Pacing Yourself

I've been pretty clear as of late that I think the market for investing in web startups is getting overheated. When I talk to some people about this, they say "you should shut down and ride out the bubble on the beach." To which I say "we don't think we can time markets."

If you had a crystal ball, then doubling down when the market is ice cold and folding your hand when the market is white hot would be a great investment strategy. But nobody has a crystal ball and timing markets is a lot harder than it seems.

So I prefer to focus on pacing ourselves. What I like to say is "we should add the same number of names each year to our portfolio and put out about the same amount of cash each year." The number we try to add each year is 6-8 new portfolio companies. USV has been investing since November 2004 so we've been in business exactly six years. And we will have 37 portfolio companies soon. So that is almost exactly 6 new investments per year. We had 31 portfolio companies at year end 2009, so we've added 6 new names this year.

I don't have the cash outlay numbers handy this sunday morning but I do know that it took us four years to put the 2004 fund to work. And or current forecasts are that it will take us four years to put the 2008 fund to work. So that's a good proxy for cash outlay per year.

This strategy works particularly well in the venture capital business because we generally will make three to four investments in each company, spread out over a five to six year period. So no one investment at a "bubble valuation" will impact our average valuations across our portfolio. Said another way, we will invest in 20 to 25 companies per fund and we will have three to four investments in each company, so we will make 60 to 100 individual investments in any fund. If we spread those 60 to 100 investments over a six to eight year period, we can average out the valuation spikes and valleys.

I observed this strategy at work in the first VC firm I worked for. The partners had been investing for fifteen years when I showed up and they had evolved into this strategy and taught it to me. When I left that firm and started Flatiron Partners in 1996, Jerry and I started out with a reasonable and steady pace. It took us about three years to put our first $150mm fund to work. But when we got our second fund of $350mm in 1999, we adopted a different approach. The first mistake was to raise a much bigger fund just as the market was getting overheated. The second mistake was to put that fund to work in 18 months. We went from putting out $50mm per year to putting out $250mm per year, just as the bubble was reaching its peak. The results speak for themselves. We made greater than 5x on that first fund. Eleven years later, we will be lucky to make 2x on the $350mm second fund.

So when I look at where we are right now, it reminds me so much of 1999 and frankly it scares me. But we are not pulling back. We are sticking with our investment strategy and putting out cash and adding new names to our portfolio. But we are doing it with a very close eye on pace, both in terms of names and cash outlays. I think that is the right approach and that it will serve us well as we navigate the tricky waters we find ourselves in.

#VC & Technology

Comments (Archived):

  1. Matt A. Myers

    ‘When I talk to some people about this, they say “you should shut down and ride out the bubble on the beach.” To which I say “we don’t think we can time markets.”‘If you’re following the crowd then “riding the bubble on the beach” is safe advice, but if you’re good at understanding where things are going and you’re looking based on your own theories then the perceived state of the market doesn’t matter. When an opportunity arises to invest in such a company than that company’s idea won’t really be affected or influenced by the markets directly to begin with – or not in the same way – because it’ll be something disruptive or something completely new.

    1. Dave Pinsen

      You still have the valuation issue to consider (see Harry DeMott’s and Fred’s comments): the same company will offer a much better balance of risk & reward, all things equal, if you can buy it at X, rather than 2X.

      1. Matt A. Myers

        Thanks for pointing out their comments. Important to point out there are the intangibles.My further thoughts are making me think back to the ideas of “working for a salary” as a motivational drive, and return on investment for everyone.From a personal productivity sense, getting $2 million versus $1 million, I will be more wasteful – I will try to do too much as once, maybe they will be things I need to do but can will do in the future – but it will give me more to handle, and unknown if that quantity is manageable, and if not then more waste can ensue.From an investor’s point of view for following rounds, turning $1 million into a company worth $20 million versus turning $2 million into a $20 million is much more impressive. I guess it depends on your confidence level that you can achieve what you want and that your ideas are good enough. Execution is important but the investor will hopefully make sure that part is done as best possible (obviously including their judgement of the entrepreneur or team’s abilities).There’s still the risk that you maybe need that other $1 million to reach the next milestones – but that shouldn’t happen if you’ve thought through the plans enough for where you need to get to.Initially, I thought I’d need $X amount to reach a certain point, but as I’ve been planning things in fairly good detail of where things will be going I realized that I need much much less, mostly dealing with anxieties for unknowns by making them knowns and creating a much more clear path for myself and my busyness.

  2. Harry DeMott

    I worked at a hedge fund where the portfolio manager would simply go to cash and ride out the storm. He wouldn’t completely stop investing – but the bar to p[ry the cash out of his hand went up significantly.It is all about risk and reward – what you are saying is that you feel that the market today – price wise – represents more risks than rewards. And my guess is that you have likely seen companies that you liked at a price – only to see them go to others at 2-5X that price.What is great about the VC business is that there are always new and fresh ideas coming to the market – and so over time you find the right companies at the right price – you just do that less at a time like this – and perhaps take bigger positions in the existing portfolio.One question: when you do make an early stage investment – say $1M – how much do you mentally reserve for future rounds?

    1. fredwilson

      we’d like to put $10mm into our best companiesand limit our investment in our weakest investments to $3mmso we’ll initially reserve $9mm on a $1mm investmentbut we’ll adjust our reserves on each investment as the opportunity reveals itself to usand yes we lost a deal this week at >2x the price we initially offered, which was in my opinion a very good price

      1. Harry DeMott

        Just my opinion – so take it for what it is worth:The frenzy these days in VC funding presents some unique opportunities andchallenges. When you lose a deal at >2X the price you were willing to pay,what that says to me is that the founders of that company were more focusedon initial dilution than they were on the partner they were going to thedance with. Now I don’t know who you lost it to – or why – but my suspicionis that it was more over price than other intangibles. So the question youhave to ask yourselves as a partnership is how do we not lose deals overprice – and how do we offer more to a founder than just the $ – because ifit is just the $, then you commoditize yourselves.I truly believe that the next frontier in venture investing will be VC’s whocan offer a lot more than $ – and the deal structures might start lookingdifferently and more creative. If, say, a new company has a service thatrelies heavily on Twitter – you might invest at a price – but takeadditional economics to buy down that price if you can help them get apartnership with Twitter going. Even better, perhaps there will be dealswhere the VC’s can accelerate the move to a cash flow positive position forthe company – making the next round far less expensive for the company – orobviating the need for it at all.This is the great and terrible thing about the internet – it is a flattenerin every industry. VC’s were once harder to find and get to and the internetcourtesy of social media tools and programs like angel list make it fareasier to send your pitch out to 100’s of investors at once. This in turnleads to higher prices and lower returns – the flattening part of thediscussion.The question is always – how do you build your competitive advantage back upso that even in tougher markets you still retain the ability to invest incompanies you like at a risk/reward profile that you think is fair.

