Tag Archives: Venture Capital

The Power Law and Venture Capital (part 4), China’s rise

In the part 1 of my post about The Power Law, I had embedded my own visual history of venture capital. There was a missing element which is China’s rise, that Mallaby adresses in his 27-page Chapter 10. Before 2010, venture capital in China was behind Europe, but today it’s challenging the USA:


Source: Mallaby’s The Power Law, appendix, page 413.

Mallaby convincingly explains that it developed not with the support of, but bypassing the Chinese government and surprisingly thanks to a combination US venture capitalists and Chinese people who had been in close contact to the American entrepreneurial culture. I knew nobody from the people below but one entrepreneur (you can check their names at the end of the post).

I had heard about the BATX which are nowadays compared to the GAFA and I loved Jack Ma’s video which could have been given by many Silicon Valley entrepreneurs. Here it is again:

I had a few Chinese startups in my 800+ cap tables and they are mostly internet and ecommerce companies. Mallaby seems to have similar views. I extracted them all (see below) and here are a few interesting characteristics:

Not only are they mostly internet/ecommerce companies, but they are recent, went public quickly, their founders are younger than average, keep more equity than others, and they have many more founding CEOs than the average. Interesting…

Equity List China

In the image above are the:
Funders: Gary Rieschel (Qiming), Neil Shen (Sequoia China), JP Gan, Hans Tung (ex-Qiming), Kathy Xu (Capital Today), Syaru Shirley Lin (ex-Goldman Sachs)
Founders: Jack Ma, Richard Liu, Wang Xing

The Power Law and Venture Capital – according to Sebastian Mallaby

Sebastian Mallaby has just published a new book about Venture Capital which looks very interesting. I have already explained here what the Power Law is and will not do it again. But I will quote Mallaby as I do when I read good books.

About the term : “Venture capital” had also cropped up in 1938 when Lammont du Pont, the president of E. I. du Pont de Nemours & Company spoke before the US Senate Committee to Investigate Unemployment and Relief. “By Venture Capital I mean that capital which will go into an enterprise and not expect an immediate return, but will take its chances on getting an ultimate return” du Pont clarified. […] but this phrase making did not stick and the term was not widely used until at least the 60s. [Note 28 page 418]

And what about this : “All progress depends upon the unreasonable man, the creatively maladjusted. Most people think improbable ideas are unimportant, but the only thing that’s important is something that’s improbable”. From Vinod Khosla [Page 3]

About the return of VC. The normal distribution applies to size, weight of individuals, traditional stock markets, but the power law applies to the exceptional – wealth of individuals when not really regulated, as well as venture capital: Like the 7-foot NBA star, unexpected large price jumps are rare enough and moderate enough that they do not affect the average. The S&P500 budged less than 3% in 7763 days out of 7817 between 1985 and 2015, that is 98% of the time. […] Now consider venture capital. Hosley Bridge is an investment company which had stakes in venture funds that backed 7,000 startups between 1985 and 2014. A small subset of these deals, accounting for just 5% of the capital deployed generated fully 60 percent of all the Hosley Bridge returns. [Page 8]

Examples of Khosla’s deals [Page 10]

Startup Investment Return Multiple
Juniper Networks $5M $7B 1,400
Siara A few $M $1,5B >150
Cerent $8M Bought for $7B

About predictions: The revolutions that will matter – the big disruptions that create wealth for inventors [and investors! HL note] and anxiety for workers, or that scramble the geopolitical balance and alter human relations – cannot be predicted based on extrapolations of past data, precisely because such revolutions are so thoroughly disruptive. Rather, they will emerge as a result of forces that are too complex to forecast – from the primordial soup of tinkerers and hackers and hubristic dreamers – and all you can know is that the world in ten years will be excitingly different. […] the future can be discovered by means of iterative, venture-backed experiments. It cannot be predicted. [Page 11] “I always tell my CEOs, don’t plan. Keep testing the assumptions and iterating” Khosla again. [Note 32, page 416] All this of course reminds me also about the Black Swan.

