Dan Primack and I did a fireside chat at the Upfront Summit this past week. It generated a few news stories that went a bit viral. It is easy to take a few comments out of the context of an overall discussion and turn them into more than they were. I think that is what happened with this interview. But it’s online now and so people can come to their own conclusions about that. Here it is in its entirety. It is about 25mins.
Posts from VC & Technology
The Upfront Summit is happening here in LA over the next two days. The folks at Upfront asked a number of well known VCs (me included) a bunch of questions. One of them was “What will be the biggest technology change over the next five years?”. Here are the answers in a short two minute video.
In a venture fund, the general partners will make something like twenty or twenty five investments. There are outliers for sure. A few venture funds will make less investments than that. And there are seed funds that will make significantly more investments than that. But that’s not the point of this post.
The thing I want to talk about is how losses (and gains) are treated in a venture fund. A traditional venture fund will take its losses on a given portfolio of twenty to twenty five investments and earn them back with their gains before calculating their carried interest. The carried interest is the primary way a venture capital firm makes money. At USV we take a 20% carry. There are firms in the VC business that take a larger carry (25% and 30% being the other common numbers). But we are happy with 20% and do not feel the need to charge more.
Let’s do some math to make this clear. Let’s say a VC firm makes twenty investments of $2.5mm each. That’s $50mm of invested capital. We will ignore management fees for this exercise to make it simple. Let’s say seven are complete losers and seven get their money back and six are winners returning 5x on each. So the seven losers produce $17.5mm of losses. And the six winners produce $60mm of gains ($75mm in proceeds less $15mm of cost). So the fund’s total gains are $42.5mm ($60mm of gains minus $17.5mm of losses) and a 20% carry on that will produce $8.5mm of profits for the VCs on that fund. The limited partners will get back $84mm on their $50mm investment, a gain of $34mm which produces a 1.68x multiple on their investment. This is not a great venture fund. But it is way more typical than people think.
There are investors who get what is called a “deal by deal carry.” In that model they do not have to account for their losses in the calculation of carry. So they take 20% on their successful deals and don’t have to net out their losses. In the example above, those investors would make $12mm in carry on the same portfolio and the limited partners would get back ~$80mm or 1.6x.
But leaving aside the math between the limited and general partners, the other thing about deal by deal carry is how it changes the incentives. If investors don’t have to worry about the 2/3 of the portfolio that produces disappointing outcomes, they will pay all of their attention on the winners and work to make those investments as successful as possible. That might be good. The VC economics already trend toward incenting that behavior because all of the gains come from a small portion of the portfolio. Deal by deal carry just amplifies that.
Deal by deal carry has not been common in the VC business. It is more common in private equity where the distribution of outcomes looks very differently. But with the rise of syndicates being raised on venture capital marketplaces, we are seeing an increasing number of angel and early stage investors who have deal by deal carry.
As I said, there are pros and cons to both compensation models. I don’t want to say that one is better than the other. But they do produce different kinds of behavior and entrepreneurs should understand how their investors are being compensated. It will explain their approach and behavior.
Richard Florida published some stats on the distribution of global venture capital investment last week. His work focused on 2012 numbers so the data is a bit dated, but I am sure it is still directionally correct.
This map summarizes his findings:
The bay area numbers are stunning. SF proper and the broader bay area make up 25% of the global venture capital investment activity (~$10bn out of $42bn).
SF, Boston, NYC, and LA are the top four (or five if you count SF and the bay area as two different locations).
London and Beijing crack the top ten. Ten of the top twenty cities are outside of the US. Berlin, a city that USV invests a lot in, was not in the top twenty in 2012 but I bet it is now.
The most interesting thing about Richard’s data are his conclusions about “dense urban cities.” He writes:
The upshot is this: While some smaller places, mainly in the U.S., do well on a per capita basis, venture capital increasingly flows to large global cities, with all their density and dynamism. The leading centers remain the Bay Area and the Boston-New York-Washington Corridor, while a number of global cities outside of the U.S. have become significant centers for venture capital-backed high-tech startups: London, Paris, and Moscow in Europe; Toronto in Canada; Beijing and Shanghai in China; and Mumbai and Bangalore in India. Across the world, the top 10 metros account for more than half of global venture investment, the top 20 metros account for almost two-thirds, and the top 50 account for more than 90 percent. Ultimately, global venture investment ishighly uneven and spiky, concentrated in a small number of leading cities and metros around the world.