        1. Matt A. Myers

          “I truly believe that the next frontier in venture investing will be VC’s who can offer a lot more than $”The problem, I’m not sure how much you can guarantee other intangible offerings.” – and the deal structures might start looking differently and more creative.”I’d love to hear some brainstormed ideas on this. I don’t have the experience to have any creative or intangibles, that can be put into a contract that can hold true under all circumstances to their initial good faith of being included in the deal.The only obvious things I can see as intangible decision factors is how much support do you think you’ll get, and do you like what you see happening with the investor’s portfolio companies – does the money their raising fit into your own beliefs and valuations for where those companies are headed and currently valued (based on the landscape of competition and strength and quality of execution seen).

          1. Harry DeMott

            They way I figure it is that every company that is started needs certainthings to succeed.In some cases it is users, in others it is specific partnerships, and in allcases it is getting to cash flow break even as quickly as possible.You can come up with any valuation you want in the early days – but unlessyou start generating cash – you are going to be at the mercy of those with $to invest.So, if a VC is quite certain they can provide certain value to a specificcompany – then I could see a deal that says, I will invest $1M at a $4M premoney valuation – for a 20% position – but I want warrants for anincremental 10% of the company, if I am able to line up the partnership youneed – or directly bring you revenue that gets you to cash flow break even.If the VC is unsuccessful, then they have paid the higher price – and ifthey are successful the VC will have bought in at a $2M pre money valuation- but the founder will have gotten far further ahead this way – than bysimply taking the highest bid out there.

          2. Evan

            getting that into an enforceable contract sounds tough, but it’s interesting to think about.

          3. Dave W Baldwin

            Interesting Harry.

          4. JoshGrot

            Doesn’t this talk about VC added value pre-suppose that VC’s will have the time to add the value they promise?One of the questions I have is whether the increasing number of companies some of the emergent Super Angels’s are backing can even be appropriately “serviced” by the VC/Angel? I.e., is the company/partner ratio growing so big due to the increased number of seed investments and the concomitant lack of exits that the Angel/VC partner can no longer provide the attention portfolio companies need?This may be less of an issues with VC’s vs. Angels. However even in Fred’s original post, he alludes to the fact that USV will have 37 portfolio companies by YE 2010; adding 6 to 8 more in 2011 would bring the total to 43-45. And while I don’t know whether that amount includes exited or to-be-exited companies, it seems like an awful lot for 3 partners to handle effectively (without driving themselves crazy).Net, net — doesn’t all of this investment activity beg the question of the Angel/VC partner’s effective portfolio company capacity threshold?

          5. fredwilson

            Hi Joshwe have exited or wound down five companies and partially exited anotherso we have 31 active companiesof those, about 10 are profitable and well run and don’t take a lot ofour time anymoreso we have about 7 deals per partner that require the kind of effortan entrepreneur would care aboutwe believe that we are now at a steady state where about the samenumber of companies reach “maturity” every year as we add to theportfoliogreat question thoughthanks for asking it

        2. fredwilson

          yeah, i thought we brought a lot more than $$but i guess not

          1. RichardF

            You do bring way more than $$ Fred. The marketing that you do via AVC alone brings enormous value.From your comments it does appear that you are regretting the loss, it’s tantalising not to know more, which obviously you cannot reveal. However I’m a big believer in gut instinct and if 2x was too much for USV then I’d be willing to bet that whoever the company is, it is not the next Zynga or Twitter.

          2. Matt A. Myers

            That’s impossible to know. They might be copying or following and know the same metrics that USV follows. But they likely won’t execute as well because they don’t have the same experience, or not execute as cheaply and as efficiently.

          3. Harry DeMott

            When you look at the firm you lost to – do you impartially think that theysold themselves and their partnership as a real value added partner, or doyou think it really came down to pure valuation?If the former, then I guess you ask yourself how do you change your pitch incompetitive situationsIf the latter – then perhaps investing in founders that can’t think morethan one move ahead is not the greatest thing anyway.

          4. Evan

            don’t most VCs think of themselves as a value added partner? I have yet to meet many successful people who underestimate themselves.

          5. Harry DeMott

            There’s a fundamental difference between thinking you are value addedand actually getting the job done or willing to bet in your skills.I agree that I’ve yet to see a VC that doesn’t believe they are valueadded and I’ve yet to meet a founder that doesn’t believe that theywere the prime movers.Harry DeMott917-439-6600

          6. Evan

            Harry, your phone number is on this comment…not sure if you really want it on there (default sig?), although I might call you…You asked Fred if his competitor sold themself as value-added. Maybe I’m wrong/naive, I just find it hard to believe that his competitor didn’t sell themself as value add.

          7. Harry DeMott

            Thanks for the heads up. e-mail, disqus and my iphone all contributed to that. Fair enough. Call away if you wish. I think my number is up on my google profile regardless.

          8. Evan

            i’m calling tomorrow then!

          9. Mark Essel

            I like your sig Harry.Mark Essel631-403-0718

          10. Harry DeMott

            That’s what you get for replying to disqus on your iphone on e-mail. Since the phone number is up on google anyway, what the heck. I’m not getting inundated with calls yet!

          11. Matt A. Myers

            The only difficult part or unknown is whether the VC will actually deliver in what they’ve delivered for their other portfolio companies. What becomes more valuable if they do delivery? The VC. If they don’t deliver? The money.Obviously the VC will want their investment to work and be as well executed as possible, so they should be able to deliver – and maybe if they’re giving you less money there’s more pressure on them to perform in order to help reach the same results 2X money might compensate for.