Why is venture capital so different from other sources of finance? Most financiers allocate scarce capital based on quantitative analysis. venture capitalists meet people, charm people, and seldom bother with spreadsheets [*]. Most financiers value companies by projecting their cash flows. Venture capitalists frequently back startups before they have cash flows to analyze. Other financiers trade millions of dollars of paper assets in the blink of an eye. Venture capitalists take relatively small stakes in real companies and hold them. Most fundamentally, other financiers extrapolate trends from the past, disregarding the risk of extreme “tail” events. Venture capitalists look for radical departures from the past. Tail events are all they care about. [Page 14]

[*] Academic survey work confirms that one in five venture capitalists do not even attempt to forecast cash flows when making an investment decision. [Note 36 page 416]

All this is from the introductory chapter only and I liked it very much. Maybe more soon but in the mean time, you can always have a look at my visual history of venture capital.

Venture capital by Bill Janeway (part II)

In a remarkable new series of videos, Venture Capital in the 21st Century, Bill Janeway describes the value and challenges of technology innovation. I mentioned in my last post the perfomance of venture capital, his third video.

The first video, Investing at the Technological Frontier, describing the radical uncertainty of innovation and how it contributes to economic development.

In the second video, What Venture Capitalists Do, he further develops his thoughts that I summarize through a few screenshots below. (They are self explanatory and you should certainly listen to Janeway if you are curious or intrigued).

The 4th video, The Failure of Market Failure, opens the debate of state intervention and private speculation. This important topic has been largely debated by Mariana Mazzucato and you will find additional posts under tag #mazzucato.

How Venture Capitalists Are Deforming Capitalism

This is the title of a great article from the not less great New Yorker, dated November 23, 2020 and written by Charles Duhigg:

How Venture Capitalists Are Deforming Capitalism,
Even the worst-run startup can beat competitors if investors prop it up. The V.C. firm Benchmark helped enable WeWork to make one wild mistake after another—hoping that its gamble would pay off before disaster struck.


Illustration by Golden Cosmos (from the New Yorker article)

I am infringing copyright here and hope the magazine and author will forgive me. But the illustration says so well what the author describes! Yes, for a few years now, venture capital has become a crazy money spending machine.

I already posted blog about VC crises as over time the activity as evolved. From frugal investors in technology in the 60s and particularly in the 70s (Apple, Microsoft,..) and 80s (Cisco, Sun, …) The internet “bubble” was not the first period of hubris, there was one in the early eighties with tons of PC clones. But the real hubris came with the social media. Today, startups raise hundreds of millions of dollars before going public and experience huge, huge losses even at IPO as you may want to check in my 600 startups analysis (and it will be probably even worse in my 700 startups analysis to come). Here are past articles:

September 2020: Theranos, the (not so)-Silicon Valley biggest scandal ever – https://www.startup-book.com/2020/09/12/theranos-the-not-so-silicon-valley-biggest-scandal-ever/

April 2016: Is the Venture Capital model broken? – https://www.startup-book.com/2016/04/26/is-the-venture-capital-model-broken/

January 2016: Is Silicon Valley crazy (again)? – https://www.startup-book.com/2016/01/28/is-silicon-valley-crazy-again/

January 2011: Is there something rotten in the kingdom of VC? –
https://www.startup-book.com/2011/01/27/is-there-something-rotten-in-the-kingdom-of-vc/

At this point read carefully what venture capital was according to the author of the article: From the start, venture capitalists have presented their profession as an elevated calling. They weren’t mere speculators—they were midwives to innovation. The first V.C. firms were designed to make money by identifying and supporting the most brilliant startup ideas, providing the funds and the strategic advice that daring entrepreneurs needed in order to prosper. For decades, such boasts were merited. Genentech, which helped invent synthetic insulin, in the nineteen-seventies, succeeded in large part because of the stewardship of the venture capitalist Tom Perkins, whose company, Kleiner Perkins, made an initial hundred-thousand-dollar investment. Perkins demanded a seat on Genentech’s board of directors, and then began spending one afternoon a week in the startup’s offices, scrutinizing spending reports and browbeating inexperienced executives. In subsequent years, Kleiner Perkins nurtured such tech startups as Amazon, Google, Sun Microsystems, and Compaq. When Perkins died, in 2016, at the age of eighty-four, an obituary in the Financial Times remembered him as “part of a new movement in finance that saw investors roll up their sleeves and play an active role in management.”

