I love today’s post from Fred Wilson titled The Valuation Obsession. It has some good hints in it about valuation vs. ownership dynamics for founders, employees, and investors. It also calls out the silliness about focusing on the wrong things.
Go read it.
I’m even a bigger fan of a statement Fred makes in the post that William Mougayar calls out in the comments.
“I like to invest in companies that smart people are joining. Capital should follow talent, not talent following capital.“
This is not just a statement on capital. It’s another hint to the importance – to a founder – of building an awesome team at every level of the journey. It matters at the beginning, as things ramp, and as a public company.
Capital should follow talent. That’s a line I know I’ll be using. I’ll try to remember to say “Fred Wilson says capital should follow talent, not the other way around, and I strongly agree.”
I’m in Minneapolis with my partner Seth. We had a meeting at Best Buy headquarters, met with a gang from the Mayo Clinic who drove up from Rochester, spent the afternoon at the Techstars Retail Accelerator which is at Target headquarters, and had dinner with Revolar. We are at the Techstars Retail Accelerator again today, then at Leadpages for a board meeting, and wrapping up with an internal Target event and an external startup community event put on by Beta.MN.
It’s two full days of immersion in the Minneapolis startup community. As I crawled into bed last night after jamming through my email, I smiled and thought to myself that Seth and I had a good day with a bunch of people talking about the power of entrepreneurship – and how the entrepreneurs are the leaders – while getting to work with a bunch of entrepreneurs.
I woke up to Fred Wilson’s post Understanding VCs and nodded my way through it. I particularly loved how he started.
VCs are not heroes. We are just one part of the startup ecosystem. We provide the capital allocation function and are rewarded when we do it well and eventually go out of business when we don’t do it well. I know. I’ve gone out of business for not doing it well.
If there are heroes in the startup ecosystem, they are the entrepreneurs who take the biggest risks and create the products, services, and companies that we increasingly rely on as tech seeps into everything.
What Fred said.
VCs – go read his post and reflect on it.
Entrepreneurs – go read his post and take it to heart.
Fred – thanks for saying it so well in your inimitable direct style. Understanding VCs is one for the books …
If you’ve missed me, it’s because I spent a week in Australia. Ten days ago, after being there for a few days, I came down with salmonella poisoning. I’m finally starting to feel normal again although I’m still exhausted. This has easily been the sickest I’ve ever been.
While I was gone, the gang at Reboot put up the Reboot Podcast #45 – What’s Love Got to Do with It?- with Fred Wilson and Brad Feld which was a delightful conversation between me, Fred, and Jerry Colonna.
The three of us have a 20+ year history that gives me joy every time I think about it.
I first met Fred in the suburbs of Boston at Yoyodyne in 1996. It was also the first time I met Seth Godin. I had just started working with Softbank and had been commanded to go to Yoyodyne and do “due diligence” by Charley Lax. I had no idea what Softbank or Charley wanted in the way of due diligence, so I went, hung out with Fred and Seth, and wrote Charley an email after saying “Looks great – Seth is awesome” or something like that. Softbank (and Fred – via his new firm Flatiron Partners, which was partially funded by Softbank) invested.
I first met Jerry in a conference room at NetGenesis in Cambridge. I was chairman and we has three product lines at that point: NetForm (an HTML form filler that was getting its but kicked by Allaire), NetThread (which was super cool but getting its butt kicked by something – maybe again Allaire), and NetAnalysis, which was the first weblog analysis tool and became the focus of the company. We sold NetForm to a company called Virtuflex (which went on to become Channelwave, which I became an investor in) and NetThread to eShare. Jerry, again through Flatiron (he and Fred had become partners), was an investor in eShare. I joined the eShare board as an outside director. eThread was acquired by Melita International in 1999 after a crazy ride that included a midnight negotiating session on the 173rd floor of some building in midtown Manhattan to try to merge with iChat. I remember walking about at around 2am with Jerry, completely wasted and frustrated. Welcome to 1999.
Over the last 20 years, the three of us have worked on lots of things in different configurations, but I’d put the deep friendship we’ve developed ahead of all of our business deals. We’ve won and lost together, had great moments as well as deep disappointments. But throughout, we’ve stayed best friends.
I enjoyed making the podcast, I hope you enjoy listening to it.
The retrades have begun. Since the beginning of the year, I’ve experienced four retrades – two early stage, one growth, and one late stage – and I’ve heard of a number of others.
If you’ve never experienced a retrade, or don’t know what I’m talking about, it’s the situation when you have a firm deal agreed upon or a term sheet signed and are proceeding to closing a deal, when the investor (or acquirer) decides to change the terms of the deal. And, in case you were wondering, it’s always to make the terms worse, not better.
