Sometimes You Just Have To Walk Away

The title of this post is a line in a Damon Gough (aka Badly Drawn Boy) song that I heard on my bike ride this morning. You can click on the black banner at the bottom of the screen and hear it play while you read this.

And it took me back to an email exchange that I’ve been having this week with some friends about "breakage" in a venture capital portfolio. Tim (Connors I assume) from USVP left this comment on my blog the other day:

i was at the ycombinator event yesterday and i think PG said they have
had 102 companies through and 14 so far have been series A funded by VCs

I was surprised that the number of VC funded YC companies was so low and forwarded the comment via email to some friends in the VC business with the following comment:

I would have thought it would be much higher

To which I got back a bunch of comments about "breakage", meaning companies that don’t make it. Early stage venture portfolios should have a decent rate of failure, and the earlier the portfolio, the higher the rate should be.

I’ve said a bunch of times on this blog that I think an early stage venture portfolio should have 1/3 failures, 1/3 money back situations, and 1/3 that deliver the returns the VC expected when the investment was made.

But that hasn’t been the case in the USV 2004 portfolio so far. We are done putting new names in that portfolio and have made a total of 21 investments. We’ve sold three companies to date, leaving 18 active portfolio companies. And to date, we have not written off a single investment. That realization prompted me to make this turn in the email discussion:

No writeoffs yet after four years

But then, that was true for flatiron from 1996 to early 2000

And then we had breakage non-stop for two years

Flatiron had 59 portfolio companies and we eventually wrote off 20 of them without getting anything material out of them. That’s one of the places I get the 1/3 failure rate from but not the only one.

But the thing of it is, we had made every single one of those 59 investments before we wrote off a single investment. From 1996 to early 2000, we had a run where we had 17 exits and no writeoffs. We went into the market meltdown with a portfolio of 42 companies (we’d exited 17) and over the next two years we wrote off 20 of them. The remaining 22 companies are almost all realized now and about half of them have been money back situations and about half have been big winners.

The 1996 to 2008 time period is not a totally normal period to be making any conclusions from, but it’s interesting to go back and look at this data anyway.

One thing is clear to me and it was stated by my friend John Borthwick in his reply to my email from above:

From what i see the VC model doesn’t offer a lot of visibility into failure until there is an external forcing event, the tendency to get someone else to invest and plug an existing investment w/ their dollars can blur what is in fact failure

That is true. The forcing function is usually a bad market when nobody wants to write a check. Then the existing investors are forced to look hard at each other and decide if they want to keep investing. And then, if the company is really not making good progress, the answer is usually no.

I don’t know if we are getting to that point yet in this cycle, but my bet is we are getting closer. It will be interesting to revist this post in a year.

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Comments (Archived):

  1. Jeremy Bencken

    This is why published returns for VC funds that are still mid-cycle (like those from the Univ of Texas) are so misleading. But it doesn’t stop reporters from getting a good headline at the expense of funds.

  2. aarondelcohen

    Also, as I understand it, Ycombo companies are getting heavily funded by angels and some by companies like Betaworks. One question we have to ask is are Ycombo companies ready for instiutional investment? If not, is that a bad thing if the angel market takes on this early level of interest?Another question, might be should the funds with 100mm to 250mm increase the number of companies they want to invest in and do more $1-2mm investments because the cost of launching companies has decreased?Aaron

    1. aweissman

      if they are not ready for “institutional investments” I would say its definitely not a bad thing that the angel, or any other, market takes on interest

    2. Andy Freeman

      Organizations have a cost structure that limits the deals that they can do.Consider our host. He has 24 hours/day. To handle 2x as many companies as he does today, he has to do some combination of spend less time per company and spend less time doing other things.Also, relative return (5x vs 10x) isn’t the only consideration – absolute return also matters. For example, he can’t afford to make 1000 $1 investments even if they all return $1000 one later.

