Doriot Quote Of The Day
The riskiest part of the spectrum has to date proved the most rewarding, and the greatest capital gains have been earned in companies which were started from scratch.
Doriot, in a 1960 talk to the Chicago Society of Security Analysts, titled “Creative Capital”
This has been our experience too. It’s not just the lower valuations you get at the formation stage, but it’s also that you are working from a blank slate with respect to everything and you can work with the founding team to form the culture, the strategy, the team, etc. Buying into companies that have done several rounds has always been a lot harder for me.
So why do some many investors move up the value chain investing larger amounts at later stages or moving onto MBOs? You do not see many private equity companies in this space. But it is the space to be – where it all happens with people and dreams.
Its about money. Let’s say we own 20pcnt of a company and we have to invest 5mm over five years to get to an exit. Let’s say that exit is 250mm. That’s 50mm of value for 5mm of investment or 10x. The partners in the firm get 20pcnt of 45mm or 9mmLet’s say you buy a company for 100mm. And then you sell it three years later for 200mm. That’s 2x but a 100mm gain. The partners in the firm get 20pcnt of 100mm or 20mmMore money in less timeEarly stage investing is largely done by people who value the adventure as much or more than the moneyFred
Amen, brother Fred.I think one of the big challenges facing early stage VC these days is that there are too many (a majority) of VCs who “don’t value the adventure as much or more than the money”
What is implied here, but never said out loud is the vice versa:If you lose everything in case A, your loss is $5M, and in case B is $100M. Except that the manager’s loss in both cases is nominal, it’s not their money and they still get the fees. So the incentive for the VC is to get a big fund (more fees), invest in bigger deals and if they pan out, get a better payout. The LP, however cares about the IRR; for the LP case A is much better – major disconnect. I guess, some people care about reputation and long term standing with the LP…That’s the situation with many financial vehicles, not just VCs. Hedge funds, LBOs, etc. This asymetry between the manager and the LP in positive and negative outcomes is a big problem, in my view.Your modus of raising small funds and investing in early deals is very admirable, should make your LPs quite happy. Hopefully it works for you in the long run. The others, as they say “pigs get slaughtered”, unfortunately not without doing damage to pension funds, college endowments, etc…
That’s a fantastic point, Fred.
Not to mention that to some degree the ability to raise larger funds is seen as a badge of success, and as funds get bigger investment size tends to follow.Do VC firms typically charge base fees on committed funds? In the infra/PE space that’s certainly an incentive to raise larger funds — more low-risk annuity income.
Might add to “started from scratch” the observation that the greatest capital gains also seem to come from companies with key players in search of passion and meaning.Thanks for the posts… seriously great music taste, and pearls of wisdom in an industry I’m enchanted with. Everything you need from a blog, but were afraid to hope for.Mike http://www.nolanonline.com
Well thanks. I appreciate the comments, particularly about the music
Fred, you’re an Angel Investor in VC clothing…
Taking your early-stage standpoint a bit further, one would arrive at an “incubator” which combines capital with operational teams under one roof. Do you have any insights why incubators (such as CMGI and IdeaLab) were considered to be such big flameouts last time around? In answering my own question, it seems like the did not keep the operational costs of their incubated “hatchlings” under tight control. As I recall, places like CMGI tended to follow the “get big quick” mantra and spent accordingly.
Companies need to be selfish and do what is in their best interestsIncubators get in the way of that with their notion of shared space,resources, etc
Yes, this opinion is consistent with what you wrote about not forcing cross-leverging across portfolio companies. Do you feel your assessment of also applies to next generation incubators like Y-Combinator.
Fred, off topic, but do you take questions, or suggestions for a blog post? If so let me know how to submit one.Thanks Guy
Just leave it in the comments and I’ll see it
here’s one:I would really like to hear your views on what should be done with GWBush and his gang next year, in light of McClellan confirming what everyone knew. Is it good for the country to dig into this and put some of these crooks behind bars (Rove, maybe Cheney, Bush?) or should we move on and let this thing in the past…
That’s why I prefer to take over companies from scratch!