This happens regularly in M&A deals especially with buyers who are buying thinly capitalized companies or ones who don’t care about their long term reputation. It’s very prevalent with buyers who over time get the reputation as bottom feeders and is often something floated during the diligence process to test the conviction of the seller.
However, for the past six years or so, I haven’t seen retrades from VCs or angels investing in companies very often. Occasionally a deal will fall apart in diligence, some famously so, but they rarely have been retraded.
This lack of retrades, however, is not the historical norm. When I started investing in the 1990s, I experienced a lot of retrades from VCs at many different stages. While a term sheet isn’t binding, part of the reason it tended to be long and complicated was to avoid the retrade dynamic and spell out all the terms of the deal explicitly.
In the late 1990s into the mid 2000s, I viewed the risk of a retrade as continuous background noise in any deal – investment or M&A. The notion of deal certainty became important to me and I started spending more time working with investors and acquirers who I believed had a very high likelihood of following through on what they said they were going to do. In contrast, once I found myself being retraded by someone, I noted it and had a higher bar for working with them going forward, since I expected there would be a future likelihood of a retrade if I did something with them.
By the late 2000s, I had stopped being emotional about the notion of a retrade. I viewed it as a normal part of business, which impacted an investor or acquirer’s long term reputation, but was woven into the fabric of things.
And then the retrades more or less stopped. From 2010 forward, the entire VC market shifted into a mode that many describe as “founder friendly.” Investor reputation mattered at both the angel and VC level. Retrades were a huge negative mark on one’s reputation and word got around. As more and more investors showed up, valuations increased, and time to close a deal shortened, there was little tolerance for a retrade, so they disappeared.
As we are now about five months into a broad market reset, both for public and private market valuations, the retrade has reappeared in private investments. The first indicator of it is that it now takes longer for a deal to close. I expect the days of transactions closing 15 days after a term sheet is signed are probably gone for a while. While some lawyers are breathing a sigh of relief, a deal that takes more than 30 days to close often starts to have a little bit of retrade risk. And, when a deal stretches out over 60 days, there’s a lot of risk around deal certainty – both retrade as well as a full deal collapse.
Recognize that I’m talking about investments, not acquisitions. I never saw the retrade dynamic go away with certain buyers and certain type of acquisitions. However, what’s notable to me on the investment side is that the retrade is happening up and down the capital stack.
Amy and I watched The Big Short on Tuesday with my partner Jason and his wife Jenn. We were electrified as we walked out of the theater – all four of us loved it. Jason commented that it was a particularly impressive movie given the subject matter. I couldn’t stop saying “that’s the best explanation of what created the financial crisis that I’ve ever seen.”
I remember reading The Big Short in 2010 when it came out. I’m a huge Michael Lewis fan and gobbled it down in a day or two. As we walked to the parking lot, I commented that the big four actors (Gosling, Carell, Bale, and Pitt) in the movie totally nailed their roles. I particularly identified with Pitt’s character Ben Rickert (based on Ben Hockett) who lives in Boulder in the movie.
As we got into our car, Amy said, “What do you think is happening today that no one sees?” This was the underlying theme of the movie – there were some completely obvious things in hindsight going on at the time that no one saw, or wanted to see. A few did notice and made huge financial bets, in non-obvious ways – about what they saw and believed was going to happen. Their foresight and conviction paid off massively, but it scarred each of them in different ways that the movie dramatized extremely well.
I like some time to pass before I look at history. While some people are good at reflecting on the past year and looking forward to predict the next year (one of the best in the VC world is Fred Wilson – read his posts What Didn’t Happen, What Happened In 2015, and What Is Going To Happen In 2016), I’ve never been particularly good at a one year time frame. Instead, I generally like a ten year moving window to process things. So, the lens of 2005 (history) and 2025 (future) is the one I’m currently enjoying.
The Big Short is picking up major steam in 2005. The climax happens in 2008 and the denouement continues on until 2011. So, from a history window perspective, the time frame landed directly on my boundary. Subsequently, Amy and I went on a binge the past few days of other media around this, including the movie Too Big To Fail (which is really about what happened in the fall of 2008) and Inside Job (which covers a broader time range, but focused on 2005 – 2008).
As I sit here on January 2nd, 2016, I’m pondering “what is happening today that no one sees?” When I go back a decade, we were just making the decision not to raise another Mobius Venture Capital fund. My partners and I hadn’t yet created Foundry Group. Techstars didn’t exist. Venture Capital and entrepreneurship was dramatically out of favor. Early stage and seed capital was extremely difficult to find.
