I feel like bitching about FAS 157 today. I was at the annual meeting for one of our LPs yesterday and there was a long discussion about the impact of FAS 157 on both the buyout and the venture capital business. Once again everyone was in violent agreement that this was yet another accounting rule – promulgated by the accounting industry – to generate more fees for the accounting industry while burdening companies, especially entrepreneurial ones, with additional regulations that have no real impact on reality.
If you aren’t familiar with FAS 157, it’s officially known as the "fair value measurement" rule and unofficially known by some as the "mark to market" provision. Before you ask, "wait – isn’t mark to market the thing that got Enron in trouble and started this whole wave of SOX regulatory stuff", I’ll simply answer "yes" and let you ponder that.
Like our dear friend 409A, FAS 157 has come out of the latest efforts by accountants to create more transparency in financial reporting. Like 409A, I’m sure these are well intentioned ideas although my cynical side envisions an accountant in a sub-basement of a building NY with green eyeshades and a little green desk lamp sitting around dreaming up ways to torture entrepreneurs while accomplishing his accounting bosses goal of generating more work (and fees) for themselves. Oops – sorry – back to the main story.
Since the beginning of the VC business, valuation methodologies were generally consistent and straightforward. They were usually some variation of:
Pretty straightforward. Very conservative. This almost always understates the value of a VC portfolio, which presumably is a good thing since it’s illiquid and the only fund performance information that should ultimately matter to a VC (and their LPs) should be the one linked to cash flows (draw downs from their LPs and distributions to their LPs.)
FAS 157 blows this up completely. Under FAS 157, VC’s now have to mark all of their portfolio company values to market (er – "fair value measurement") qualify for GAAP (which is a requirement for every VC firm – our investors require we have audited GAAP financial statements.)
It gets worse. Our LPs (who typically invest in multiple VC funds – in some case many multiples) also have to adopt FAS 157. So they also have to mark their portfolios to market. It used to be the case that they could simply rely on the VC valuations. To comply with FAS 157, they theoretically have to look at all of the underlying assets in the VC portfolios and make an independent judgement on the values of those underlying assets.
Some VCs (and LPs) are just starting to implement FAS 157. Ironically, some accounting firms wanted 2007 as the start year; others seems to want 2008 as the start year. Many VC firms are viewing this as an annual exercise even though they report to their LPs quarterly. Some VC firms (like us) have already built it into our quarterly reporting cycle (our accountants told us we needed to comply in 2007). Yeah – it’s all over the map.
But that’s not the real problem. I’ll get to the real problem(s) in my next post on our new friend, FAS 157.
Having been an entrepreneur and VC for over 20 years, I’ve now seen plenty of economic cycles – both at a macro level and specifically in the areas I invest in. As a result, I smiled when I received three conflicting pieces of information today from two people I know and like and one person that I don’t know but know is respected.
Matt McCall at DFJ Portage calls the current VC cycle "dead" as of Q2 2008 in Rough Ride Ahead: Buckle Up & Get Your Money Now (if you can). He says it with conviction, although he does acknowledge that he hopes he is Peter the Wolf.
Fred Wilson at Union Square Ventures asks (and answers) the question Am I Bored With “Web 2.0”? Fred is heading off to Europe for a month with his family "to see how the web is changing the world and I want to see how entrepreneurs who are operating with a different worldview are thinking about the power and potential of the web. I could do the same thing in Asia or some other part of the world, but Europe is particularly easy place to do this because of the range of cultures and countries within a couple hours plane ride from each other."
Merrill Lynch’s chief strategist Richard Bernstein in "Some thoughts on alternative investments (6/23/08)" says "The growth in alternative investments seems linked to the growth of the credit crisis" but then goes on to say "There may be two areas of alternative investments that seem relatively attractive in the current financial environment. In both cases, these are areas that might benefit from the tightening of global credit. The first is early-stage venture capital. … If return-on-investment does indeed tend to be higher when capital is scarce, the significant tightening of traditional credit funding to smaller companies seems to make early-stage venture capital strategies more attractive."