Although venture capital investment has certainly “gone global” by spreading to places like China and India, the dominant centers remain large U.S. cities that combine density, great universities, and the open-mindedness and tolerance required to attract talent from across the world. While cities like Mumbai, Bangalore, Beijing, and Shanghai have certainly shown their ability to attract venture investment and create start-up ecosystems, their levels of venture capital remain well below that of the Bay Area, New York, and Boston. As of yet, these former cities are hamstrung by their inability to attract the world’s top talent. Outside of the U.S., the places that seem to have the brightest future as start-up hubs are dense, diverse, global cities like London, Toronto, and Paris, which can effectively compete for talent on an international scale.
This uneven or spiky nature of investment and its flow to great cities marks a broader transition away from sprawling suburban campuses, or “nerdistans.” In recent years, innovation and entrepreneurship have returned to the great global cities and dense, diverse urban areas that have long served as fonts of creativity and invention. What once seemed like a shift toward suburban innovation and startup clusters in the late 20th century has proven to be a brief aberration from the long-held connection between density and innovation.
I would add one more thing to Richard’s analysis. Transportation convenience matters a lot. You can fly direct multiple times a day to and from all of the cities on Richard’s top ten list. Investors value their time and focus it on markets that they can get in and out of easily. I think that has a big impact on where money flows.
But regardless of the reason, I agree with Richard’s conclusion. VC has gone urban. And I think that trend will continue as far as I can see.
One of my favorite business moves over the past twenty years was the one Netflix pulled off. They started out as a subscription DVD rental business and evolved into the leader in subscription streaming video. I’ve never seen anything written about whether that was intentional all along or whether they figured it out as the business evolved. It doesn’t really matter, it was a great move in either case.
This move, the “analog to digital”, ought to be more common but I can’t think of many sectors in which it has played out that way.
But we are certainly witnessing another one in the ridesharing sector. If anyone really thinks that ridesharing is a way to get more drivers work, the news this morning that GM has invested $500mm in Lyft and will be strategic partners on “developing a network of self-driving cars that riders can call up on-demand” should put that to rest.
In this case it isn’t DVDs that will go away and replaced by bits. It is the drivers.
How this all plays out is anyone’s guess. But using an analog asset to build a large customer base that can then be leveraged in a native digital model is a great business move and I am surprised it has not been done in more markets over the past couple decades.
It’s easier to predict the medium to long term future. We will be able to tell our cars to take us home after a late night of new year’s partying within a decade. I sat next to a life sciences investor at a dinner a couple months ago who told me cancer will be a curable disease within the next decade. As amazing as these things sound, they are coming and soon.
But what will happen this year that we are now in? That’s a bit trickier. But I will take some shots this morning.
- Oculus will finally ship the Rift in 2016. Games and other VR apps for the Rift will be released. We just learned that the Touch controller won’t ship with the Rift and is delayed until later in 2016. I believe the initial commercial versions of Oculus technology will underwhelm. The technology has been so hyped and it is hard to live up to that. Games will be the strongest early use case, but not everyone is going to want to put on a headset to play a game. I think VR will only reach its true potential when they figure out how to deploy it in a more natural way.
- We will see a new form of wearables take off in 2016. The wrist is not the only place we might want to wear a computer on our bodies. If I had to guess, I would bet on something we wear in or on our ears.
- One of the big four will falter in 2016. My guess is Apple. They did not have a great year in 2015 and I’m thinking that it will get worse in 2016.
- The FAA regulations on the commercial drone industry will turn out to be a boon for the drone sector, legitimizing drone flights for all sorts of use cases and establishing clear rules for what is acceptable and what is not.
- The trend towards publishing inside of social networks (Facebook being the most popular one) will go badly for a number of high profile publishers who won’t be able to monetize as effectively inside social networks and there will be at least one high profile victim of this strategy who will go under as a result.
- Time Warner will spin off its HBO business to create a direct competitor to Netflix and the independent HBO will trade at a higher market cap than the entire Time Warner business did pre spinoff.