But some famous experts of innovation are quoted about the current situation:

Steve Blank: “I’ve watched the industry become a money-hungry mob. V.C.s today aren’t interested in the public good. They’re not interested in anything except optimizing their own profits and chasing the herd, and so they waste billions of dollars that could have gone to innovation that actually helps people.” and his answer to the crisis is quite strong: “The first time you see a venture capitalist prosecuted for failing to uphold their duty as a board member, you’re going to see Silicon Valley transform overnight. All it takes is one V.C. doing a perp walk and everyone gets the message—you’re responsible, you have a legal duty, and if you do things that are bad for society you’ll be called to account.”

Martin Kenney, the professor at the University of California, Davis, said, “Obama loved Silicon Valley and V.C.s, and Trump craved their approval.” He went on, “Regulators have been totally defanged from doing real investigations of venture-capital firms. I think people are finally waking up to the damage the tech industry and V.C.s can do, but it’s slow going.” Today’s V.C.s, “money-losing firms can continue operating and undercutting incumbents for far longer than previously.”

Josh Lerner, a professor at Harvard Business School: “Proclaiming founder loyalty is kind of expected now.”

A Harvard Business School professor, Nori Gerardo Lietz, noted that the document exposed WeWork’s “byzantine corporate structure, the continuing projected losses, the plethora of conflicts, the complete absence of any substantive corporate governance, and the uncommon ‘New Age’ parlance,” the S-1 was “misleading, and probably fraudulent.”

I will finish my post with a quote mentioned by Bruce Dunlevie, the partner from Benchmark who was one the WeWork boardmember, a task he did not handled perfectly even if not that badly. Nothing to add. “Power tends to corrupt, and absolute power corrupts absolutely.” Lord Acton and the rest of the quote (not mentioned in the article) is “Great men are almost always bad men…”

Apple and its first investors : hilarious!

This morning, I was participating to a workshop about startups and one question came about the relationships with investors entrepeneurs are trying to attract and invest in their company. I told them it could be frustrating for many reasons, often because VCs never say no but decline too often to invest too. The best illustration comes from Something Ventured, a documentary movie I never stop celebrating. The Apple case is close to being hilarious. You find the extract beginning around minute 51 in the video:


and here is the text: [Narrator] In 1976, the computer was about to get personal. […] For venture capitalists, this represented the opportunity of a lifetime.

[Perkins Chuckles] We turned down Apple Computer. We didn’t – We didn’t even turn it down. We didn’t agree to meet with Jobs and Wozniak.
[Reid Dennis] Oh, that would have been a fabulous investment if we had made it, but we didn’t. We said, “Oh, no, we’re not really in that business.”

[Pitch Johnson] “How can you use a computer at home? You’re gonna put recipes on it?”

[Bill Draper] I sent my partner down to look at Apple. He came back and he said “Guy kept me waiting for an hour, and he’s very arrogant.” And, of course, that’s Steve Jobs! I said, “Well, let’s let it go.” That was a big mistake.

[Narrator] In 1976, the only people who believed in the personal computer… were the geeks and nerds who gathered at Homebrew Computer Clubs.

[Bushnell, founder & CEO of Atari] They needed an investment, and, uh, they offered me a third of Apple Computer for $50,000… and I said, “Gee, I don’t think so.” I could have owned a third of Apple Computer for $50’000. [Sighs] A big mistake. But I said, “Call Don Valentine.”

[Valentine] So we had our meeting. I went to Steve’s house. And we talked, and I was convinced it was a big market… just embryonically beginning. Steve was in his Fu Manchu look, and his question for me- “Tell me what I have to do to have you finance me.” I said, “We have to have someone in the company… who has some sense of management and marketing and channels of distribution.” He said, “Fine. Send me three people.” I sent him three candidates. One he didn’t like. One didn’t like him. And the third one was Mike Markkula. Mike Markkula worked for me at Fairchild before he went to Intel.