          12. Evan

            Ambiguous clauses that potentially invite litigation (and screw up the expected cash flow distribution while the fund is in litigation) would be red flags for venture capital investors, I would think. So I would assume that most VCs would not want to take the risk.

      2. LIAD

        Why do you look at it as losing a deal? You chose not to do it. You could have if you wanted to.If you stop pursuing a girl because she wants things your not prepared to give, even though you could give them if you wanted to, you haven’t lost her, you’ve elected to give her up – she lost you.

        1. fredwilson

          i look at it as a lost deal because it was a project and a team that iwould love to have worked with. i think i could help them a lot and iwould learn a lot from them. it feels like a loss to me.

          1. LIAD

            We act in accordance with our rational self interest.Your desire to adhere to your investment principles won out over your desire to work with that team.Your decision generated you a net gain in marginal utility.It may feel and seem like a loss but in reality it wasn’t.- economics and psychology 101- FTW!

          2. fredwilson

            only time will tell on the marginal utility of our decision

          3. Matt A. Myers

            But if you start to base decisions on how much you really like a team is that compromising your judgement elsewhere? I imagine a team seems so desirable because of the their product though too.

          4. William Mougayar

            This is the key part here that’s the essence of USV (or any good VC) “it was a project and a team that i would love to have worked with. i think i could help them a lot and i would learn a lot from them”.That statement is an entrepreneur’s dream. To have their VC see them as a partnership, not just an investment.I’m curious to find out who that other company was (if that ever comes out). It seems they went for more money, and less advice/help. Time will tell if they were right.

      3. Mark Zohar

        As a founder and serial entrepreneur, I’ve got to say that the pace and frothiness of the market is extremely disconcerting. First, it creates more noise as more “me-too” companies get funded thus diluting the market & value potential of existing companies. It also creates much more confusion on the demand side as customers struggle to understand the differences between many similar products/solutions; thus delaying purchasing decisions & negatively impacting retention & engagement rates. Second, it creates significant pressure on start-ups to demonstrate rapid valuation gains in order to allow existing “frothy” investors to mark-to-market their investment.The other structural issue that concerns me is that while there are hundreds if not thousands of start-ups being funded in the Web space, it is clear that users have consolidated their online activities around a handful of companies/products (e.g., Google, Facebook, Twitter, Amazon, eBay, etc.). In fact, the percentage of total page views from the top 10 websites has almost doubled over the past five years and now stands at about 70-75%. It is the rare company that breaks out and joins the elite ranks of the Big 5 “daily engagement” sites. Twitter is the most recent example. I can’t think of another one; though Tumblr and Etsy may be gaining ground.The conclusions for me therefore are: 1) there’s going to be a lot of carnage, especially among the spray and pray crowd; 2) exits are going to be small tuck-ins by the Big 5 or aqu-hires like Hot Potato and FriendFeed; and 3) it will be another three years before we see the next big wave of displacement when new challengers to the current Big 5 will emerge. In the meantime, I hope more seed and VC fund take Fred’s advice and start pacing themselves more.

        1. Matt A. Myers

          “… thus delaying purchasing decisions & negatively impacting retention & engagement rates”So build a better product because you know the leading metrics and aren’t just following and getting a chunk of cash, and are executing well compared to competition, and eventually they’ll come to you! 🙂

      4. dlifson

        It’s refreshing to see that you allocate $3M – as opposed to zero – for your weakest investments. Angel-funded companies who raised $1M will get stuck when times get tough, and it remains to be seen if mico-VCs will support their struggling companies or act like angels and run away.

        1. fredwilson

          yup, i’ve been saying that a lot lately

  3. Dave Pinsen

    A similar strategy often makes sense when putting money to work in publicly traded companies. One advantage is, as you note, some smoothing out of market valuations/cyclicality.Another advantage is that there are only so many attractive investment ideas at any one time, so by spacing out your investments over time, you can select from a greater number of attractive investment ideas.I’m guessing you don’t have this flexibility in running your VC fund, but a way investors in publicly traded companies can avoid crashes such as the one that came after the 1999 peak (or after the 2007 one) is be market neutral: long strong ideas and short weak ones. Another way is to hedge opportunistically.

    1. fredwilson

      nobody has ever called me up and asked to borrow some of our stock sothey could sell it 🙂

      1. Matt A. Myers

        I have a feeling you might have spurred some phone calls for yourself.. 😛

    2. Kate Huyett

      Dave, you took some of the words right out of my mouth. I read Fred’s post and immediately thought of “averaging in” to the stock market. The main argument against that strategy in the publicmarkets is that you only return what the market does – you are all beta and no alpha. I think in VC however you can average in and protect yourself but you also have the ability to help *create* alpha by the help you are able to provide your portfolio companies. Because of that, more than in probably any other asset class, it makes sense to average into this one. I know this post is more focused on pace but I think focus on fund size is also laudable. Right now in private equity, portfolio managers are paying very large premiums because there is so much pressure for them to put to work the cash they raised before the crash.

      1. Dave Pinsen

        “The main argument against that strategy in the publicmarkets is that you only return what the market does – you are all beta and no alpha.”That might be the case if you are indexing, and your only source of alpha is market timing. What I’m doing now, however, is entirely different. I’m not indexing or trying to time the market, but I am “pacing myself” by putting cash to work every two weeks. I am doing it in market neutral trades though (e.g., my most recent one, last Thursday: Long GTY, Short JOE), so my returns will be independent of what the market does, and I am canceling out nearly all market risk. My plan is to build a portfolio of 26 long and 26 short positions over the course of a year and eventually start exiting old positions as I add new ones. Here, I am borrowing a technique from a Short Screen member who has run a market neutral portfolio for 10 years with impressive results. I’ve been sorting through a few hundred candidates to come up with each market neutral trade, and, if I had to, I could probably come up with an additional set-up or two each time. But I’m not finding anything close to 26 attractive market neutral set-ups at any one time, so “pacing myself” will, I think, lead to better set-ups and better returns over time. I agree that a VC’s ability to affect the returns of his investments adds an element and provides another reason for VCs to pace themselves: the fewer portfolio companies they, the more support they can offer each one.

    3. James Altucher

      Another way of saying “market neutral”. Twice the money at risk with half the return.

