Investing In Thick and Thin
A few weeks ago at Le Web, I participated on a panel made up of VC investors. There was a really good discussion about what next year holds for venture investing.
The moderator Ouriel asked if we would be cutting back our investing in 2009 and I replied that we did not plan on doing that
I went on to explain that the venture business is very cyclical and that I’ve seen at least three and possibly four cycles in the 22 years I’ve been in the venture business. But I don’t feel that its possible, or wise, or prudent to attempt to time these cycles
Our approach is to manage a modest amount of capital (in our case less than $300 million across two active funds) and deploy it at roughly $40 million per year, year in and year out no matter what part of the cycle we are in
That way we’ll be putting out money at the top of the market but also at the bottom of the market and also on the way up and the way down. The valuations we pay will average themselves out and this averaging allows us to invest in the underlying value creation process and not in the market per se
Eric Archambeau of Wellington Partners was on the panel and he described some research work he and some associates did a while back. They went back to the 1970s and charted for each year through the late 1990s the number of venture backed companies started that year and the number of $1bn revenue companies and $500mm to $1bn revenue companies that emerged in each ‘vintage year’. The result of that work, he explained, was that the number in each category was relatively constant year after year with no discernable pattern and certainly not correlated with or against market or economic cycles. Interestingly, the data was not correlated with innovation and technology cycles either
This says to me that, like the lottery, "you got to be in it to win it" and staying on the sidelines is not a wise approach in any market environment
Mike Moritz was quoted in an SF Gate piece today making a similar point (which inspired this post and its title). He said:
"We’ve always invested through thick and thin. In fact, we prefer to invest in thin"
It is easier to invest in thin times. The difficult business climate starts to separate the wheat from the chaff and the strong companies are revealed. With many investors on the sidelines (particularly corporate buyers/investors and ‘momentum’ investors like hedge funds and the like), there is less competition to invest in these ‘winners’ and the prevailing valuation environment means you get more equity for your dollar invested. That’s quite a recipe for success.
But its not a lot of fun to be operating in the ‘thin times’ even as an investor. Most good firms have a portfolio full of companies that will be struggling to stay afloat and the VCs will spend more time working with their companies in this environment. And when we get an opportunity to put more capital to work in a portfolio company we know and love in this kind of market, well that is often the best investment of all. Note that SF Gate piece mentions that Sequoia just led a big new round in AdMob which if I am not mistaken is an existing Sequoia portfolio company that is a top mobile ad company. Look for more of that sort of thing in this market.
As I’ve written here recently, I see no signs that the venture market is drying up. Its changing, for sure, and if you aren’t running a company that’s emerging as a clear winner, its going to be tough to raise money in 2009 from anyone other than your existing investors. And look for them to be more cautious, more diligent, and less generous than they may have been in the past few years.
There’s money out there in venture land and its going to get invested in 2009 and its going to get invested wisely for the most part. At least that’s our plan and I’m confident we can execute on it.
Its here for the taking. Anyone can reuse this piece without my consent as long as they adhere to my creative commons license
As the CEO of a bootstrapped company, You2Gov, I find this reflecting what I have been hearing. My company launched in July 2008, by lots of hard work, focused early money spending and cutting edge technology. We have already seen “competitors” fall by the wayside. I for one, would prefer to be growing my company in the “thin” times, so that as the company grows and matures, when the “thick” times hit, my company is right in the middle of the thicket.Thanks for the insight and reasonable points. I wonder how long till the Mainstream Business press picks up on your take?Alan W. SilberbergCEOYou2Govhttp://www.you2gov.org
I agree that discipline and consistency are essential for successful investing (albeit, while such offers no guarantee of success, it does reduce the risk of failure.)Of course, there’s always the issue of knowing when to stop/quit/change, as Seth Godin has written about at length (e.g. in his book, The Dip>)One cautionary note to entreprepreneurs and founder and startup teams — its worth bearing in mind that when venture investors talk about how “the prevailing valuation environment means you get more equity for your dollar invested” and how “That’s quite a recipe for success.”, you should boost the power to your radar a little. There is only 100% of company to sell. So for a venture to “get more equity for [their] dollar”, the common shareholders — you, founders/entrepreneurs/teams — have to end up with less. Less than you would have ended up with in a less stressed environment.This doesn’t men you should or should do any particular deal. Only that its just as important for common shareholders “get more equity for [their] dollar” — their dollar of sweat, or of foregone short term cash compensation or whatever…As an aside, it doesn’t have to be this way — why can’t commonshareholders get a fixed percentage of the exit, after preferred shareholders are fairly compensated for their capital and risk. After all, this is how GPs in venture funds get “upside” (after their LPs receive fair compnesation for their risk and capital). Oh, I know; I’m dreaming again…
It’s just the basic idea of the cost of capital – it costs investors more to take a risk on a company in a challenging environment, because that capital is inherently more difficult to come by (even if it’s already been in a pre-recession fund). Thus, the costs are higher for those looking for funding and this is amplified during times like this. Fred’s post is very relevant and true for any type of value investor in different cycles. I’m curious, though, what performance has been like for many funds looking to increase investments in thin times. As an economist, I can tell you the data does not reflect what one would think. As an investor, I really hope previous trends are evolving.
Yeah, I wrote that on my bberry after sleeping to 9am, going to the gym, and enjoying a relaxing cappucino in the hotel while waiting for the rest of my family to wake up
It is lucky for startups to work with VC lik Fred
totally agree…i was at a networking event here in socal, and spoke with a “seed” stage vc, who essentially told me, “well, in this economy, it’s very hard for me to invest in seed stage companies when for the same amount of money, i can invest in a company that is generating half a million to two million in revenue at the same valuation at a much lower risk” for days this sat in the back of my head, but i couldn’t quite pinpoint what bugged me about it, because it generally made sense. but then as i thought about it more, if you follow that thought to it’s logical conclusion, the guy might as well put his money in t-bills instead of investing in startups, it would be a lot less risk, that’s for sure. and at the end of the day, isn’t the whole point of a vc to invest in risky startups? and if you’re a self-proclaimed seed stage VC, shouldn’t you, by definition, be investing in seed stage companies? isn’t that what you sold your LPs on in the first place? to me, that type of thinking is very typical herd mentality, and i’d much rather be working with VCs who focus on what is possible rather than what is safe, because, afterall, that seems like what the startup game is all about, isn’t it? so it’s very encouraging to read that you have a much longer term perspective that seems much more aligned with the startup ethos.
The problem with most seed stage investors is they don’t have large enough funds to invest in the whole lifecycle of the company. That makes it much harder for them to be consistently in the market because in times like this you’ll need to do several rounds at least before you can be sure of what you have. I think seed funds without follow-on capacity are a bull market play and can’t really work in bear marketsOur fund is a ‘lifecycle of the company’ structure and we often start at the seed stage, generally about half of our investments start there
I beleive this is the best time for VC’s for number of reasons…..one…as you mentioned you get more for your dollar …two…you can easily spot the running horse from the marching crowd….three….when seed funders shy away there is a huge pool of start-ups you can choose from…..four ….spending (control the spending) of the start-ups are easy pointing the meldown as the reason….five….inherently the spending of the start-ups are going to be less because u get good work-force for lesser dollar…..six…..start-ups don’t do any business for atleast 1-2 years and when they start doing business u have a new world (most probably a better one than this)….seven…..you will have lots of good tech companies which are running out of gas….put gallon of gas and you get 100miles/galGood luck with 2009.