[Markkula] I said, “Okay.” ‘Cause that’s what I did on Mondays. I was retired. [Chuckles] I think I was 32 when I retired from Intel. But one day a week, I would help people start companies and write business plans. I did it for free, just for the interaction with bright, uh, people… So I went over and talked to the boys. [Laughs] The two of them did not make a good impression on people. They were bearded. They didn’t smell good. They dressed funny. Young, naive. But Woz had designed a really wonderful, wonderful computer. […] And I came to the conclusion that we could build a Fortune 500 company in less than five years. I said I’d put up the money that was needed.

[Narrator] Mike Markkula came out of retirement, becoming the president and C.E.O. of Apple. And the first call he made was to Arthur Rock. Arthur would have missed Apple if it weren’t for Mike Markkula.

[Rock] Jobs and Wozniak came up to see me, and they were very unappealing. Goatee, long hair [Muttering] Markkula said, “Well, before you make up your mind, there’s a computer show. You ought to come down and see what’s going on.” And he did. He thought somethin’ was happenin’. He wasn’t quite sure what. And there was this booth with everybody around it. I couldn’t even get next to it. And it was the Apple booth.
Then I got a call from Don Valentine. [Chuckles] “I want to put some money in that company” I said, “Okay, you gotta come on the board then.”
You know in the venture capital business, if you look at 200 deals, and you, you might do 10 of’em, and you will think they’re all great, and if one of’em is great, then you’re in the hall of fame.

Just in case, a little more about something ventured from my blog in 2012: https://www.startup-book.com/2012/02/08/something-ventured-a-great-movie/.

Finally, let me remind you of other “missed deals” in another recent post: The amazing challenge of finding great startups.

A Fury of Software IPO Filings

After many, many IPO filings from biotech startups in 2020 (I counted 20 out of the 43 I followed and made cap. tables of), the end of August had 8 filings from Software companies (and only 15 in total). I do not think there is any rational here (except maybe Palantir as a trigger), but I decided to have a look at these 8 companies.

These are
BigCommerce (Australia)
Palantir Technologies (see my previous post here)
Asana, Sumo Logic, SnowFlake (Silicon Valley)
Unity Software (Denmark), Jfrog Ltd (Israel)
AmWell (Boston)

You can have a look at some cap. tables in the pdf (pages 633, 636-42) but more than the individual data (also below at the end), it is the (limited) stats which I find interesting:

The data deserve some explanation and also deserve to be compared with the averages of the more than 600 startups studied in the pdf (pages 644-659).

These “young” startups took 12 years to go public, this is much more than in the (recent) past and they used amazing amounts of venture capital, in the hundreds of millions. Even the series A, the 1st round, is huge, about $10M. Their sales are big too (more than $100M for all of them) with a mediam value of $150M. Their losses are not small with a median value of $100M…

Now If we look at shareholding, investors own about 45% of the company, not more than in the past (despite the huge fund raising), IPO shares are pretty small (about 4%). Common shares (mostly employees) is about 35% and you should also notice that these startups have hundreds not to say thousands of employees. As a side comment non-founding CEOs are not the norm and have about 3.5% of the company (CFOs have about 0.7%)

The founders keep about 14%. They are about 2 per company, with a median age of 35 (mean is 33 so slightly lower than the overall 38.

I think all this is pretty interesting and feel free to have a look at overall stats in my post earlier this year: data about equity in 600+ startups.

Equity List August2020

 

Palantir files to go public

I am not sure this was worth a post as there is nothing really surprising with Palantir IPO filing that can be found here on the NASDAQ website. Still, this is Palantir, the secretive software company cofounded by Peter Thiel, Alexander Karp & Stephen Cohen (as well as Joe Lonsdale and Nathan Gettings)


Thiel, Karp, Lonsdale & Cohen (Gettings cannot be found online)

So I did my favorite exercise, building a tentative cap. table. Here it is:

What are the striking facts: the high level of sales, losses and fund raising. The startup, neither its founders are not young anymore… That’s it. Or feel free to comment!

Return on Investments – IRR & multiples

In venture capital, returns on investments is the ultimate metric and although it is not very difficult to understand, there are many little tricks worth knowing about!