      1. Dave Pinsen

        In a secular bear or range-bound market, a competently-run market neutral portfolio should beat the market with less risk. Here’s one example:…^GSPC

        1. Dave Pinsen

          And here is another example (that’s the portfolio run by the Short Screen member I alluded to elsewhere in this thread).

  4. Dan Ramsden

    Fred, I completely agree that pace and moderation and discipline are all hugely important. I wonder if, in addition, we are now at a point of industry evolution where more thematic issues should also factor in. Something along the lines of social investing, although not necessarily green tech or other obvious prototypes of that format. I am thinking about the NY Times article this morning that, in my opinion, should get national attention… although it isn’t anything new. Now that the web has reached a point of relative maturation, I wonder if the investing pace to which you refer should also apply to a thematic pace – I can’t really put my finger on it… something along the lines of long term vision and thought leadership.

    1. fredwilson

      i have three kids who exhibit all of those traits. they have impactedmy view of what is investable and what is not. it is a good piece

      1. Dan Ramsden

        By the way, I think Tumblr is a good example of such a positive investment, and the distinction you drew the other day between writing a blog post and updating a Facebook status was right on. (Or maybe you didn’t say that, maybe I inferred it, I forget.)

        1. fredwilson

          thank you Danmy kids are a bullish signal for me on tumblr

    2. Dave Pinsen

      From that article:”Several recent studies show that young people tend to use home computers for entertainment, not learning, and that this can hurt school performance, particularly in low-income families.”Not exactly a shocking conclusion, but it’s interesting to consider when you think of those charitable initiatives to give every poor kid a laptop.

      1. Dan Ramsden

        I think the intentions are probably right, I think everyone means well – maybe not everyone, I’m just saying – but I don’t think anyone has really stepped up to lead on a larger scale. In finance, for example, there is (cough) the Fed. I don’t know, maybe the FCC should play a role? Or maybe Eric Schmidt? Steve Jobs? I don’t see Zuckerberg doing it. But someone should probably start thinking about long term consequences and steering courses accordingly.

        1. Rick Bullotta

          Dan, I asked the chairman of the FCC that same question last week at the Web 2.0 Summit – whether the FCC needs a policy position on the impact of ubiquitous wireless/smart device access by kids and teens. My original concern was on both the health impact of 1, 2 or 5 orders of magnitude more wireless signal and the impact on learning, attention span, and socialization.I would be the last person to ask for government regulation on the latter (social impact – this needs to be managed by parents, educators, and responsible providers), but I think here is much work to do on assessing the health risks of a million-fold or billion-fold increase in wireless communications. I wanted to ask Julius how he would feel about a 4G cell tower mounted on the roof above his children’s room. 😉

          1. Dan Ramsden

            Rick, what was his response?

          2. Matt A. Myers

            Edit: Just re-read first paragraph and confirmed my own question. 🙂

        2. andyidsinga

          Lets not ask anyone else to do anything..As parents we need to actually do the things we expect them to do. Theory is bull crap, practice is everything :)If we want them to read more – we need to read more.If we want them to eat healthy food, we need to re-learn how to cook, buy and eat health food.If we want them to be curious about the world – we need to be more curious about the world by asking questions out loud and engage with them to find the answers.If we want them to be more creative and artsy and makery – we need to be more creative and artsy and makery.If we want them to know how to change the oil in their cars we need to get out and change the oil in our cars and get them under the hood with us./rant 🙂

      2. Matt A. Myers

        I wonder if the problem here is that their interests aren’t tweaked before getting a computer or if the parents and family and home-living environment doesn’t cater to guiding a child to wanting to learn; Lack of engaged parents, whether to themselves never having discovered an interest or passion in anything, or not being home, or not knowing how or when or what stimuli and range of experience to expose them to. I surely don’t know this myself, but I’m hoping it would become natural to me, and to my future kids wanting to learn.

      3. andyidsinga

        Weeeeellll – the performance isn’t because of the computer its because of the lack of direction and focus. ..and as Matthew suggests below lack of engagement on parents part (and on some teachers too).

        1. Dave Pinsen

          Since you can’t reach into poor kids’ heads and flip a switch to give them more direction and focus, and you can’t replace their parents with more engaged ones, the salient question is whether they are better off if you give them a computer or not. The studies referred to suggest they may not be.

          1. andyidsinga

            sure – no switches to flip. There hardly ever are.

  5. John Frankel

    FredYour strategy makes a ton of sense. Can you comment on other strategies, such as those that involve investing in 30-40 companies a year and if you think that those might lead to lower returns.

    1. fredwilson

      i think spray and pray works well in up markets like we have been init does not work well in down marketsi want to have a strategy that works well in all markets

  6. William Mougayar

    First, I agree with your assessment. I’ve been through the 99 pre-bubble where all was going fine and suddenly people started to do stupid things. And I kept thinking through these times they were spoiling a good growth path we were already on, and rushing into valuations and assumptions that didn’t make sense, because it was all speculation. It became a betting exercise, not shrewd investment anymore. Let’s not forget when we were reading that the Internet was going to replace everything. Today, we’re saying that Social and Mobile are everything, and yes they are great markets, but they don’t need to be overheated. I am seeing the same land-grab mentality of 99-00. It was land-grab at any cost. I watched your interview with John Doerr. And I wished he didn’t use superlative words like “we are at unusual and exciting time”…”…in the middle of a huge wave…”, “..booms are good and lead to over investment..”, etc. These are signals that some people will interpret as jackpot time, and money will starting flowing in the wrong places or bad money will start polluting the good stuff. The problem with irrational investment periods is that they bring casualties along the way. Let’s not forget that. Those handing the money will survive, but for those taking it irrationally are like taking a poison pill, which leads me to my next point……which is that your headline seems to be aimed at the VC/investment community. But it applies equally well to the entrepreneurs out there. Taking higher valuations (in most cases, and especially during over-valuation times) sets them up for a higher fall. The expectations are higher, but if they don’t quickly perform, we all know what happens. As an entrepreneur on the path to taking a new investment, I will gladly take a 2X LESS valuation than the craziest offer and will stick with the right VC, a reasonable valuation and the right amount of money which will allow me to maximize my control and ability to operate my company. If some VC’s & entrepreneurs are stupid, users and customers are not. Users can be fooled and wowed once or twice, and they will try anything for a bit, but those that stick around are the ones that see value from their product usages, beyond the marketing hypes. Fred – btw feel free to pass me that term sheet that was turned down 🙂

    1. Matt A. Myers

      I’m glad someone else posted regarding taking a look at the entrepreneur’s side of things regarding pace. I mentioned a few more details in my comment but agree wholeheartedly you need to introspection to know what’s best for you.I look forward to meeting you even more now when I come to Toronto next, which should be soon. 🙂

      1. William Mougayar

        It’s tempting to get drunk for the entrepreneur, but the hang over is bad.

