I really enjoy Fred Wilson’s blog and read it avidly.
Recently, he wrote about the importance of having enough capital as a VC to invest in multiple rounds, and also, having the guts to lead an inside round in your winners. I completely agree, given the payoff structures that exist for start-ups.
What’s always been true about VC is that you are dealing with “asymmetric outcomes” in a portfolio. It is a hits-driven business whereby a small percentage of your investments generate 90%+ of the gains. (And, this has enormous ramifications for entrepreneurs, as I explain below.)
So, a symmetric investment approach really doesn’t work when the outcomes are asymmetric; for example, investing in just one round only can lead to a good multiple on the money invested in that one particular company, but it won’t move the needle on a fund.
Moreover, what’s very challenging in VC is that it often takes a long time before you know if a company is going to be a winner. So, in the meantime, you use your best judgment to keep supporting companies to a valuation inflection point.
What does this mean for entrepreneurs? I think anything you can do to show your Board that you’re making progress and keeping the burn rate relatively low is key. You can and should up the burn once you have very predictable user acquisition processes and, ideally, monetization. But, before that, you’re still in the “figure it out” mode, and you should try to prolong the runway as much as possible.
Also, what if you already have a winner? We encourage our founders in those cases to keep going. Don’t sell the company. Go public and be a big company. Raise the valuation and sell some of your shares in a secondary to take money off the table if you’re worried about risk, but as much as possible, keep going.
Go public and then establish a currency by which you can buy other companies. Get bigger, and then, if a great offer comes after you’re public, it’s a great situation for you.
But, by then, you will have earned multiple premia on your stock price: a premium from the private markets as your revenues become scalable and predictable, a premium from the public market as you go public, and a premium from an acquirer who buys you (e.g., Trulia just sold recently at 2x their public market cap).
You’re in a game with asymmetric outcomes. Most entrepreneurs get only one true winner in a career. It may be the best horse you ride in your whole career.
So, if you have a winner, keep going!
Red Sox owner John Henry, who runs a hedge fund, recently talked about baseball trades. He think the best trades are the ones the fans don’t like. In other words, they are contrarian moves.
All this made me think about entrepreneurship. When do you hold vs. fold? Are you being unreasonable and, in fact, crazy if you give up? Or, are you simply being “gritty” by staying course?
Honestly, I personally believe the “hold vs. fold” thought process is the key decision that an entrepreneur and his/her Board has to make. And, you have to make it more than once in a company’s life. IMO, it’s the “management alpha” that generates superior risk-adjusted investment returns.
I really liked the comments about being a contrarian, how you do really well as a founder or a VC when you’re not pursuing what others are. It takes a lot of internal strength to be OK when other people don’t like your idea.
In fact, I remember at one point there was a particular VC firm going through some tough times. Some friends worked there, and they were pretty stressed out. They tried to restructure some of their funds, and their LPs voted against it. There was fall-out, and some prestigious LPs spoke very loudly that they were dropping the VC firm.
But, the VC firm mentioned above persevered. And, it invested in Facebook, which has been the most successful VC investment of all time.
The VC? Jim Breyer.
“What are you up to this summer?” I asked.
“Taking off for two months,” he said.
“I’m getting a kidney transplant.”
I recently visited my favorite wine shop, Marty’s, and reconnected there with Peter Tryba (up top, with his daughter). He is the head of the wine department and has picked out for me some incredible and extremely cost-effective wines from around the world.
Peter’s kidneys have failed, and he needs an organ transplant. He is hoping it will happen in August. Unfortunately, a kidney transplant isn’t easy to do. There’s a lot of lost time at a job. So, I was hoping you’d join me and support Peter (click here to donate). He doesn’t know that I blog for fun and that I’m writing about him, and so, let’s make his day?
What’s amazing about Peter’s situation is that a social media campaign helped surface a potential kidney donor (it’s much better if your new kidney is sourced from someone still alive). Isn’t that insanely altruistic, that someone will donate one of his/her two kidneys and go through a very challenging surgical procedure?
I can promise you that kidney transplants can change a person’s life. My mother had one. I won’t bore you with the dangers and debilitating effects of dialysis, which you need if your kidneys fail. It really and truly sucks. A kidney transplant is completely transformative, a new lease on life.
I can truly say that Peter is an incredibly thoughtful, humble and awesome person. Please give.
Best of luck, Peter. We all are rooting for you! My thoughts and prayers for you and your family.
Last week, I really enjoyed meeting up with Kitt George, Dennis Keohane and M.E. Francis for a “Beers with…” video interview. I was supposed to do the inaugural one last spring, but I had given up alcohol for Lent. The clip is here.
The New England Venture Capital Association (NEVCA) originated the idea, and I think it is awesome that the series has taken on a life of its own.
My only rules for the taping was that I would not drink alone and I would pay for the drinks. So, yes Directr, Beta Boston and NEVCA, your colleagues were daytime-drinking.