The reason of this short post is a recent article my friend Fuad advised me to read from the Financial Times : The parallel universe of private equity returns by Jonathan Ford. If you are not a subsciber to the FT (and I am not), you may not be able to read the article so here are short extracts: “Ever wondered about the extraordinary performance figures that listed private equity firms trumpet in their official stock market filings? […] Not only do the firms generate stratospheric numbers — far higher than anything produced by the boring old stock market — but they can apparently do it year in, year out, with no decay in returns. […] The reality is that these consistent IRRs show nothing of the kind. What they actually demonstrate is a big flaw in the way the IRR itself is calculated.”

When I looked at venture capital (VC) returns in the past, I learned you must carefully look at what IRR means. It looks simple at first sight as the next table shows, just simple math:

So the first question you care about is what matters: IRRs or multiples? And my simple answer is “it depends”. Up to you!

Secondly, measuring returns makes a lot of sense when you have your money back. Of course! But IRR and multiples can also be measured while you are still invested and when your investment is not liquid, which is the case for private companies in which invests private equity (PE) – venture capital belongs to PE. You can have a look at a former post of mine, Is the Venture Capital model broken? and among other figures look at this:

VC2016-1-IRRs
The VC performance according to the Kauffman foundation

The peak IRR is measured when your assets are not liquid whereas the final IRR is when you have your money back… A fund as usually a 10-year life (or 120 months) and you can check the peak IRR month.

Even more tricky, the money is called by periods to make the holding as short as possible: basically, when the money is needed to invest, though you commit to it for the full life of the fund. Measuring the real IRR begins to be complicated but what matters to me is the multiple from the day of commitment to the finaldah when the money is back… And to you?

A final point I love to mention all the time is that VC is not so much about a portfolio of balanced investments. In the same post mentioned above, I added two links, and one of the best quote is “Venture capital is not even a home run business. It’s a grand slam business.”

Have a look at The Babe Ruth Effect in Venture Capital or In praise of failure. VC statistics are not gaussian, they follow a power law:

Equity sharing in startups – a presentation

A few days ago, I had the opportunity to present a video conference on equity sharing in a startup, between founders, investors and employees. I’ve done it many times in the last few years like the one Slideshare here, but I had never recorded it. It’s now done:

As archive, the Slideshare presentation…

The other links

600 capitalisation tables: https://www.startup-book.com/2020/04/06/updated-data-in-equity-of-600-former-startups/

Universities and equity ownership in startups : https://www.startup-book.com/2013/11/05/how-much-equity-universities-take-in-start-ups-from-ip-licensing/

Startups and titles : https://www.startup-book.com/2019/12/11/titles-in-start-ups/

Penny Schiffer’s Tweet : https://twitter.com/PennySchiffer/status/718323492006076417

Slicing pie : https://slicingpie.com/

Pie calculator : https://www.andrew.cmu.edu/user/fd0n/35%20Founders%27%20Pie%20Calculator.htm

Two additional lists of references I just found thanks to Penny Schiffer: Useful resources for (present and future) investment analysts — Part 1 and Part 2

The amazing challenge of finding great startups

“Prediction is very difficult, especially about the future.” attributed to Niels Bohr.

I was asked yesterday which startups I knew were the most promising, not to say the greatest. So I prefer to refer you to the quote above as I did not understand the potential of Google and Skype when I first heard of them. I am less shy of my lack of talent as this difficulty in predicting has been acknowledged by others.

Already in 2011, I had posted on the topic in The Missed Deals of Venture Capitalists. You should read the examples of Amazon and Starbucks by OVP.

So I did a little search and found again some more examples from again the antiportfolio of BVP (Bessemer Venture Partners) as well as from the book The Business of Venture Capital by Mahendra Ramsinghani. Enjoy!

First from the book The Business of Venture Capital on page 207:

Legendary investor Warren Buffet admired Bob Noyce, cofounder of Fairchlid Semiconductor and Intel. Buffet and Noyce were fellow trustees at Grinnell College, but when presented, Buffet passed on Intel, one of the greatest investing opportunities of his life. Buffet seemed “comfortably antiquated” when it came to new technology companies and had a long-standing bias against technology investments.