  3. Ed

    Thank you for the insight, and globally cerebral nature of this post.Despite the moderate word count, you very much joinedreaders, indeed participants, to the broader discussion.Both in that dialog in your head, and in the emails. Appreciated.[And the song was definitely round peg-round hole] √+

    1. fredwilson


  4. terra210

    Do you think this down-trending market cycle, and the failing of so many financial institutions, (which seems to be continuing), is worse than other down cycles in the past? Do you worry it may come to a point where investors will start pulling their funds from investments they have made, and no new investing will be done? Or is there enough liquidity to ride out this storm, (for your investors and those who fund start-ups), and continue?I am not sure if this question can be answered, but your post made me realize that your sector might also be impacted, which for some reason, I had thought not.

    1. fredwilson

      I think our sector will be impacted but I also think that most investors inventure funds have the liquidity to make their capital commitments to thefunds easily

  5. RAGZ

    Hi Fred, nice to see you @ the TechStars shindig. I’d be worried if I was amongst your remaining portfolio companies after reading this post. To me, it foretells pending doom for 1/3 of them. That’s just my reaction.From my observation (I’m only 28, but I think I know everything), the first movement in a fund comes from the quick sales, like Reddit or SocialThing.The second movement will be trimming of the fat, as it presents itself, and it has to be the toughest part of your job. Saying “no” to a deal is not hard when you get thousands each week. Saying “no” to any of the carefully selected portfolio companies has far reaching implications into your own self-assessment as a qualified investor, and not just those that trusted you with their money. Oftentimes a start-up has to invest two to three years of development before launching any regular operations. Then its another year or two to see if it works. A lot of people have invested time, energy, and money into the success of the company, and nobody wants to see failure. I liked your comments on Tech Crunch’s “Dead Pool” that I read on “The Deal”. People invest their souls into these companies to solve their customers problems, your problems. If someone makes their failure a public spectacle, that someone reveals absolute shit for their own character.…The third and final movements are the big and highly publicized exits that build your reputation as a VC, thus securing contributions from contributors to your next fund.I aspire to be a VC one day, but I’m also apprehensive of the responsibility.

    1. fredwilson

      i am not saying that we will “walk away” from 1/3 of our portfolio. i sure hope we can deliver a fund with no writeoffs. it’s been done before. there was a biotech fund in san diego in the early 90s called Biovest,, that did something like 10 seed stage deals and every one of them worked brilliantly.

      1. RAGZ

        I wish you luck, but honestly, I think you make your own.

  6. Michael Masnick

    Hey Fred,On the issue of VCs finding “someone else to invest,” I recently wrote about one firm that seems to be the “go to” place for some top name valley VCs:…So it may actually be reaching that “bad market” position…

    1. fredwilson

      it’s weird. i’ve never heard of that firm.

  7. Paul Graham

    It’s really 14 out of 80. You can’t count the current batch, because they’ve just started talking to investors. Plus (a) several of the remaining 66 probably will raise series A rounds in the future, and (b) there are certainly more that could have but either got acquired (Reddit, Omnisio) or made it to profitability on angel money (Wufoo, Bountii).

    1. tweetip

      For us of the fringe, the success of bountii (maybe wufoo) just became an indicator for consumers addicted to stuff loosing their buying power, so they’re buying really bad stuff like an ipod speaker system which fits in a bike water bottle cage (*). Seriously – just stop mfg’ing & funding – and do not bring this shit to moab unless it’s during halloween. Preferred – sing your own voice, chant, rhythm …(*)

  8. davemc500hats

    Fred: this statement is most relevant: “The 1996 to 2008 time period is not a totally normal period to be making any conclusions from”and John Borthwick’s comment is on target… however the realization of that statement should prompt some folks to do some more work on creating better short: my belief is that most VCs & entrepreneurs are mostly incompetent (= fucking clueless) about metrics and how they evaluate progress between the “mark to market” moments of infrequent financing.a MUCH better way to understand whether your companies are working or not is to have a more consistently applied method of internal metrics for the progression of customer interaction with the website / application / business.(and in any case, this is the philosophy i’ve been working on more rigorously over the past year with the companies i’ve been investing in… also with the conference i’m putting together).