While Bernstein’s definition of "early stage venture capital" is mostly likely different than mine (given my interpretation of his assertion), knowing how sound bites work, the three tag lines are "VC is dead", "I’m bored of Web 2.0 and need more meaning in my investments", and "early-stage VC is attractive again."
Like Fred, I also am about to embark on a month outside of my normal context. Amy and I are about to head to our house in Homer, Alaska for the month of July. I’m looking forward to going to a place where the Supreme Court rules Homer voter initiative invalid and thinking big (but not big box) thoughts.
My partner, Jason Mendelson, had a post yesterday on AskTheVC about our view on the problem of figuring out who will have to serve as the shareholder rep following the closing of M&A deals. For anyone who doesn’t know what this shareholder rep issue is, Jason does a good job of briefly explaining it.
We’re pretty much done serving as the rep on these transactions. It’s been a problem for us for years, but we’re now working with and advising a company called Shareholder Representative Services that professionally manages the post-closing process so that we no longer have to get stuck with this job. We also get better information and results when SRS is our rep than when one of the other stockholders takes the job.
See Jason’s post more background on what this shareholder rep issue is and why we try hard to avoid it.
I just posted the great VC blog of the day over on Ask the VC but I think that it is so useful I’m reposting about it here.
One of my favorite VC posts of all times was my partner Seth Levine’s post titled How to become a venture capitalist. I regularly get emails from folks looking for a job in the VC industry and I almost always point them at this post.
Seth has followed up with a new post titled How to get a job in venture capital (revisited). It’s updated with some additional information for those that respond to the first post by saying “I get it that it’s hard, but what should I do over the next five years to position myself for a VC job.”
While the bullet points (go to business school, work for a start-up, start a company of your own, work for a bank or consulting firm, and put yourself out there) may seem obvious, Seth’s commentary is really helpful.
I strongly encourage anyone interested in pursuing a VC career to read both of these posts.
I was talking to a friend yesterday about exits. In it, he suggested that the tech M&A market had shut down just like the tech IPO market had.
This didn’t square with my experience. I’ve seen plenty of modest M&A in the last two months (which I categorize as sub-$100m deals.) Two popped up today – AOL acquired Sphere for a reported $25m and someone is rumored (possibly Expedia) to have acquired Farecast for $75m.
While these are modest acquisitions, they are not distressed deals (e.g. company that is struggling gets bought for very little by other private company, usually for private company stock.) There are plenty of distressed deals happening – they are usually pretty easy to recognize.
While modest deals aren’t the end game of a VC investor, they are definitely a key part of the diet. Everyone knows that "singles and doubles" don’t turn a VC fund into a winner, but they are needed to fill in the holes. So – it’s good to see a steady tempo of these modest deals continuing. Plus, it makes for good copy.
Holy Absurdity Batman, someone actually writes a dedicated 409A site called 409A Dismay. For the latest and greatest 409A silliness, you are one click away from a subscription.
Over the past few years, I’ve spent a lot of time thinking about how people communicate with each other. As an active user of all computer based communication technologies such as email, IM, web collaboration, and twitter, I realize that direct, bite size communication is often effective. However, given the lack of persistence of data in these mediums, I’ve felt like something was missing.
For as long as I can remember, I’ve been a huge fan of t-shirts and have an extensive collection. I’ve noticed that the vast majority of my entrepreneurial colleagues prefer t-shirts over other types of dresswear. Finally, the t-shirt industry has grown nicely alongside of the software and Internet industry, as most companies have accelerated the growth of the t-shirt industry through their use of swag.
I’ve concluded that the opportunity to transform this market is ripe. Fundamentally, I believe that technologies like instant messaging are going to be replaced by t-shirt messaging. After much thought, I’ve decided to work with my partners to create a new fund we are calling the iWear Fund. This fund will be a first mover in the market, investing in the best young t-shirt designers, thinkers, collectors, and technologists.
We’ve already identified several promising young companies, such as VCWear and StartupWear. We are very interested in companies that have deep intellectual property in this area, especially patents, as we think this is an underserved market for patent trolls and if we can get out ahead of them, we can help our portfolio companies create an unassailable position. Like most investors, we expect there to be some overlap in our portfolio due to the proximity of similar technologies (such as VCWear’s new line of StartUp t-shirts) – we’ll work to resolve those conflicts when they arise.