I think the Internet and social media have really changed how entrepreneurs and VCs interact. I remember when I started in the business in 1998, and many entrepreneurs wrote letters to VCs, whose addresses they looked up in the Pratt’s Guide, an industry directory. Now, people connect easily via LinkedIn or Twitter.
I’m entering my last year as a member of the Association’s Board, and I’ve been really impressed with what Kitt and C.A. Webb have done. I really hope one of them runs for public office, frankly.
I’ll miss working with them, but hey, we always can meet again over beer at 2 p.m., right?
One of our investors is updating his POV on the VC environment and reached out for my 2 cents. After thinking about it, I would describe my observations of VC with this headline: “steady as she goes.” Here’s why.
Intra-firm dynamics have stabilized. I think the firms that needed to restructure pretty much have, as I’m not hearing much new anxiety from peers. In some situations, firms have shut down offices and exited certain vertical sectors. In some cases, senior partners were pushed out, and in other cases, they decided to turn over the reigns to the next generation.
I’ve blogged in the past here about how a legal entity called a “management company,” which is separate from a firm’s fund and partnership structures, really controls a VC firm. A handful of individuals tends to dominate a management company and the ensuing economics of a firm.
Restructuring has usually meant that other individuals have been phased into a management company. And, senior partners have negotiated a “tail” of fees in exchange for letting others into the management company.
The roles for various funding players are now well-known. I think entrepreneurs have become very informed. They know the pros and cons between a micro-VC (invest in one round only) and a life-cycle VC (who invests in every round), between a new VC brand and an established one, between a convertible note and a priced equity round, between working with an Associate vs. a Partner vs. a Management Company member, etc. They also seem to know which VC firms have fresh money, which ones have just a few shots on goal left, and which ones are tapped out.
So, entrepreneurs know to whom they should go for a seed round vs. a Series A vs. a later-stage round. For seed and Series A rounds, which is the entry point 95%+ of the time for Kepha, I’m finding that it has become a very streamlined set of players. For seed rounds, we usually see some micro-VCs, angels, ourselves and two other Boston-based firms.
For Series A rounds, it is also a focused group. I’ve blogged in the past (click here) that, IMO, there are only 15 individual partners based in Boston who have the capital to price Series A Internet/software/tech rounds. It is even tighter when you break that group down by sector, as some focus mostly on B2B whilst others do B2C mostly. So, this group of 15 is seeing very good in-bound flow right now.
In addition, I’m not seeing many new VC firms entering the market. I get the sense from LPs that they’ve already picked which established firms and which new entrants they want to back. So, it is a stable group of players right now.
It is a two-tiered market. I’m seeing fewer financings get done, but that firms are willing to “pay up” for quality, even in the seed and Series A rounds. National data from Pitchbook seems to imply the same (their recent report is here). I’ve seen this at other times in the cycle when there’s a “flight to quality,” which means entrepreneurs in the perceived top tier are getting great terms and everyone else is struggling to raise money.
It certainly isn’t fair, as perception of quality early on is nebulous at best, but that’s the market reality. And, I don’t see this trend changing much unless there’s another global crisis or the IPO window becomes more robust.
So, what does all mean for VCs?
I cannot speak for the industry, but Eric, Ed and I talk about it a lot. And, this what we think for our firm: investment “alpha” has shifted to management.
Alpha is what all investors seek. You can get higher returns by taking on more risk, but alpha denotes a manager’s ability to generate returns in excess of a given level of risk. When I entered the VC business in 1998, for example, sourcing seemed to be a big source of alpha. VCs were hard to track down, and you either wrote letters to them or received a referral to them via a portfolio company. Inbound flow therefore could be somewhat proprietary.
Social media and blogging have completely changed all that. I think entrepreneurs can pretty much get to any VC they want. I don’t think there’s alpha there for the VC as a result.
In fact, in the “VC value chain” of sourcing, picking, winning and managing opportunities, I think alpha is in the managing part. I think it’s fairly easy to source and pick the investments you want. It will always take skill to beat out other VC firms, but when everything is pretty much auctioned, spreads in returns will come largely from managing an investment.
My partner Eric calls this “company building,” and there’s a myriad of difficult decisions board members face when progress is slow for a start-up. Some start-ups catch lightning right away, but the vast majority need to adjust/pivot/retrench, and this is where business judgment for the VC really needs to come and play.
Sometimes, your co-investor gives up and you have to decide whether to keep funding the company alone. Sometimes, the market for that start-up is really slow, and you need to decide how much patience you’re willing to show. Sometimes, a co-founder leaves, and you have to wonder why. Sometimes, a founder has a glaring weakness about which he/she is unaware, and it’s your job as the VC to be a coach without alienating that person.
I could go on.
So, those are my 2 cents. After a great deal of change and tumult, this now feels like a period of stability for the VC industry. Things of course could be better, but they can certainly be a lot worse. IMO, portfolio returns will come not from sourcing/picking/winning, but from helping entrepreneurs succeed.
Steady as she goes.