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I was on an airplane for the first time for business in a while and when I woke up from my nap I found my self staring at CNBC on the DirecTV seat back display. I never watch CNBC so I was attracted to the talking heads, who were silent since I didn’t have earphones in. I kept thinking I was watching ESPN with all the sports metaphors, blinking lights, constantly changing headlines, and tightly coifed and good looking men talking at me in rapid fire.
Between a headline about Carly Fiorina exploring a run for president and Zebra Technologies equipping all NFL players with tracking devices I noticed one about companies who were raising prices to inflation proof their business. At least, that’s what I thought it said since it flashed up there quickly between a headline about “Steel is on Fire” and then a video of Warren Buffett walking around without a headline so I had no idea why they were showing him.
The inflation proofing headline stuck in my head. We’ve had a very long period of low to no inflation, at least based on the way the government calculates it. While my cynicism around government math and how inflation is calculated is substantial, there isn’t much question that since 2008 capital has been extremely cheap. Fred Wilson wrote a great post titled The Bubble Question a while ago where his punch line was:
It is the combination of these two factors, which are really just one factor (cheap money/low rates), that is the root cause of the valuation environment we are in. And the answer to when/if it will end comes down to when/if the global economy starts growing more rapidly and sucking up the excess liquidity and policy makers start tightening up the easy money regime. I have no idea when and if that will happen. But until it does, I believe we will continue to see eye popping EBITDA multiples for high growth tech companies. And those tech companies with eye popping EBITDA multiples will use their highly valued stock to purchase other high growth tech business and strategic assets at eye popping valuations. It’s been a good time to be in the VC and startup business and I think it will continue to be as long as the global economy is weak and rates are low.
But I think cheap capital is only half of the equation. The other half is ever increasing labor costs across all aspects of the wage chain. When I was in business school in the 1980s, we talked a lot about the productivity paradox. The premise was that computers and automation would drastically improve productivity, making labor less important as tasks were automated, resulting in lower cost of labor.
As the technology industry rapidly evolved, the notion of non-productivity kept coming up. Nicolas Carr’s HBR Article “IT Doesn’t Matter” was probably the capstone piece around this and how companies could take advantage of the commoditization of IT, rather than how IT was a transformative input into companies and societies.
Suddenly, in 2010, technology was disrupting everything and the technology industry was booming. By 2013 everyone was talking about a bubble, even though the companies being created this time around were substantial. Once again, wages for IT employees and computer scientist were skyrocketing and suddenly coding schools were popping up everywhere, to the point that people are now saying that Computer Programming Is a Trade; Let’s Act Like It.
Capital remains incredibly cheap, so it’s flowing into wages. But that’s only at the high end of the market around technology jobs. At the other end of the spectrum, we have the famed jobless recovery with the elimination of massive numbers of jobs that previously existed, especially in industrial and Fortune 5000 companies. While this is happening, we have an entirely new class of entrepreneurs, or self-employed, being created by companies like Uber.
Yeah – this shit is super complicated and it plays out over a long period of time. In fact, it might only be really possible to understand what is happening in hindsight. But the combination of cheap capital and expensive labor has created a very powerful economic dynamic which right now is driving massive innovation across virtually every industry sector around the world.
We know that extremely low cost of capital will not last forever. We know that eventually there will be real inflation again. And we know that wages can’t increase endlessly. I wonder what happens to the allocation of capital, entrepreneurship, and the impact on society when capital gets expensive again?
I know many entrepreneurs who feel that VCs have played them, gamed them, deceived them, or bullshitted them. But this doesn’t only happen to entrepreneurs. VCs play this game with VCs all the time.
One of our deeply held beliefs at Foundry Group is that there is no value in bullshitting anyone. We screw up a lot of things, make plenty of mistakes, and often look back and say some version of “oops.” But we never bullshit each other or bullshit anyone we work with.
Seth, Jason, and I had an awesome dinner with one of our LPs last night. In addition to being an incredibly supportive investor in us from the beginning, this LP has become an extremely close friend. He’s someone we trust with anything and listen to carefully whenever he has feedback. And we always enjoy being together – a lot.
As I was walking home after dinner, I thought about the person who had introduced us to this LP. His name will be familiar to plenty of you – it’s Fred Wilson. This LP is also a long time investor in Union Square Ventures and was one of the first people Fred introduced us to when we started raising the first Foundry Group fund in 2007.