As part of our investment thesis, we are focused on helping create several new platforms to enable the expansion of the t-shirt industry. We realize that these platforms may have applicability outside the t-shirt industry, but expect that this fund will – at least for now – limit itself to only t-shirt related technologies.
While forming this new fund, we looked for deep thinkers in the intersection of the t-shirt and software industry. Simultaneous with the announcement of the fund, we are honored to announce that Dan Primack is joining as an advisory board member. Dan writes the very popular PE Week Wire and was one of the first industry insiders to identify the huge potential of the t-shirt market. While Dan’s first effort to create PEWear was co-opted, we know that he has a collection of dozens of t-shirts, including some from the rock concert and professional sports sectors, and will be a huge help to us in identifying promising new t-shirt segments to invest in.
We’ve been asked by some whether, given the current credit crisis, now is a good time to launch a fund dedicated to t-shirt investing. While we expect there to be a slow down in certain areas of the market, especially around LBOWear, HedgeFundWear, and AuctionRateSecurityWare, those areas have historically not been meaningful consumers of t-shirt technologies beyond generic white undershirts, so we are not concerned about our timing. All markets are cyclical and we expect to be investing in t-shirt companies for a long time to come.
I was going to edit my Getting A VC’s Attention post but I thought the point I was going to add was important enough to highlight it in a separate post. In the post I wrote:
The feature is not the magic. Listening to your customers (in the case a prominent VC blogger – who’s attention is in high demand) and reacting to requests quickly and publicly is.
What I meant to emphasize is that the magic is in "the doing." It’s not about talking. It’s not about commenting. It’s not about emailing. It’s about doing. Rapidly iterating your product – demonstrating that you know how to process feedback, prioritize (based on whatever your current goals are), and executing.
If your goal is getting a VC’s Attention (as I expect Bret Taylor had as one of his goals), this was a brilliant approach. I’m not suggesting that you should orient your development schedule and feature list around what a VC wants (yeah – that would be a generically bad idea), but if you are trying to get a specific VC’s attention that you think has something to add to the mix, this is a great way to do it.
All of this (and the early morning, thin mountain air) made me think of my favorite Star Wars quote. "Do, or do not. There is no try." … Yoda
I regularly get asked "how do you get a VC’s attention?" Fred Wilson at Union Square Ventures just demonstrated – on his blog – how this works.
Last week while Working On Vacation, Fred was screwing around with FriendFeed. He wrote a post titled Ten Things I’d Like FriendFeed To Do. Bret Taylor from FriendFeed immediately commented on the post "Thanks for the thoughtful comments. Wanted to let you know we all read them here at FriendFeed, and I agree with you on almost every single request." A few days later FriendFeed implemented the ability to post an @reply to twitter from FriendFeed.
Result: Fred posts I Just Fell In Love With FriendFeed. For those of you that don’t know, Twitter is one of Fred’s investments. So – the fact that FriendFeed rapidly integrated with his investment is the clincher.
Now – the "post an @reply to Twitter" feature is no big deal. SocialThing – one of the TechStars companies – that does something similar but different to FriendFeed – has had this feature for a while. The feature is not the magic. Listening to your customers (in the case a prominent VC blogger – who’s attention is in high demand) and reacting to requests quickly and publicly is.
I’ve had similar experiences over the years with great entrepreneurs. The first one was within a month after I started blogging when I got connected with Dick Costolo at FeedBurner. If you go way back in my blog archives to June 4, 2004 (eek) you’ll see Feedburner signals improved feed stats coming soon. I wasn’t yet an investor, nor did I realize that "Feedburner" was really spelled "FeedBurner" but Costolo was all over me (and Fred) and we both fell in love with him (and FeedBurner.)
Speaking of Dick Costolo, yesterday he had an insightful tweet about M&A and Sex which Paul Kedrosky picked up. What a deliciously self referential world I live in. I wonder how good his 14 year old is at Rock Band? I guess we’ll find out tonight.