Posts from VC & Technology

You Make Money With Wins, You Make Friends With Losses

Brad Feld has a great post about the emotional toll of the collapse of the internet bubble.

Near the end, he writes:

When I reflect on my relationship with Seth, Jason, and Ryan much of the intense loyalty between us was forged in the period during and after the debacle that was the collapse of the Internet bubble. Some of my lifelong friendships, with people like Len Fassler, Dave Jilk, Jenny Lawton, Will Herman, Ilana Katz, and Warren Katz were solidified by the intensity of this time frame.

There really isn’t anything like going through a painful process with someone or a group of people to forge the bonds of friendship, loyalty, and trust that make for great professional and personal relationships.

When I look for partners in a business deal, I always start with the folks who I’ve been through tough times with. Because I know that they will hang with me again, just like they did the last time.

Diversification (aka How To Survive A Crash)

I was emailing with my friend Harry this past week and we started talking about crypto and the inevitability of a massive crash. I am certain the big crash will happen. I don’t know when it will happen and I think it may be some time before it does. But better safe than sorry. So I’m going to write some thoughts about how to survive it.

I told Harry my personal story of having 90% of our net worth go up in smoke in the dot com bubble and crash.

The only reason it was not 100% was that we owned two significant pieces of real estate that were about 10% of our net worth before the crash and became our entire net worth after the crash.

We were not diversified. We had all of our money in venture capital and internet stocks and had ridden that wave all the way up. Before Flatiron Partners (the venture firm I co-founded at the start of the Internet boom), we had no net worth. So everything we had, we made in the 1996-2000 period. And we essentially lost it all when the bubble burst.

Had we not sold Yahoo! and other stocks to purchase the real estate and pay the taxes on the gains, we would have been wiped out completely.

You might think “you could have sold when things went south” and that is a good point. But when things blow up, your first instinct is that they will come back. They didn’t this time. The selling just continued. A few companies we owned a lot of went bankrupt. These were public stocks that went all the way to zero. So, while it is true that we could have and should gotten out when the bubble burst, we did not, and in some cases could not.

So selling when a market blows up is not the best way to protect yourself from a crash. Selling long before it blows up and diversifying your assets is a much better way. Like we did with real estate, but with a lot more than that.

I like a mix of cash (t-bills, money market funds, etc), blue chips stocks (Amazon, Google, etc), real estate (income producing with little to no leverage), and a risk bucket (venture capital, crypto, etc). I think 25% in each would be a good mix. We have more in the risk bucket but I am in the VC business professionally and have been for 30+ years. 25% in each is where I’d like to get to in time.

I have advocated many times on this blog that people should have some percentage of their net worth in crypto. I have suggested as much as 10% or even 20% for people who are young or who are true believers. I continue to believe that and advocate for that.

But we don’t have that much of our net worth in crypto. We probably have around 5% between direct holdings and indirect holdings through USV and other crypto funds. I think that’s a prudent number for a portfolio like ours.

I know a lot of people who are true believers in crypto and have made fortunes in it. They are “all in” on crypto and have much of their net worth (all in some cases) invested in this sector. I worry about them and this post is aimed at them and others like them. It is fine to be a true believer and being all in on crypto has made them a lot of money. But preservation of capital is about diversification and I think and hope that they will take some money off the table, pay the taxes, and invest it elsewhere.

That is the smart and prudent thing to do. I wish I had done it during the internet boom. I did not, but the next time we made a bunch of money, I did. I learned the hard way. I share my story so that others don’t have to.

Worry

I remember when I was in my early 20s and just starting out in the venture capital business, I came across an old wall street saying that “a market climbs a wall of worry.” I didn’t understand it and that made me want to. I read a bit about the saying and came to understand that bull markets require an uneasy feeling.

Worrying is a fundamental characteristic of most investors I know. Greed and fear are the two opposing elements of market forces.

I read a board deck this weekend from a portfolio company that is absolutely crushing it and forwarded it to our team at USV with a short memo outlining all of the risks I am worried about. Not a single enthusiastic comment was in that email.

Why is that? Because although we invest on “what could go right”, we manage our investments on “what might go wrong.”

I believe one of our greatest assets to our portfolio companies is to be an early warning sign of trouble. If we can help the founders/leaders and their teams be aware of risks on the horizon, they can manage against those risks. And if there is one thing investors, particularly ones who have been around a while know about, it is how things can and do go wrong.

Of course, how you worry is critical. You can’t weigh down the leadership teams with your worries. You can’t fill up the board meetings with angst.

You have to be supportive, optimistic, encouraging, and positive in your interactions with founder/leaders and their teams. But you must also flag areas where there could be trouble. Getting that balance right has been a work in progress for me for my entire career.