- Bitcoin finally finds a killer app with the emergence of Open Bazaar protocol powered zero take rate marketplaces. (note that OB1, an open bazaar powered service, is a USV portfolio company).
- Slack will become so pervasive inside of enterprises that spam will become a problem and third party Slack spam filters will emerge. At the same time, the Slack platform will take off and building Slack bots will become the next big thing in enterprise software.
- Donald Trump will be the Republican nominee and he will attack the tech sector for its support of immigrant labor. As a result the tech sector will line up behind Hillary Clinton who will be elected the first woman President.
- Markdown mania will hit the venture capital sector as VC firms follow Fidelity’s lead and start aggressively taking down the valuations in their portfolios. Crunchbase will start capturing this valuation data and will become a de-facto “yahoo finance” for the startup sector. Employees will realize their options are underwater and will start leaving tech startups in droves.
Some of these predictions border on the ridiculous and that is somewhat intentional. I think there is an element of truth (or at least possibility) in all of them. And I will come back to this list a year from now and review the results.
Best wishes to everyone for a happy and healthy 2016.
Last year in my What Just Happened post, I said:
the social media phase of the Internet ended
I think we can go further than that now and say that sometime in the past year or two the consumer internet/social/mobile gold rush ended.
Look at the top 25 apps in the US:
The top 6 mobile apps and 8 of the top 9 are owned by Facebook and Google. 10 of the top 12 mobile apps are owned by Apple, Facebook, and Google.
There isn’t a single “startup” on that list and the youngest company on that list is Snapchat which is now over four years old.
We are now well into a consolidation phase where the strong are getting stronger and it is harder than ever to build a large consumer user base. It is reminiscent of the late 80s/early 90s after Windows emerged as the dominant desktop environment and Microsoft started to use that dominant market position to move up the stack and take share in all of the important application categories. Apple and Google are doing that now in mobile, along with Facebook which figured out how to be as critical on your phone as your operating system.
I am certain that something will come along, like the Internet did in the mid 90s, to bust up this oligopoly (which is way better than a monopoly). But it is not yet clear what that thing is.
2015 saw some of the candidates for the next big thing underwhelm. VR is having a hard time getting out of the gates. Wearables and IoT have yet to go mainstream. Bitcoin and the Blockchain have yet to give us a killer app. AI/machine learning has great potential but also gives incumbents with large data sets (Facebook and Google) scale advantages over newcomers.
The most exciting things that have happened in tech in 2015 are happening in verticals like transportation, hospitality, education, healthcare, and maybe more than anything else, finance, where the lessons and playbooks of the consumer gold rush are being used with great effectiveness to disrupt incumbents and shake up industries.
The same is true of the enterprise which also had a great year in 2015. Slack, and Dropbox before it, shows how powerful a consumerish approach to the enterprise can be. But there aren’t many broad horizontal plays in the enterprise and verticals seems to be where most of the action was in 2015.
I’m hopeful that 2015 will also go down as the year we buried the Unicorn. The whole notion that getting a billion dollar price tag on your company was something necessary to matter, to be able to recruit, to be able to get press, etc, etc, is worshiping a false god. And we all know what happens to those who do that.
As I look back over 2014 and 2015, I feel like these two years were an inflection point, where the underlying fundamentals of opportunity in tech slowed down but the capital rushing to get invested in tech did not. That resulted in the Unicorn phase, which if it indeed is over, will be followed by an unwinding phase where the capital flows will need to line up more tightly to the opportunity curve.
I’m now moving into “What Will Happen” which is for tomorrow, so I will end this post now by saying goodbye to 2015 and hopefully to much of the nonsense that came with it.
I did not touch on the many important things that happened outside of tech in 2015, like the rise of terrorism in the western world, and the reaction of the body politic to it, particularly here in the US with the 2016 Presidential campaign getting into full swing. That certainly touches the world of tech and will touch it even more in the future. Again, something to talk about tomorrow.
I wish everyone a happy and healthy new year and we will talk about the future, not the past, tomorrow.
I’ll do the same tomorrow and friday, but today I’d like to talk about What Didn’t Happen, specifically which of my predictions in What Is Going To Happen did not come to be.