    1. Nate Westheimer

      Dave, I’m with you. The single biggest thing this market could use is the normalization and rationalization of metrics. I started trying to do this a few years back here…. but I need more help gathering data. Maybe you could rally the metrics-troops (pirates?) to tackle this…

  9. Nate Westheimer

    Fred, great post. I wonder if regional funds, vs sector-oriented funds, have similar trends when a bad market hits. In a flattening world, perhaps regional is the way to go (as it becomes increasingly random what companies are started where).

  10. Marc Brandsma

    This forcing function stuff is weird. It implies that VCs do look at their portfolio with pink glasses before it happens (as seems the case with Flatiron) and then turn all negative. This reminds of well documented market behavior (self consistency, over confidence, aso.).What if there is no forcing function? Are VCs going to keep their portfolio alive up until the last moment when liquidating the fund becomes mandatory?Is this “batch strategy” (it’s either all good or all bad) having an impact on returns? There must be dogs that are kept alive in good times, burning money and reducing directly and indirectly the future returns. There must be unrealized yet potential companies that are written off in bad times, directly reducing the returns.In theory, the portfolio should follow some kind of normal distribution over the life of the fund. It would be great if academics (Steve Kaplan @ Chicago GSB) could have access to portfolio data from funds and get back with market evidence that VCs are not different from other investors.

  11. shareme

    Maybe I am miss understanding th detail. I was sure PG stated that out of 104 companies only less than 5 were write offs or did I get that detail wrong?

  12. Don Jones

    As Warren Buffet likes to say, (paraphrasing) “When the tides goes out, you see who is swimming without any trunks on…”The ‘forcing event’ is here and the credit crunch is beginning to hit us now. 2009 is not going to be fun.Sorry for the 🙁

    1. RAGZ

      I disagree with your correlation. Venture Capital and CDO’s are not the same markets. People hit most by the credit crunch are not venture capitalists. That is for damned sure. I talk to angels and vc’s on a daily basis, and not one of them is selling the yacht, or mansion, because they didn’t take on home mortgages, car, or student loans they couldn’t afford to finance.However, the true source of innovation and value, entrepreneurs risking all they are worth, are already being affected by the credit crisis. The short-term effect has been less deals getting done. i think it is because broke entrepreneurs can’t finance themselves long enough to even get to an angel round. I also blame the downturn in VC spending on some of their stupid investments made while chasing the “anything social must be worth lot’s of money” fad for the last two or three years.The solutions are already here too. TechStars and Ycombinator offer seed incubation that startups need and very personal mentoring from experienced investors, effectively bridging the gap to funding that may or may not be created from the credit crisis.I see other incubators popping up in tech news everywhere, so there is definitely something to this approach, and kudos to those that moved on the incubation opportunity first.

      1. Don Jones

        I didn’t say that the credit crunch was directly hitting VCs – it is hitting their portfolio companies that rely on ad spending, it is hitting other companies relying on IT spending.TechStars and YC may end up doing great things, but the incubators of past years have failed. I’d like to see a company that has come out of these incubators that has gone on to create a large and compelling operating business with profits…

        1. RAGZ

          I can agree with most of your first part.Your second part is out of character as “Don Jones, from Venture Deal”. You’re supposed to be concerned with venture deals, right? I’m not attacking you, either. I just don’t understand why you mentioned sustainable, scaled, large, or operable business models as your TechStars and Ycombinator success metrics. It’s not that I disagree with you, it’s that I see a lot of bling-bling deal headlines, a la TechCrunch, on Venture Deals. I don’t see anything that reads, “nice, ho-hum, slow, and steady growth for ‘X’ company!”I actually agree with your metrics as a good assessment. I just think it sounds way out of character as “Don Jones, from Venture Deal”.