Peter O. Crisp of Venrock adds his misses to the list: One “small company in Rochester, New York [came to us, and one of our junior guys] saw no future [for] this product… that company, Haloid, became Xerox.” They also passed on Tandem, Compaq and Amgen.

ARCH Venture Partners missed Netscape – that little project Marc Andreessen started at the University of Chicago. An opportunity that, according to Steven Lazarus, would have been worth billions! “We just never knocked at the right door,” he would say. Eventually, ARCH decided to hire full-time person to just keep tabs on technology coming out of the universities to “make certain we don’t miss that door next time.”

Deepak Kamra from Canaan Partners comments on his regrets: “Oh, God, I have too many … this gets me depressed. A friend of mine at Sun Microsystems called and asked me to meet with an engineer at Xerox PARC who had some ideas to design a chip and add some protocols to build what is now known as a router. The drivers of bandwidth and Web traffic were strong market indicators, and he was just looking for $100,000. I really don’t do deals that small and told him lo raise some money from friends and family and come back when he had something to show” That engineer was the founder of Juniper Networks. He got his $100,000 from Vinod Khosla. Khosla, then with KPCB, added an IPO to his long list of winners. Juniper slipped out of Kamra’s hands because it was too early.
And of course, those were frothy times when everyone was deluged with hundreds of opportunities each day.

KPCB missed an opportunity to invest in VMWare because the valuation was too high: a mistake, according to John Doerr.

Draper Fisher Jurvetson (DFJ) was initially willing but eventually passed on Facebook (ouch!), as the firm believed the valuation was too high at $100 million pre-money.

KPCB, not wanting to be left out of an opportunity like Facebook, invested $38 million alt a $52 billion valuation.

Tim Draper of DFJ, turned down Google “because we already had six search engines in our portfolio.”

K. Ram Shriram almost missed his opportunity to invest in Google when he turned the founders away. “I told Sergey and Larry that the time for search engines had come and gone but I am happy to introduce you to all the others, who may want to buy your technology. But six months later, Ram Shriram, who had once turned Google down, now invested $500,000 as one of the first angel investors.

By the way Tim Draper’s father Bill also missed Yahoo. You can check The Startup Game by Bill Draper.

Now some examples of the updated BVP antiportfolio:

AirBnB: Jeremy Levine met Brian Chesky in January 2010, the first $100K revenue month. Brian’s $40M valuation ask was “crazy,” but Jeremy was impressed and made a plan to reconnect in May. Unbeknownst to Jeremy, $100K in January became 200 in February and 300 in March. In April, Airbnb raised money at 1.5X the “crazy” price.

Facebook: Jeremy Levine spent a weekend at a corporate retreat in the summer of 2004 dodging persistent Harvard undergrad Eduardo Saverin’s rabid pitch. Finally, cornered in a lunch line, Jeremy delivered some sage advice, “Kid, haven’t you heard of Friendster? Move on. It’s over!”

Atlassian: Byron Deeter flew straight to Atlassian in 2006 when he caught wind of a developer tool from Australia (of all places!). Notes from the meeting included “totally self-financed, started with a credit card” and “great business, but Scott & Mike don’t ever want to be a public company.” Years and countless meetings later, the first opportunity to invest emerged in 2010, but the $400m company valuation was thought to be a tad “rich.” In 2015, Atlassian became the largest tech IPO in Australian history, and the shares we passed on are worth more than a billion dollars today.

Tesla: In 2006 Byron Deeter met the team and test-drove a roadster. He put a deposit on the car, but passed on the negative margin company telling his partners, “It’s a win-win. I get a great car and some other VC pays for it!” The company passed $30B in market cap in 2014. Byron paid full price for his Model X.

eBay: David Cowan passed on the Series A round. Rookie team, regulatory nightmare, and, 4 years later, a $1.5 billion acquisition by eBay.

But one of the nicest stories I had heard of is Nolan Bushnell, founder and CEO of Atari, declining Apple… I heard of it through (absolute must-watch) Something Ventured. More here How Atari’s Nolan Bushnell turned down Steve Jobs’ offer of a third of Apple at $50,000.