        1. mike gilfillan

          Tell me about it. Too much money in the bank sends the wrong signals to the startup team. What was once a bare-bones operation can quickly become “spend spend spend’. It’s incredibly difficult to run a tight ship when money is being thrown to your company and to your competitors. That is ultimately what caused the dotcom crash — too many Webvans lead by seemingly smart people (former head of Andersen Worldwide) who thought they could spend their way to a sustainable business model.

  7. Steven Kane

    I like this – “pace” being a kind of sort of argument for VC “dollar averaging”, which is a basic, core philosophy and practice with which I agree, and doi worry a little, though, about “fundamentals”. eg, supply and demand. scarcity, or lack thereof. etc.if one can stick to fundamentals — to trying to have rational theses for what to invest in and why, and to what kind of exit valuations can be realistically achieved and when and why — then I’d wager VC “dollar averaging” technique will win over time.i know i know — VC investments are bets on a pretty distant future (5-9 years out) so such rational theses can be darned speculative. but still. the alternative is at best spray and praywhich is what we are seeing all over the place in VC. IMHO, VC — though not USV per se, rather overall — and digital media VC investing in particular, has become, at best, “momentum” investing, or at worst, trend and herd chasing. and its easy to understand why — its just so darned easy to give in to the temptation to chase the herd, especially when a VC gets paid such huge compensation (from rich management fees) for such a long long time (each fund equals guaranteed employment for VC partners for 8 years, and firms often manage multiple funds simultaneously!) and just simply for making any investments at all.but back down here on earth, where investors don’t get rich employment-for-life deals, someone extremely wise (who?) said, “the best deals I ever did were the ones I did not do”and my dear departed Dad (himself a successful entrepreneur) constantly said, “The goal is to buy low, and sell high — not to buy lowest and sell highest.”word.

    1. Matt A. Myers

      A lot of what you said is why I imagine it’s easy for Fred to raise capital for funds.

    2. Scott Barnett

      I thought the exact same thing as I was reading the post – dollar cost averaging for VC’s. And in terms of the opportunity that USV just passed on because they felt it was valued too high, everything is in the eye of the beholder. They made an educated guess on the valuation, and I know that I don’t pay 2x more for things I like than what I think it’s worth. They could be wrong on this investment (only time will tell), but I’d say the discipline and approach is a long term winner.

    3. JLM

      Dad’s comment is brilliant.Success is a chalk stripe and as long as you are within the width of the chalk stripe, good outcomes are possible.

  8. William Mougayar

    Are you seeing these crazy valuations with start-ups that have traction and a large number of users (A rounds) or even earlier in product adoption cycles?

    1. fredwilson

      everywhere in the web startup sector

      1. Dave W Baldwin

        Then you appreciate it when the startup tries to handicap expectations?From my side, it has been a worry related to it not looking like you have faith in product, though I stand firm in not making too many assumptions.

  9. Terry Smith

    Common advice to entrepreneurs is to raise as much as possible; I would think this could be broadened to your business. You have admitted that pushing so much cash out the door as quickly as possible was a mistake, but if you anticipate a bubble coming, you could raise the equivalent of the $350M and just spread it out over more time when it will be much harder to raise in a post-bubble world in order to keep your start-ups afloat. While people are expecting 5x now, I’m betting a 2x return on the $350M fund is still pretty good given the circumstances. It’d be a big bet, but if a bubble really is coming I’d rather see the best investments stay protected.

    1. William Mougayar

      Raising as much cash as possible and raising too much possible cash are 2 different things.As an entrepreneur, it’s better to continue raising as you hit milestones, i.e. like the AVC strategy where they expect to continue believing in you along the way. Whereas others may want a one night stand and want it to be the best ever at same time.

  10. chris dixon

    Totally agree with your overall point. But at the end you saying this period reminds you of 1999 struck me. Putting aside the fact that valuations and amounts of money raised are puny compared to then, isn’t the big difference that the fundamentals of the tech/internet industry are incredibly strong? A bunch of my investments have reached profitability on seed rounds – something you could never imagine back in 1999 (unless you were selling to VC backed companies – effectively hooking into the big ponzi scheme). The entire “super angel” class is probably $300M of serious money, and the two biggest tech companies alone (apple and google) are approaching $100B in cash that they will likely use for acquisition to support their incredibly profitable businesses (again, very unlike 1999). I just don’t understand why people talk so much about valuations, how quick vc’s are doing deals, etc without talking more about fundamentals.

    1. Matt A. Myers

      Great observation.

    2. fredwilson

      fundamentals to me mean revenues and cash flow and discounted cashflow to get valueson that basis, the entire sector looks extremely overvalued to me chrisi can’t argue that facebook isn’t worth $41bn. i suspect that mighteven be a bargain on a DCF.but i believe facebook is the exception that proves the rule insteadof the basis for valuing every internet company

      1. David Semeria

        This is quite confusing Fred. You make no secret of the fact that USV looks for traction and ability to scale ahead of revenues. Hence you were comfortable calling-up Twitter when they had no revenues and – let’s be frank – no real idea at that time where the revenues would come from.So why now all this DCF talk? What was Twitter’s DCF valuation at the time?I think Chris makes a valid point, and your answer is not as convincing as it usually is.No hard feelings.

        1. Evan

          The way I take it is that Fred is saying that this is the beginning of the end. Hence some indicators don’t yet show that the market is overheated, but some do. And those indicators are roughly what he sees most intimately on a daily basis as an investor.