I remember having deep conviction that there was an enormous wave of technological innovation coming. I knew that many of the things that had been created in the Internet bubble were great ideas, but they were just – as Jerry Colonna and I like to say – a decade ahead of their time. Today, it’s pretty obvious that was correct. At the time, talking about this stuff was a conversation stopper of the sort that Michael Burry (played brilliantly by Christian Bale) seems to generate every time he talks to someone.
Unlike Mark Baum, who is based on Steve Eisman (and played even more brilliantly by Steve Carell), I’m not angry, cynical, and convinced the world is a giant, rigged, inside game. But I do believe that the vast majority of people have absolutely no idea what is really going on, especially those who are in the middle of whatever game they are playing.
While this comes out in The Big Short, it’s even more apparent when you watch (or read) Too Big To Fail. And, while watching Inside Job, you see people lying or trying to obscure the truth in almost every interview. You can’t fake reality – it always catches up with you.
In the mean time, I’m getting ready for the next season of Game of Thrones.
I don’t listen to that many podcasts, but I like ones that are a short (< 45 minute) interview format. I can listen to one of these on a run or a drive to/from my office.
Until recently, the only one I was listening to regularly was the Reboot.io podcast. Jerry Colonna, the co-founder of Reboot.io is a dear friend and his interviews are often magical.
A few months ago I noticed The Twenty Minute VC by Harry Stebbings. I can’t remember which one was the first one I listened to, but I thought his style and interview approach was great. It was fast, started with an origin story, but quickly moved on to the present and then ended with a set of short questions.
Jon Staenberg, a long-time friend from Seattle who did an interview with Harry on episode 034, dropped me the following email at the end of April:
He seems like a good guy, want to be part of his podcast?
U good?
Ever in seattle?
I told Jon I’d be game. Harry responded immediately and we did a podcast together six weeks ago. I’d been listening regularly since Jon introduced us and heard several great podcasts, including mentions of me in 055 with Jonathon Triest and 059 with Arteen Arabshahi.
Last week Harry releases two episodes 065 with me and 066 with my partner Seth Levine. I had fun doing mine but absolutely loved listening to the one with Seth, especially around his version of the Foundry Group origin story.
Harry promises to interview our other two partners – Ryan McIntyre and Jason Mendelson – so he’ll ultimately have a triangulation (or maybe a trilateration) of our origin story.
In the mean time, enjoy the interviews with me and with Seth if you are looking for a podcast to listen to.
In January, Jerry Neumann wrote a long and detailed analysis of his view of the VC industry in the 1980’s titled Heat Death: Venture Capital in the 1980’s. While I don’t know Jerry very well, I like him and thought his post was extremely detailed and thoughtful. However, there were some things in it that didn’t ring true for me.
I sent out a few emails to mentors of mine who had been VCs in the 1980s. As I waited for reactions, I saw Jerry’s post get widely read and passed around. Many people used it as justification for stuff and there were very few critical responses that dug deeper on the history.
Jack Tankersley, a long time mentor of mine, co-founder of Centennial Funds, and co-founder of Meritage Funds, wrote me a very long response. I decided to sit on it for a while and continue to ponder the history of VC in the 1980’s and the current era we are experiencing to see if anything new appeared after Jerry’s post.
There hasn’t been much so after some back and forth and editing with Jack, following is his reaction to Jerry’s piece along with some additional thoughts to chew on.
It is good that Mr. Neumann begins his piece in the 70’s, as that era certainly set the table for the 1980’s. You may recall I got into the industry in 1978.
The key reason for the explosion in capital flowing into the industry, and therefore the large increase in practitioners, had nothing to do with 1970’s performance, early stage investing, or technology. Instead, it was the result of two profound regulatory changes, the 1978 Steiger Amendment, which lowered the capital gains tax from 49% to 28%, and the 1978 clarification under ERISA that venture capital investments came within the “prudent man” doctrine. Without these changes, the 1980’s from a venture perspective would not have happened and the industry would have remained a backwater until comparable regulation changes stimulating capital formation were made.
Secondly, the driver of returns for the funds raised in 1978 – 1981 was not their underlying portfolios, at what stage, or in what industries they were built. Instead, the driver was the 1983 bull market. The Four Horsemen (LF Rothschild, Unterberg Tobin, Alex Brown, H&Q and Robinson Stephens) basically were able to take any and everything public. Put a willing and forgiving exit market following any investment period and you get spectacular returns.