So being a worrier is an important characteristic in an investor. But you have to mostly keep those worries to yourself and your partners/team (this is a place where partners are invaluable). And you have to decide when a worry is significant enough to share it with your portfolio companies and then you need to find the right moment and narrative to communicate it. When you do it right, the teams appreciate it immensely.

Some Thoughts On Burn Rates

The startup and venture capital businesses are based on a general idea that you can and should invest heavily into your business in order to increase value creation, amplify it, and accelerate it.

These investments mostly take the form of operating losses, driven by headcount, where the monthly expenses are larger, often much larger, than revenues.

These losses are known in the industry vernacular as “burn rates” – how much cash you burn on a monthly basis.

But how much burn is reasonable?

I have been thinking a lot about this in recent years.

Instinctively I feel that many of our portfolio companies, and the startup sector as a whole, operate on burn rates that are too high and are unsustainable.

But it is hard to talk to a founder, a management team, or a Board about burn rates objectively.

There are no hard and fast rules on burn rate so you end up getting into an emotional discussion “it feels right vs it feels wrong.”

That’s no way to have a conversation as important as this one.

So I’ve been looking for some rule of thumbs.

One that I like and have blogged about is the Rule of 40.

The rule of 40 makes an explicit relationship between revenue growth rates and annual operating losses. Below 40 is bad. Above 40 is good.

But the issue with the Rule of 40 is that it is oriented toward businesses (like SAAS) where there is a well-understood relationship between value and revenues and ones that are reasonably developed.

So I’ve been deconstructing the Rule of 40 in hopes of trying to get to a more fundamental truth about burn rates.

And what I have come up with is this:

Your company’s annual value creation (valuation at the end of the year minus valuation at the start of the year) should be a multiple of the cash your company has consumed during the year.

That seems simple and obvious and that is a good thing.

But in order to make this work you need to lock down two things;

  • how are you going to objectively measure valuation absent a financing event?
  • what is the multiple?

The latter one is easier I think. The multiple should be large. 1x is clearly not enough. I don’t think 2x is either. 3x is borderline. I like 5x. I would want a 5x return on my annual burn.

I think annual value creation should produce a 3-5x return on annual burn. That feels like a good solid range to me.

The first question is trickier. If you have revenues, then using a revenue multiple to establish value is a good way to do this. You can look at comparable company financings and acquisitions and also public company valuations to figure out what revenue multiple to use. But you should be careful to understand that revenue multiples are a function of revenue growth rates. The faster your revenue is growing the higher they are.

So let’s do an exercise here to flesh all of this out.

Let’s say you are a $10mm annual revenue company in 2017 growing to $18mm in 2018.

And let’s say that you look around at public comps and companies similar to your are trading at 6x revenues.

So you can estimate that your business is worth $60mm this year and $110mm next year.

So there will be $50mm of value creation in 2018.

If you want a 5x return on your burn, you should not burn more than $10mm in 2018.

If you are willing to accept as little as 3x, you should not burn more than $16mm in 2018.

That’s how this rule works.

I like it because it is objective and will lead to rational discussions about burn rates vs emotional ones.

It does break down in pre-revenue companies where it is harder to objectively measure value creation. You can use financing valuations as a proxy in pre-revenue companies but then you quickly get back into emotional territory as the end of year valuation will be an aspirational number and unreasonable aspirations/expectations are what lead to unsustainable burn rates in the first place.

Founder Friendly

Long time VC watcher, writer, and analyst Dan Primack suggested on Friday that the days of VCs trying to out “founder friendly” each other are now over.

It is an interesting observation and was worthy of a reply. The VC industry is highly competitive for the best opportunities and we certainly do try to ingratiate ourselves and our firms to the entrepreneurs who will decide who gets to invest in their companies and who does not. Being “founder friendly” is an important way to do that.

But there is another important participant in the VC/entrepreneur relationship and that is the Company the entrepreneur creates and all of its stakeholders; the employees, the customers, the suppliers, and even the community around the Company.

Having worked with entrepreneurs for over thirty years now, I have developed tremendous admiration for what they do and for the Companies they create. Entrepreneurs are a very special breed of people.

But there are times when interests diverge and what is best for the Company and it’s stakeholders may not be what an entrepreneur perceives to be in their own best interest. This creates a conflict situation and VCs are often caught in the middle of it.

I’ve been there many times and my mantra in those moments is “what is best for the Company?”. It has to be that way and, many times, when it is all over and done, the founder realized it was in fact best for them too.

Of course, reasonable people will disagree about what is best for a Company. That is what Boards are for. They are the bodies made up of reasonable people who can and should debate these issues and find resolution and make the hard decisions.

I reject the notion that being led by its founder is always what is best for a Company. It is often so, but certainly not always so.

Orthodoxy in thinking and believing is quite troublesome. There is no one way to do things and no single truth. You have to figure things out all the time based on facts and circumstances, based on a combination of experience and knowledge. If you do that well, you will get a lot right but never everything right.