        2. Guillermo Ramos

          I think there are several steps in value creation for social web start-ups (very simplified version):First step: building critical massSecond step: reaching a minimum critical mass that is sustainable (low churn rate, high use rate) and growingThird step: monetization starts (trial & error)Fourth step: one revenue line flow proves to be a sustainable onenext steps….At the very beginning, valuation has nothing to do with DCF and as you walk through the steps, it makes more sense.It would be great to have a post to discuss about valuations.

        3. Dan Ramsden

          Exit values are by far the biggest part of the DCF analysis, for almost any business. If Chris is right and there is $300 million of “super angel” money in the market right now, and if that’s, say, half of total seed-finance capital available (including non-super angels and VC carveouts), then refer back to venture math problem to put exit requirements in perspective and see impact on DCF.

          1. David Semeria

            It all depends on the ability of the startups to generate revenues and profits.Zuckerberg recently made a big point at Web 2.0 by emphasizing that the web as a whole is still growing strongly and it shouldn’t be seen as a zero-sum gain (when he spoke about the map behind the stage).In other words, if a decent chunk of these startups can create real value, they don’t need to find an exit strategy – because an exit strategy will find them.

        4. fredwilson

          you couldn’t do a DCF on twitter when we invested in the summer of 2007you can now

          1. David Semeria

            fundamentals to me mean revenues and cash flow and discounted cash flow to get valueson that basis, the entire sector looks extremely overvalued to me chrisEmphasis mine.You’re invoking a valuation technique used mainly for mid/late stage companies to justify the overvaluation of the full spectrum.

          2. Mark Essel

            familiarity or perspective bias? From Fred’s perspective (all the companies he invests in or wants to invest in), he may be seeing similar valuations to 10 years ago.I suspect there’s a combination of factors that drive capital into early stage investing. If other options are not performing VC looks good. Plus if there is real deflation masked by federal spending, the “real” value of money is lower causing valuations to be higher than they normally might be.I’ve mentioned it before, but any bubble on valuations is the product of companies that are more hype than social utility/entertainment. I’m not crazy about intrinsic value outside of a market but there’s certainly greater stability in businesses that provide a customer valued service, as in paying with attention or dollars preferably the latter.

          3. David Semeria

            Mark, I’m just pointing out that early stage valuations have always been pretty subjective – and have historically been based more on rules of thumb than anything more concrete eg (max $5M pre for seed, $10-15M for series A, etc – with, granted, clear scope for exceptions).Perhaps we should be saying that early stage valuations are now generally beyond the rule-of-thumb range – but, of course, that doesn’t sound as scary…

          4. lazarofuentes

            David, I agree with you. What fundamentals can you expect at the very early stage? This new investment cycle has barely begun, on the heels of a recession, and now we want to spook everyone again. Why do that just as the engine is getting started? What purpose does it serve? Why, a DCF? Seriously? That is what this is all about?To entrepreneurs like me, out here raising early stage capital in New York (already a hurdle) this could shut us out of the capital markets entirely. And they only just opened, really.To get the capital we need in order to execute on our business strategies the sector needs confident investors. They need to feel confident that that they will receive some multiple of their money back when they exit their investment. That sector confidence is an important part of a fragile ecosystem and it should be handled with much care.Fred, with all due respect, be careful to not bring the whole thing grinding to a halt. There is a lot of edginess out there. Your words have weight (as you know) and could have far reaching repercussions beyond what may have been your original intention. Thanks.

          5. Harry DeMott

            Might it also be that when you did Twitter 3+ years ago, the absolute valuation was relatively low compared with the scale opportunity – as opposed to the companies today where the absolute valuation is relatively high compared with the scale opportunity?When I look through just the past 2 weeks of angel list e-mails, I see a lot of companies where the end market is just never going to be that large – so the addressable market better convert to paying customers real quick. The opportunity to scale some of these companies is very small.

          6. fredwilson


    3. William Mougayar

      The 2010 macro’s are good indeed. That’s another reason for not spoiling this party.But there was lots of money in 99 being thrown at companies, e.g. the B2B craze where close to 200 companies got funded for B2B marketplaces that didn’t even exist.If you could fog a mirror, you could have raised money in 99/00. I don’t want to see this in 2010/11.

    4. Dan Ramsden

      I don’t think “fundamentals” is the amount of cash on Apple’s and Google’s balance sheets, but rather the intrinsic valuation of an asset based on its particular business profile. It would be the same distinction between public market composites trading at 22x earnings, say, because that is really the growth opportunity of the underlying stocks, or because investors are overflowing with liquidity. In fact, that second alternative is exactly what makes a bubble.

      1. chris dixon

        obviously the cash itself isn’t the fundamentals but the profitability that generates that cash. and profitability which seems sustainable and growing and is also occuring in lots of smaller tech companies.

        1. Dan Ramsden

          Agreed. But then it becomes a question of degree… how profitable, how sustainable, and how much of a multiple does all of that warrant… as an independent calculation from the level of cash available to make the exit happen. All presupposing that Apple, Google, etc. will evaluate their targets judiciously.

        2. lazarofuentes

          …or the potential for that profitability all things being equal.

      2. fredwilson

        totally agree dan

      3. JLM

        P/E multiples have some tenuous — though certainly not linear — linkage or correlation to current interest rates.When rates are as low as they are today, it is not illogical to expect P/Es to trend in the same direction.All of finance is a big over filled balloon and when a finger is jabbed into one side the other side must react accordingly. The challenge is finding where the bulge is going to occur.

        1. Dan Ramsden

          I think part of what you’re saying is that the cost of equity is relative to the risk-free rate, which is true. Risk-free, however, does not mean that the rate itself is without risk, but just the asset to which it is associated. The rate itself will fluctuate over time, and when it does, so too the cost of equity. In the case of a private investment, which may have to be held over several rate cycles, it’s good to use a normalized return hurdle – regardless of where interest rates happen to be at that point. In other words, if there is an abundance of liquidity in public markets, which causes interest rates to be low and P/Es to spike, this is not a good criterion for valuations in early-stage ventures to spike also… Unless there is reason to believe in the permanence of the present environment – which I don’t think there is.

