me. That narrative ignores a lot of great companies and terrific work being done by founders and management teams. And it makes it harder to build a company that isn’t in that top cohort.

I understand why the attention is focused on the big winners to the detriment of everything else. But I can assure you that is not how we operate at USV, and it is not how the best early venture capital firms operate. When you start a company, you want to find an investor who will be there with you through thick and thin. Do yourself a favor and look at how the firms you are talking to behave toward their second and third quartile portfolio companies. That will tell you all you need to know.

Putting The Year In The Review Mirror

I’m in the process of going over all of the songs I favorited this year and putting my top ones into a playlist and then culling that list. I’m planning on posting it at some point this coming week, maybe as soon as tomorrow as a Christmas gift to the AVC community.

That’s a precursor to a larger effort of looking back on 2017 that will result in a What Happened post on New Year’s Eve followed by a What Will Happen post on New Year’s Day.

This stuff is fun for me but it is also a great mental exercise to go through. It forces me to reflect, think, and focus on what is/was most important.

There is so much that blogging does for my brain. I am not sure how I would do my work without it. The daily routine of writing something for public consumption is a discipline that brings clarity in a confusing time. The bigger posts that come every now and then, and the year end ones, are particularly valuable to write.

So I am looking forward to spending the coming week reflecting on the year that is ending and looking forward to the year that is about to begin. I will do that while celebrating the year end holiday with our family skiing in the rockies.

And the year in review thing is already in swing in VC blog land. Semil Shah posted his year in review a few days ago and it is a good read.

There won’t be much in any of these year in review posts that you don’t already know. But it is the context and reflection that comes with them that are so valuable.

Playing Your Role

Investing in many different companies, with different founders, different cultures, and different missions requires the ability to adapt to each and every one. I like to think about it as playing a role in a play.

Even though I am the same person, with the same fundamental beliefs, I end up playing very different roles in the companies I invest in and work with. The Fred Wilson that works with Coinbase is different than the Fred Wilson that works with Kickstarter and the Fred Wilson that works with Etsy and the Fred Wilson that works with SoundCloud and the Fred Wilson that worked with Twitter.

It starts with the founders and the mission. They set the course for the company. As an investor, you show up and something is already underway. You have to take the time to understand where the company is headed, why it was formed in the first place, where it is going and why. You have to figure out how to insert yourself into that journey in a way that is constructive and value adding. And you have to do that work before you invest because if you can’t figure out how to play a role that is constructive and value adding, you should not make that investment and join that Board.

Some founders start companies to make money first and foremost. It is important to understand that. They will be “coin operated” and transactional.

Some founders start companies to solve a very specific problem, often one that they themselves have. They will be very product and market focused.

Some founders start companies to chart a course that is different from others. They will be iconoclasts who like to zig when others zag.

Some founders build companies to sell.

Some founders build companies to go public.

Some founders build companies to outlive them.

What I have learned is that there is no right way to build a business, no right way to exit a business, no right way to operate a business. There are many different ways to do the startup thing. And I have learned that getting everyone on the same page about the specific way you are going to do it is critical. If everyone on the management team, investor group, and Board are bought into the long term vision and wanting to go to the same place, on that specific opportunity, then great things can happen.

If, on the other hand, there is tension between the founders about the direction, or between the Board and founders about the direction, or between the management team and the founders about the direction, or between members of the management team about the direction, then it makes it very hard to move things forward.

I know that people who read AVC, who follow the investments we make at USV, who work in USV-funded portfolio companies often scratch their head trying to figure out why what is right for one company is not right for another.

Why is it that its a great idea for one of our portfolio companies to move to a token based business model and do an ICO when it is not a great idea for another one of our portfolio companies to do that?

Why is it that it is a great idea for one of our portfolio companies to accept an M&A offer before they have reached their potential when it is not a great idea for another one of our portfolio companies to do that?

Why is it that it is a great idea for one of our portfolio companies to go public when it is a bad idea for another one of our portfolio companies to do that?

To understand these conflicting choices that companies we work with make, it is important to understand how these companies were funded, what the vision was, what they founders wanted out of the effort, what the investors signed up for, how they were capitalized, how they were managed, and how all of that changed over the years. And it is hard to understand those things from afar.

To understand it better, you need to think about each company as a different journey, to a different place, and all of us – the employees, the management, the founders, the investors, the board members – as role players in that journey. And when you choose to join a company as an employee or an investor or as the CEO, you really need to take the time to understand that journey before you step into that role. Because you will be playing it, possibly for a long time.

The Early Stage Slump

I tweeted out this article from Techcrunch in the middle of last week:

And the response from the Twittersphere was a desire to hear my views on it.

The data is pretty clear. The seed and early stage investing market has cooled substantially in the past few years.

On a dollar basis, the cooling off has been mild.

On a deals basis, the cooling off has been dramatic and looks to be getting worse.

So what is going on?

When I talk to my friends who do a lot of angel investing, I hear that they are being more selective, licking some wounds, and waiting for liquidity on their better investments.