In 2014, it’s easy to reflect on what has happened over the last seven years and feel good about it. I’m fortunate to have three amazing partners, an awesome team that I get to work with every day, a hugely supportive set of about 20 LPs, and hundreds of entrepreneurs who we love to work with, and whom I think respect us and appreciate us a great deal.
But is wasn’t always this way. In 2007, when we set out to raise our first Foundry Group fund, early stage tech VC was in the shitter. No one believed that you could make any money as an early stage VC and when we went out to raise our first fund, we heard over and over again that we were on a fools errand. The prior fund that I had co-founded – Mobius Venture Capital – had blown up after having a very successful first fund in 1997. The collapse of the Internet bubble was not kind to us and by 2005 it was clear that our second fund – raised in 1999 – was a disaster, and our third fund – raised in 2000 – was off to a very rocky start.
In early 2006, my partners at Mobius and I decided not to raise another fund. In 2007, several of us (Jason, Ryan, Seth, and I) set out to create a new firm.
I thought I had a lot of VC friends and supporters from the last decade of my life as a VC. I quickly learned that it was easy for these so-called friends to say “I’ll help” and very hard for them to actually follow through.
When we started raising our first Foundry Group fund in 2007, I called many of the VCs I knew and asked them for introductions to their LPs. While some of them said they would help, I only recall three who actually made any serious introductions.
Fred Wilson at Union Square Ventures was by far the most helpful. Fred introduced me to all of his significant institutional LPs. We had been friends for a long time and had worked together on several companies. I had deep respect for Fred and I think he felt the same way about me. There was no hesitation on Fred’s part – he made real introductions, advocated strongly for us, and was unbelievably supportive. Over 33% of our capital ended up being from the same LPs who invested in USV. I will never, ever, ever, forget this. Fred can ask me for help on anything he wants for the rest of his life and I will always be there for him.
The next person on the list of supporters is Scott Maxwell at OpenView Venture Partners. Scott and I were both on the Microsoft VC Advisory Board that Dan’l Lewin organized and ran. While we had never invested together, I felt like Scott was a kindred spirit. We both spoke truth to Microsoft execs, even though they mostly ignored us. I remember a meeting with the Microsoft Mobile 6.0 team as they were pitching us their vision for Microsoft Mobile 6.5. Both Scott and I, on iPhone 1′s or 2′s at the time, told them they were completely and totally fucked. They ignored us. A year or two later they had less than 3% market share on mobile. We had a blast together and as we went out to raise our Foundry 2007 fund, Scott made several introductions which resulted in two wonderful, long term LP relationships.
The last person who was helpful was Jack Tankersley at Meritage. When I moved to Boulder, Jack was one of my early mentors. He was a partner and co-founder of Centennial Funds and he and Steve Halsted basically created the VC industry in Colorado in the early 1980s. Jack was extremely helpful in coaching me on how to create a new firm and made a number of introductions, one of which became an LP. I appreciated the energy he put into this immensely.
There were at least a dozen other VCs who said “I’d be happy to make some introductions for you.” Very few of them did, and the ones that did made introductions to junior people at LPs who quickly blew us off.
My partners and I are forever appreciative of Fred, Scott, and Jack’s help. And, after 90 meetings in the first three months of fundraising, which resulted in 20 immediate rejections and no obvious path to a fund at the end of the first quarter, our appreciation for these three people grew. As we started to have momentum in the second quarter, Fred and Scott really stepped up and advocated for us. By September we were oversubscribed and did our first close with our final close in November. We’ve never looked back.
The wonderful dinner last night with the LP Fred introduced me to reminded me of this. But more importantly, it reminded me of how often VCs bullshit each other and entrepreneurs. And, in the situations where they don’t, how incredibly powerful it is.
Fred, Scott, and Jack – thank you.
I woke up to an article in Daily Camera today titled Small Business Administration trying to bring SBIC funds to Colorado.
There are so many things wrong in the article I felt compelled to write about it. This isn’t a knock on the writer (Alicia Wallace) – I like Alicia and think she does a good job. Rather, it’s an example of the difference between signal and noise in any kind of reporting around the VC industry.
I’m an investor in over 40 VC funds around the world (mostly in the US) and three of them are SBIC funds. Each of the SBIC funds were raised in the 2000 – 2002 time period. On paper, only one is in positive return territory as a fund, but the SBIC leverage is a substantial negative factor for the LP investors in that particular fund. And, in the other two, I don’t expect to ever see any of my capital back because of the SBIC leverage. Furthermore, I don’t believe any of the GPs in any SBIC-backed fund would ever take money from the SBIC again.