          1. JLM

            You are over thinking the comment just a bit. Money is a lubricant like an underground oil field and will flow to the point where pressure and gravity dictate its short term future. What is constant through many cycles is the movement.If the flows of capital were as rational and dependable as such higher level finance seems to indicate then Finance Profs would live in much, much nicer houses.Debt and equity are simply different price tags on the same commodity — money.Measures of return are comparative benchmarks placed upon risk and are determined by the very nature of the investment but also colored by the return expectations of the investor.Investors make the decision to hold, buy or sell every asset they own on a daily basis. Doing nothing — even if doing it in th Turks & Caicos — is a decision. Inertia is the proxy for hold.

      4. David Semeria

        When rates are as low as they are today, it is not illogical to expect P/Es to trend in the same direction.I’m pretty sure you meant opposite direction, especially given the rest of your comment…

    5. Johnfurrier

      I have to say that Fred is “all wet” on this 1999 stuff. There is nothing similar there.

      1. fredwilson

        what does “all wet” mean?

    6. Harry DeMott

      What’s the definition of fundamentals?I look at something like Apple and their success and their warchest and conclude that they all but choke off any possible competitors in the consumer electronics space. Great for Apple – not so great for guys selling Zune.Now the growth of the iPad does give rise to a lot of potential companies – just like the iPhone has.A zero sum game? or have the ecosystems created real value?Facebook – the same. Anybody going to invest in a social platform these days – or is everything just being built around the edge?Anyone for a search company to take on Google? or again, do you build around their ecosystem?If the only way to define positive fundamentals is to sell to one of 5 or 6 companies – then I’d argue that the market might actually be in worse fundamental shape for a start up than before – as more power is concentrated in fewer hands.I read Fred’s comment as sort of a reverse engineering comment. I.E. if you reverse engineer the cash flows necessary to justify today’s valuations at the rates of return necessary to justify a VC’s existence with investors – they can all start to look pretty expensive.The fact that some of your companies have reached break even quickly on small amounts of capital is great – but there is a flip side, which is that the lean start up – capital light model also means that all of these companies are small and shallow moat companies, so if there are $’s to be made on the idea – generally fast followers will come in and compete away the opportunity fast.So getting back to the DCF analysis – you need cash flow (okay maybe we have that at an earlier age than before, and thus we might all suffer less dilution), but the cash flows are more variable, far harder to predict, much more difficult to guess the growth rates, and in the end, since almost all of these companies get acquired these days (IPO anybody?) the takeout is the most important thing – and you are looking at a truncated number of buyers.Since I was around in 99 I remember well the frenzy. But one thing that was positive, if you were starting a company, was that you could sell out to many many public companies -take their stock and ultimately cash it in. Nowadays, you start a company with far more competition around you, more competition coming in every day – and ultimately have fewer buyers.Tough.

  11. vruz

    do you feel that sticking to your strategy would prevent you from getting certain deals you would want to participate in when some startups are being flooded with cash?

    1. fredwilson

      yes, it did so this past week

      1. vruz

        maybe the team was good in some aspects.but gambling on an unreasonable valuation for extra money they don’t need anyway… maybe they just weren’t a good match.

      2. seankelly

        Fred could you share if you were first to the deal or came across it after others? And maybe some insights about how the deal came to your attention? Would be very helpful to those of us on the “other side of the fence”.

  12. Frank E. Smith

    Anything Wrong With A Solid Investment?This Could End Identity Theft & Credit Card Fraudhttp://champressed.wordpres…Investors may contact me here: [email protected] Smith

  13. Eric Marcoullier

    Dollar cost averaging. One of the few financial practices that I can name.

    1. fredwilson

      and one of the best

  14. Wesley Verhoeve

    It’s so interesting how much truth there is to be found in children’s stories, fables and parabels (The Tortoise and The Hare, The Ant and the Grasshopper) that applies as general rules to our life and our career. Our brain seems to think that we can outsmart them sometimes, but then we always end up coming back to that old simple wisdom. Like steady wins the race.

    1. fredwilson

      i am particularly fond of The Little Prince

      1. Wesley Verhoeve

        Agreed! The Little Prince is great and profound. Little known fact: it waswritten in New York City (ok, Long Island, but I like to claim it for ourhome town).

      2. Dan Ramsden

        The boa constrictor that swallowed an elephant is actually a chart of fundraising in the last decade. Seriously, I love that book. Was the source of my high school yearbook quote. Really shook things up.

  15. howardlindzon

    I riffed on your pace point…

    1. fredwilson

      and i went and left a comment. a blog discussion!!!!

  16. William Mougayar

    aka “Fred Wilson’s Warning #2”.

  17. Frank E. Smith

    How Does One Get An Investors Attention?. OK … lets say an investor is enjoying a fine day at the museum, totally captivated, standing close up observing a painting called “WATCH OUT” which features a row of ducklings waddling across a grassy field headed toward a pond,where a hungry fox awaits behind a tree.. and … lets say, I too am observing the same painting, but from a distance.. from where i stand i can see an object, perhaps a large metal weight fastened to a rope,swinging toward the investor who is still captivated by the painting,. do i yell out “DUCK!” or “WATCH OUT!” ???……………………………………………………………………………….wellthis has nothing to do with ducks so i’m yelling “PLEASE LOOK AT MY TECHNOLOGY!”http://champressed.wordpres…Frank E. Smith

  18. Biff Baxter

    Please don’t say that it’s overheated.I just finished my Bidness Plan, Pooperpoint Presentation, and Escalator Pitch.http://smartstartup.typepad

    1. Tereza

      that’s hysterical

  19. Evan

    From an institutional investor perspective, it seems like USV is probably good diversification b/c of Fred’s “pacing yourself”/dollar cost averaging approach. My understanding from the CAIA exams is that most VC funds have more condensed J-curves return profiles than what you’re describing. Thus USV is probably good diversification on a portfolio’s holdings for a particular vintage year.Also, it seems that many commenters here don’t understand that when a VC raises a fund, he/she might not call a significant part of the actual money for a few years, so it doesn’t really work against most performance measures to be “in cash” for a VC, because he/she isn’t really in cash. That cash is sitting in the institutional investor’s bank account.