I have heard from quite a few founders that they read the book Hatching Twitter and came away thinking that they would not want to work with me. That sucks for me but I don’t regret anything I did or said in the events that were described in that book.

You must try to make the right decisions for what is best for the Company and if that means being labeled unfriendly to founders, so be it.

A Public Record

AVC has been going on for almost 14 years now. I write every day, mostly about tech and investing in startups and observations about entrepreneurs and entrepreneurship.

WordPress says I have posted 7,622 times. That is more than once a day but that is because I used to post multiple times a day. Now I can barely find the time to write once a day.

Anyway, posting your thoughts and investment ideas every day creates a public record.

That can be bad when you are consistently wrong about something, like I have been about Apple since Steve Jobs left the company.

But all in all, I would not have it any other way.

A few days ago, Founder Playbook posted a timeline of my writing on Bitcoin and Blockchain, stating that “Since 2011, Fred has been bullish, yet critical, on the crypto market.”

I have been a believer in Bitcoin, Blockchain, and Crypto since 2011 and my confidence in this macro investment thesis gets stronger every day.

And I will continue to critique the sector, calling it out when I see things like greed, infighting, or other issues that get in the way of its collective success.

One could do a similar lookback on my roughly decade long obsession with social media that led me to blogging and ended around the time I fell for crypto.

I tend to get obsessed about one thing and write a lot about it. Which creates a public record. You can’t hide from that, but then again blogging is the opposite of hiding.

Greed Isn’t Good

The famous Gordon Gekko line that “greed is good” is bandied about quite often to explain why capitalism, and the pursuit of riches, is a positive thing for the economy, society, and the world at large.

Greed is not good. There is a fine line between the profit motive and greed.

I am a firm believer in the profit motive. It drives many of us to work hard, make new things that can move the world forward, and better our lives and the lives of our children, and others, through philanthropy.

But when the profit motive is taken to excess and you enter into the territory of greed, things go bad quickly.

We have seen this in the tech sector in many places, we have seen it in wall street, in real estate, and elsewhere. And we certainly are seeing it crop up in the crypto sector as well, particularly recently.

I like the concept of checks and balances. It is important to make sure to stay on the right side of the line between what is reasonable and what is excessive. Surrounding yourself with the right people, who have been around this issue a lot, can help a lot.

There are a lot of temptations out there when a lot of money is sloshing around. It is good to resist them.

Succession Planning In Partnerships

I read today that the founders of KKR have named Joseph Bae and Scott Nuttall as co-Presidents and heir apparents. I’ve written before about succession planning in investment firms. Getting this right is challenging. There are a lot of stakeholders; the investors, the partners, the employees, the portfolio companies. Everyone worries about what might change under new leadership.

I am a fan of gradual but clear and transparent transition, which is what KKR is doing and what we have done at USV.

Our partners Albert and Andy have been running USV for the last eighteen months as Brad, John, and I have focused our time on our portfolio companies and new investment opportunities (which Albert and Andy also do).

Giving everyone clarity about what is going to happen but allowing the transition to play out over time seems to work best in investment partnerhsips, which contrasts with the quick handovers which seem to work best in operating businesses.

Partnerships are complex and powerful operating models. When they work well they are a beautiful thing. But they are easy to mess up and so transitions need to be handled with a lot of care.

Working Across Many Time Zones

I was in Europe for most of June and working on a lot of things with people in the bay area. The nine hours of time zone difference was challenging. I was doing a lot of calls in the evenings with people who were just waking up.

There were many times when I woke up in Europe to a brief window where I could talk to people in the bay area who were still working and had not wrapped things up for the day before.

Our portfolio at USV spans ten hours (Estonia to San Francisco/Los Angeles).

Being based in NYC helps a bit as we have longer overlaps between Europe and the Bay Area than those two locations have with each other.

But I continue to find working across many time zones challenging.

Yesterday I had a conference call between people in five time zones. Getting everyone to agree to the correct time was almost laughable.

I’ve learned to use the time zone feature in Google Calendar to make sure I’ve got the time right. That helps me a lot.

As the world becomes more globalized, we find that we can do business more easily across time zones. And so we do more business across time zones.

That in turn leads to longer days.

When I am in LA, I often wake at 5am to an inbox that is full and active.

When I am in Europe, I am often on conference calls on the way to dinner.

I suspect there is someone working at a USV portfolio company at every hour of every day.

And new technologies is pushing this trend even farther.

Traditional capital markets open and close. The NYSE will open for trading today at 9:30amET after being closed all day yesterday for the July 4th holiday.

But crypto traders can trade on GDAX 24/7 and do.

So the tech and startup business is quickly becoming a 24/7 affair.

It wasn’t that way at all when I got into the business in my mid 20s.

But thirty years later the pace and rhythm is very different.

Keeping up with that pace and rhythm can be exhausting if you let it be.