So contrary to the piece, it wasn’t VC were good at early stage technology, it was that they had newfound capital and a big exit window. For example, my firm at the time, Continental Illinois Venture Corporation, the wholly owned SBIC of Chicago’s Continental Bank, had many successful investments. Some were Silicon Valley early stage companies, such as Apple, Quantum, and Masstor Systems. I handled CIVC’s investments in the latter two (in fact, I also “monitored” Apple as well). Take a look at the founding syndicates of each:
| Masstor Sytems (5/1979) | Quantum Corporation (6/1980) | ||
| CIVC | $ 250,000 | CIVC | $ 200,000 |
| Mayfield II | $ 250,000 | Sutter Hill | $ 790,000 |
| Continental Capital* | $ 250,000 | KPC&B II | $ 775,000 |
| Genstar** | $ 275,000 | SBE+ | $ 700,000 |
| S & S*** | $ 225,000 | Mayfield III | $ 500,000 |
| BJ Cassin | $ 75,000 | ||
| Total | $1,250,000 | Total | $3,040,000 |
*Highly regarded private SBIC, **Sutter Hill Affiliate, ***Norwegian Shipping Family, +B of A’s SBIC
What is striking about these syndicates is that nobody had any meaningful capital, which forced syndication and cooperation. CIVC’s only “competitive” advantage was its ability to write a check up to $1 million. In this era, the leading VC firms such as Mayfield, Kleiner, and Sutter Hill (all shown above), rarely invested more than $1 million per company.
When we syndicated the purchase of the Buffalo, New York cable system, we literally called everybody we knew and raised an unprecedented $16 million, a breathtaking sum in 1980. As dollars flowed into the industry, cooperation was replaced by competition, to the detriment of deal flow, due diligence, ability to add value and, of course, returns.
CIVC had a number of highly successful non-technology investments made in the late 1970’s timeframe, such as:
None of these companies fit Mr. Neumann’s definition of the era’s venture deals and each generated returns we would welcome today.
For many years preceding 1999, the 1982 vintage was known as the industry’s worst vintage year. Was this a function of “too much money chasing too few deals” as many pundits claimed? Not really; it was a result of an industry investing into a frothy market at higher and higher valuations in expectation of near term liquidity, and suddenly the IPO window shutting, leading to no exits and little additional capital to support these companies.
Mr. Neumann’s post also misses the idea that it was a period of experimentation for the industry, This time period saw the rise of the industry-focused funds and the advent of the regional funds. Many of the industry funds were wildly successful (in sectors such as media communications, health care, consumer, etc.), while none of the non-Silicon Valley regional firms were long-term successful as regional firms. Some regional firms, such as Austin Ventures (in Austin, TX) did prosper because they subsequently adopted either an industry or national focus. The remainder failed as a result of the phenomenon of investing in the best deals in their region which typically were not competitive on a national or global scale. Just imagine doing Colorado’s best medical device deal which was only the 12th best in its sector in the world.
Some additional observations include:
The 1980’s proved there is more than one way to “skin a cat”. Early stage technology may be one; but it is not the only one and may not be the best one, then or now. My advice to a venture capitalist, then, now or later, is simple: Do what you know, do what you love; build great companies and over time you will succeed.
I was in a conversation last week with a friend who asked “do you think this is the beginning of the end?” We were discussing something totally wacky that had just happened that clearly could be viewed as an indicator that we have crested the peak of this economic cycle. Then, earlier today, I was on the phone with one of my favorite lawyers and he made a joke about a deal I’m doing as harkening back to the late 1990s. He asked if I thought it was an indication of the top of the cycle. We had a good chuckle (probably PTSD gallows humor from 15 years ago) and I suggested that they slow down the hiring of the associates at their law firm so they wouldn’t have to lay off so many in the inevitable downtown.
Somewhere in between these two conversations I told someone that I thought this was actually the “end of the beginning.” And, tonight at a wonderful dinner, I made the statement to the friend that we were having dinner with that I thought the next 30 years were going to be incredible.
I think we are at the end of the beginning of a dramatic shift in how our species deals with existence. Depending on who you believe, we are either 30 years from the singularity (Kurzweil) or only 15 years away (Vinge). The new science fiction coming out is doing a remarkable job of helping us set a context for the different aspects of what we’ll need to deal with. Some of it will be just as off as Philip K. Dick can be while some will be just as accurate as Philip K. Dick can be. If you are a fan of Philip K. Dick, like I am, you know exactly what I mean. And if you aren’t, I suggest you start with Do Androids Dream of Electric Sheep?
Humans have serious issues with exponential curves as we want to make everything a line. But a lot of the stuff around us is happening exponentially and we don’t realize it. As a result, we’ve dramatically underestimated the impact of technology on – well – everything. And, since so much of it is exponential, it compounds at an incomprehensible pace. When we look outside at concrete, steel, and glass going up slowly, it lulls us into a sense of normalcy.