  20. JLM

    The wisdom of the fundamentals of any investment thesis must be measured by reality of what is going on in the overall economy. Perhaps the most important measurement criterium is — what the hell else can one do with one’s money today?Alternative investment opportunities and attendant returns.On that score, the current times are quite unique as there is almost no meaningful return for holding money these days.This is balanced by the fiction that the current low interest rates should make debt so cheap as to replace equity as a basis for investment. Of course that is very, very true until one realizes that there is simply no lending going on except when you can absolutely and unequivocally prove that you do not really need the money.A steady plan is always a better plan for shaving off the peaks and filling in the dips.While I heartily agree that one can never really time the market, I do think that — as Fred has observed in this post — one can be ultra sensitive to from whence the wind is blowing and adjust your sails accordingly.The trend is always your friend.

  21. Jkuria

    Timing markets is hard indeed. Reminded me of this…

  22. Michael Diamant

    Yup… dollar cost averaging is what crossed my mind first too.

  23. Anon

    wilson and dixon: frothy and overheated capital markets (macro) are created by a collection of stupid decisions made at the (micro) level. both of you have yet to really establish yourselves as veteran venture guys and come across as potential “big hat no cattle guys” because you talk and blog too much. many of the sand hill road funded teams are quietly toiling away without pomp and fanfare. you are solely measured at what you create at exit and nothing else. shut the f up and get to work.

  24. eromer

    Do you think that you would follow the same approach if it was all your money?

  25. Mark Essel

    The law of averages, over any sufficient period the costs will approach an average level. Good stuff. That philosophy can only be done with patience and discipline. Long term strategies for the win!

  26. Brent Harrison

    Smart strategy. Reminds me of all the talk around timing the market in selling vested options when I was at Netscape, AOL and Apple. I evolved my personal strategy to identifying a target % networth you were comfortable in holding in a single equity (e.g. your employer’s stock). Mine was 20%. So when the stock price was trending high relative to my other investments, I would see enough to get back to the 20% of networth target. When the stock price was trending low relative to other investments, I would hold. My colleagues thought I was a genius of market-timing, but it was all formulaic. Not saying venture investing is quite so formulaic, but having a long-term view with a strategy and process makes sense.

    1. Kate Huyett

      Not diversifying out of a single-stock position is one of the biggest drivers of wealth loss for high net worth individuals.

    2. fredwilson

      i like that approachvery sensible

  27. George A.

    Hi Fred, good piece. Nobody ever likes being told that they are drunk, probably the same with bubbles.Curious, on the comparison with 1999, isn’t the big difference here the fact that the bubble is isolated to the VC/Angel community? We have yet to see anything like the large acquisition prices for slideware (JDSU/SDL or AOL/TW) or the high IPO valuations for company’s with strong prospects, but no revenues.It would seam to me that every bubble starts in its own way, but always ends in the public markets. If that is where we are heading, we appear to be a long way off….perhaps this is what you mean when you say you cannot time the markets.

    1. fredwilson

      yes, i think the valuation excesses are largely limited to a verysmall slice of the overall economy

  28. Rob Rawson

    In theory I would think it should be better to try and time the bubbles, raise a lot of money at the top and not use it to invest in companies unless you can find companies where the valuations are reasonable. Probably the investors would be screaming at you if you did that however!Seems like it’s a good time to raise money, I’m thinking about raising some seed funding for my current even though I don’t need the money, more to tap into the expertise of the Angels.

  29. fredwilson

    yes, that is why i blog so much. because i get incredible feedback. like this comment.i don’t think anyone can time markets consistentlyi don’t think it is possible. not by hedgies. not by PE investors. and most certainly not by VCs

  30. Evan

    Isn’t Fred saying that he learned from the 99 experience not to raise a bigger fund and invest like crazy just because the capital (and 2% management fee) is out there? From his POV, he thinks he is showing that he learned his lesson.I think Fred’s dollar cost averaging approach makes a ton of sense as an investment strategy. He doesn’t think he has any alpha in market-timing, so attempts to diversify throughout as much of the boom to bust cycle as he can. Instead, he focuses on maximizing his alpha where he thinks he can add value. As someone involved in manager selection, that’s what you want to see.

  31. Harry DeMott

    valuation matters, but outcome matters moreAnd that sums up my point.Your comments belie a person who has been to the rodeo before – and has hadsuccess.The problem is that many of the founders these days are either on theirfirst company – or have never really had great support from an investor – sothey are still very much in the cash is cash camp.What they fail to grasp is that 100% of nothing is still nothing. If youvalue your company at $3M or $8M – you still have to return the VC’s $before you get paid – you your first question has to be: “How do I buildenough value to get into the common equity?” followed closely thereafter by”How do I get cash flow positive so I don’t have to take anyone’s money?”

  32. Matt A. Myers

    I agree with your conclusion. It would be reassuring even if not needed – the support would in fact magnify how much I can get done.I guess it also can come down to how confident the entrepreneur or company is in executing things themselves without the help or knowledge or rolodex of the VC.

  33. JLM

    Yes, JLM will say that “cash is cash” but that is not all he would say — I know the guy well.He would also say — “the single most important thing you ever do is deciding with whom to be in business.”On that score, it is possible to be true to both aphorisms.A discriminating and thoughtful entrepreneur would attempt to place an anticipated value on what other value added proposition a VC brings to the business directly and where else one might troll to simply buy that talent or service.There is a time to buy at Tiffany’s and there is a time to buy at WalMart and a skillful entrepreneur should be willing to buy certain things at different times at different places.The last thing I will note is another couple of aphorisms — in business you don’t get what you deserve, you get what you negotiate; and, competition makes every deal better.If you have a good offer but not quite good enough — negotiate exactly what you want by simply negotiating directly with guys you want to do business with.Funding deals is not like bidding for road contracts.

  34. Mark Essel

    Great comment & reply by JLM :)The meta game of startup funding and negotiation is serious business. Attention jiu jitsu for users who socially refer your product to investors is the best trajectory, certainly with revenue. The connector wins everytime.hitting SXSW in March? hope to meet up, I’ll bring my lampshade

  35. Evan

    this must make you popular in NYC. heh.

  36. Tereza

    I second Charlie on that. The entrepreneur needs to know that customer better than anybody. And if you’re relying on the VC to execute then you have problems. A great VC should be able to amplify…but not create.