- I said that the big companies that were started in the second half of the last decade (Uber, Airbnb, Dropbox, etc) would start going public in 2015. That did not happen. Not one of them has even filed confidentially (to my knowledge). This is personally disappointing to me. I realize that every company should decide how and when and if they want to go public. But I believe the entire startup sector would benefit a lot from seeing where these big companies will trade as public companies. The VC backed companies that were started in the latter half of that last decade that did go public in 2015, like Square, Box, and Etsy (where I am on the board) trade at 2.5x to 5x revenues, a far cry from what companies get financed at in the late stage private markets. As long as the biggest venture backed companies stay private, this dichotomy in valuations may well persist and that’s unfortunate in my view.
- I said that we would see the big Chinese consumer electronics company Xiaomi come to the US. That also did not happen, although Xiaomi has expanded its business outside of China and I think they will enter the US at some point. I have a Xiaomi TV in my home office and it is a really good product.
- I predicted that asian messengers like WeChat and Line would make strong gains in the US messenger market. That most certainly did not happen. The only third party messengers (not texting apps) that seem to have taken off in the US are Facebook Messenger, WhatsApp and our portfolio company Kik. Here’s a shot of the app store a couple days after the kids got new phones for Christmas.
- I said that the Republicans and Democrats would find common ground on challenging issues that impact the tech/startup sector like immigration and net neutrality. That most certainly did not happen and the two parties are as far apart as ever and now we are in an election year where nothing will get done.
So I got four out of eleven dead wrong.
Here’s what I got right:
- VR has hit headwinds. Oculus still has not shipped the Rift (which I predicted) and I think we will see less consumer adoption than many think when it does ship. I’m not long term bearish on VR but I think the early implementations will disappoint.
- The Apple Watch was a flop. This is the one I took the most heat on. So I feel a bit vindicated on this point. Interestingly another device you wear on your wrist, the Fitbit, was the real story in wearables in 2015. In full disclosure own a lot of Fitbit stock via my friends at Foundry.
- Enterprise and Security were hot in 2015. They will continue to be hot in 2016 and as far as this eye can see.
- There was a flight to safety in 2015 and big tech (Google, Apple, Facebook, Amazon) are the new blue chips. Amazon was up ~125% in 2015. Google (which I own a lot of) was up ~50% in 2015. Facebook was up ~30% in 2015. Only Apple among the big four was down in 2015 and barely so. Oil on the other hand, was down something like 30% in 2015 and gold was down something like 15-20% in 2015.
Here’s what is less clear:
- Bitcoin had a big comeback in 2015. If you look at the price of Bitcoin as one measure, it was up almost 40% in 2015. However, we still have not see the “real decentralized applications” of Bitcoin and its blockchain emerge, as I predicted a year ago, so I’m not entirely sure what to make of this one. And to make matters worse, we now seem to be in a phase where investors believe you can have blockchain without Bitcoin, which to my mind is nonsense.
- Healthcare is, slowly, emerging as the next big sector to be disrupted by tech. The “trifecta” I predict will usher in an entirely new healthcare system (smartphone becomes the EMR, p2p medicine, and a market economy in healthcare) has not yet arrived in full force. But it will. It’s only a matter and question of when.
So, I feel like I hit .500 for the year. Not bad, but not particularly impressive either. But when you are investing, batting .500 is great because you can double down on your winners and stop out your losers. That’s why it is important to have a point of view, ideally one that is not shared by others, and to put money where your mouth is.
For the second year in a row, USV did an event in Berlin in November and invited entrepreneurs to attend a moderated discussion. Our friends at Tech Open help us produce these events.
This year the USV partners who were able to attend this event were Brad, Albert, and John. The conversation was moderated by Ciaran O’Leary, who is one of our favorite VC co-investors in Europe.
Here’s the video of that moderated discussion. It’s long, at almost one hour, so you might want to chromecast this one to your TV and watch “on background.”
Having a mantra for your work is helpful.
Mine is “the VC’s job is to help entrepreneurs realize their goals and dreams.”
That doesn’t mean that every VC should have that same mantra.
To each his or her own.
But the longer I work in VC, the more I see misalignment between investors and founders.
And misalignment gets in the way of getting somewhere.