The machines want us to feel this way.
Think about it for a brief moment. Suspend disbelief. Wind the clock forward 100 years. Do you think, as a species, we will still be struggling with the things that vex us today? Will we still be arguing about the same stuff? Will physical instantiation of things have the same meaning? We will still be eating Cocoa Puffs?
We are at the end of the beginning. It’s going to get wild. Buckle up.
There will be a downturn. It might be in a day. It might be in a year. It might be in a decade. We have no idea when it will come, but it will come.
I was talking to a VC yesterday who was an entrepreneur in the late 1990s, which we now commonly referred to as the Internet bubble. He was very successful as an entrepreneur and has continued to be very successful as a VC. A VC who has been around for a long time recently told him that you aren’t a real VC until you’ve been through at least one downturn. He commented that while knowing this, it’s hard not to be a cynic when things are going well and he wondered out loud if there was a way to balance optimism and cynicism as a VC. I had a quick reaction about continually being deeply rational about what one encounters, but it didn’t feel very satisfying to me as an answer.
We are in a very positive part of the startup / entrepreneurship cycle. Given that, there is a regularly occurring discussion about whether or not we are in a bubble, or this is a bubble, or is a bubble forming, or some other bubble thing. The conversations devolve quickly into “yes we are” and “no we aren’t.” This is often followed by justifications of positions with a bunch of random data to support the position, where most of the data is either inaccurate, narrowly chosen with huge selection bias, or a function of what the public market guys like to call “talking your own book.”
I have no idea if we are in a bubble or not. And I don’t care since, as an early stage investor, I play a long term investing game, because I have to. I can’t control liquidity or timing, especially when I initially make an investment. The market is going to move wherever it is going to move and is completely exogenous to me so timing it is irrelevant.
I’ve lived through several severe cycles – both positive and negative – as an investor. I’ve had successful companies created and built at all stages of the cycle. I’ve had failure at all stages of the cycle. There are great strategies for success in both the positive part of the cycle and the negative part of the cycle. And you can do completely stupid things that blow up your company in both the positive and negative part of the cycle. While the stage of a cycle has impact on a company, it’s only one factor.
As I pondered the cynic vs. optimist question this morning, I landed on a synthetic view that feels right to me. I was walking around my office looking at my physical book shelves, mostly for words to try to characterize what I was thinking about, and I landed on Andy Grove’s amazing book Only The Paranoid Survive. I bought the physical copy after reading The Intel Trinity (one of the business / history books I’ve read recently) which inspired me to go back and read – slowly and on paper – each of Andy Grove’s books.
Boom – that was it – I’m a paranoid optimist in a business context. As a human, I’m optimistic. I believe in good. I like good. I hope for good. I prefer good. I am hopeful about the future. I love the work I do. I love helping create companies. I love playing with technology. I love seeing amazing new ideas come to life. I love being alive. I hope to live a long time.
But I know that there is plenty of bad out there. I’ve experienced a lot directly in business, whether it’s bad actors, stupid decisions, unintended negative consequences, self-inflicted trauma, passive aggressive behavior, or outright deceit. I’ve made assumptions about what I think will happen only to have my assumptions be completely incorrect, or correct in my parallel universe to the reality that actually ensues. Some of this has been under my control or impacted by my viewpoint while some of it has nothing to do with me in any way, but is like the proverbial elephant that accidentally steps on and crushes the ant.
When I link this to the cynic vs. optimist dichotomy, I’m definitely not a cynic. But I’m not an unbridled optimist that can only expect more positive. And I don’t vacillate between cynic and optimist based on individual situations, companies, or the macro.
Instead, I ignore the macro. I recognize that I have no control over it. I try to use the experience and lessons from the last 30 years of being in business to guide me steadily through whatever part of the cycle we are in. I know the cycle will change and the companies I’m part of will have the opportunity to be successful regardless of the situation. But I also know they have the opportunity to fail. And that’s where the paranoia comes in. It’s a powerful calibrator.
When I reflect on Andy Grove’s leadership of Intel, it was through a series of intense up and down cycles – both within the semiconductor industry as well as the global macro environment. While he leads with the idea of being intensely paranoid, there’s a thread of clear optimism through his big decisions. When faced with brutal challenges, he dealt with them. When there was daylight in front of him, he ran incredibly hard in a positive way to cover as much ground as possible. But he always knew he’d face more challenges.
The next time I get asked the question, “How can you avoid turning into a cynic when things are going well and you know it won’t last forever” I now have an answer. Be a paranoid optimist.