When I talk to my friends who started seed funds in the past decade, I hear them thinking about moving up market into larger funds and Series A rounds.

You can see that in the data. Less deals and bigger deals.

Here is the thing. Seed is really hard. You lose way more than you win. You wait the longest for liquidity. You lose influence as larger investors come into the cap table and start throwing their weight around.

It is where most people start out. Making angel investments, raising small seed funds. They learn the business and many see better economics higher up in the food chain and head there as soon as they can.

If you hit one or two right, you can make a fortune in seed. But those bets take a long time to get liquid. And if you don’t hit one or two right, you end up with a mediocre portfolio.

The Facebook IPO in May 2012 was a real boon to the angel and seed markets. A lot of instant millionaires re-invested their gains back into startups (just as BTC and ETH instant millionaires are re-investing their gains into ICOs right now). Many startup people reinvented themselves as angel investors, AngelListers, seed VCs, and early stage VCs. As I quoted Techcrunch in my tweet “2012-2016 was a bubble in early-stage funding.” I think the bubble actually started letting out air in mid 2015.

You could see all of this in the pricing of seed rounds. For most of my career, seed rounds were sub $1mm and they bought 15-25% of the company ($4-6mm post money). At the peak of the seed bubble, uncapped notes of $3-5mm were the norm for seed rounds. That wasn’t going to work. It was unsustainable.

So where does that leave us now?

For entrepreneurs just starting out, it will be tougher to raise your first rounds. That is how it always has been so it is a return to normal. It is not great news, but it is the reality. If you price your seed round appropriately and have a good team and plan, you can raise money. But it will be harder.

For investors, it means seed rounds are going to be the place to be. When others leave the market, it is time to get in. The uncapped note will turn into a priced $1mm round at $4mm pre/$5mm post. This is as it should be. The risks of seed investing are so significant that the valuations need to be reasonable. When you lose on 60-80% of your investments, you really need the ability to make 10-20x on your winners. And getting the entry pricing right is part of how that happens.

You can tell where there is too much money and too little money by looking at valuations. When valuations are extended, that means there is too much money. That was seed in 2014, growth in 2015/2016, and ICOs in 2017. The trick is to get into these sectors before the money shows up and get out when it does. And then get back in after it leaves. And not get burned along the way.

Meetup

I remember at our first USV Sessions event in the summer of 2006 Scott Heiferman stated that he wanted to spend 20 years building a company that would “last.” This was in an era of quick flips where many entrepreneurs wanted to build and sell as quickly as possible. I was impressed by that long term perspective and told my partner Brad that we should see if we could invest in Scott’s company Meetup.

We did invest in Meetup shortly after that, Brad joined the board, and we have been investors in Meetup for the past ten years.

Today, Meetup announced that it is becoming a part of the WeWork network.

Meetup launched in June 2002, fifteen years ago. Over those 15 years Meetup has become synonymous with the idea of community being an in person thing.

Community on the Internet is easy but prone to a lot of bad behavior. Community in person is harder but works better. Humans tend to be more interesting and more decent in person.

And with the ever increasing encroachment of digital devices into our daily/hourly/constant existence, taking the time to sit down face to face with other people is more important than ever.

Meetup, like its NYC community peers Etsy and Kickstarter, has been profitable since its earliest days. As Scott said in the Wired piece “Our number one priority was independence and to live within our means.” That has meant always balancing growth and profitability, like most businesses do.

But on the Internet, particularly now in the age of winner take most, it is hard to balance profitability and growth and very few companies do.

So Meetup decided to do something this year that it had not done in a decade, since USV invested in 2007. Scott went out and talked to investors about investing in more growth. That led to “offers from what Heiferman calls the usual suspects.”

The most interesting of the offers came from WeWork which is building another in-person network, maybe the largest in-person network of scale on the Internet. It seems like such a perfect match. And so Meetup is joining forces with WeWork who will aggressively invest in Meetup to help it scale to reach even more people who want to engage in live in person conversations.

And Scott is going to continue to lead Meetup inside of WeWork meaning he will likely achieve his goal of working on Meetup for 20 years or more.

It is always bittersweet to see a company as important as Meetup leave the USV network. But we agree with Scott that this is the right thing for Meetup and WeWork and we are enthusiastic about the potential of this combination.

200x Growth

Back in 2011, my partner Brad suggested that USV invest in a search engine called DuckDuckGo.

I laughed at the idea, “why would we ever want to compete with Google?”

“Because they do something Google will never do”, Brad explained.

That thing was private search, no storage of search history, no storing of personal information.

DuckDuckGo was doing about 100,000 searches a day when we had that conversation.

Last week, they had a day in which over 20mm direct searches were done.

That’s 200x growth over the six plus years we have been invested in DuckDuckGo.

Brad was right, of course, and I saw that pretty quickly as did everyone else at USV and we made that investment.

And I’m very glad we did.

I suspect I’ve told this story a few times now at AVC.

I love it so much.