So I’m speaking from at least a little experience – albeit indirectly – with the SBIC, as I’ve never been a GP in a fund that had SBIC leverage.
The article starts off saying that “Matthew Varilek has traveled across the state, proselytizing the potential benefits of the Small Business Investment Company Program.” As a partner in one of the most visible VC firms in Colorado and an LP in many of the Colorado VC firms, I’ve never heard from Matthew or anyone from the SBIC. Matthew, if you really want to have a deep discussion about why the SBIC program isn’t effective for VC funds anymore, feel free to give me a shout. I’d be happy to meet with you.
Next, there is the wonderful PR quote about the SBIC that says “Since the program’s inception, SBIC “success stories” include the funding of companies such as Apple, Costco and FedEx when they were burgeoning small businesses.” The SBIC was instrumental in the creation of the venture capital business. The Small Business Investment Act of 1958 helped catalyze many of the VC firms created in the early 1960s. When I first heard about VC firms in the late 1980s, and my first company (Feld Technologies) started writing portfolio management software for some Boston-based VC firms, many of them had funds with SBIC leverage, although even by the late 1980s this was changing and many of them had shifted away from the SBIC. If you want to see a fun quote on it, read A History of Silicon Valley which quotes:
“ …many venture capital pioneers think the SBIC program did little to advance the art and practice of venture investing. The booming IPO market proved the model of investing in new companies, as some SBICs cash out at attractive levels. SBICs did give a boost to early venture firms, and some like Franklin “Pitch” Johnson, profiled below, thought the new law made the US “see that there was a problem and that [venture investing] was a way to do something… it formed the seed of the idea and a cadre of people like us.” Bill Draper, the first West Coast venture capitalist, has been more blunt: “[Without it] I never would have gotten into venture capital. . . it made the difference between not being able to do it, not having the money.” Many believe SBICs filled a void from 1958 to the early 1970s, by which point the partnership-based venture firms took off. The US government, however, lost most of the $2 billion it put into SBIC firms.”
So, while Apple, Costco, and FedEx benefited, the PR would be more credible if the SBIC was trumpeting iconic companies created after 1990 or even 2000, especially where the lead investors (rather than follow on investors) had SBIC capital.
Peter Adams, head of Rockies Venture Club, is quoted a few times. I like and respect Peter, so this isn’t aimed at him, but rather at the clear lack of understanding of the capital dynamics around VC funds.
“It looks really great on the surface,” said Peter Adams, executive director of the Rockies Venture Club, a nonprofit aimed at connecting investors and entrepreneurs. “Then when you dig into it, there were some problems.” Adams, who has been involved in many of the meetings with the SBA and members of the investment community, said the greatest concerns voiced by investors and venture capitalists involved management team qualifications, investment track records and the addition of debt to the equation. No. 1 for us is they want a management team with multiple people that have track records in venture capital and have worked together as a team before,” he said. “I can see where they’re going with it, but the VC industry in Colorado has been fairly decimated through the economic downturn.”
Peter is right about the context, but has two fundamental things wrong here. First, the VC industry in Colorado wasn’t decimated through the economic downtown. It was decimated because of lack of performance between 2001 and 2009, just like much of the rest of the VC industry around the US. There’s nothing special about Colorado in this mix, and it has nothing to do with the economic downtown. This dynamic has been reported thousands of times so I don’t need to go through it again, but we don’t have to look back very far to hear the drum beat from the media, LPs, and everyone else about how “VC is dead.” And if you’re curious, it wasn’t too long ago that Silicon Valley was also dying.
The other problem here is the need of the SBIC to invest in “a management team with multiple people that have track records in venture capital and have worked together as a team before.” Any VC firm that fits this qualification is unlikely to have difficulty raising money in today’s environment, and subsequently has no need for the SBIC leverage. And, more importantly, the only firms that will look for SBIC leverage are one’s that don’t have this, which is a classic adverse selection problem.
Then there’s this:
The recession also then plays into requirements that the management team members have been involved in a meaningful number of successful exits during a four- to six-year period. “From 2008 to 2013, that was not a good time for exits,” Adams said.
Huh, what? At Foundry Group, our significant exits (at least 10x capital returned) since we raised our first fund in 2007 include AdMeld, Zynga, MakerBot, and Gnip. We’ve had plenty of other exits, but these are the big ones. One of those companies, Gnip, is Boulder-based and another from our older funds (Rally Software) also generated a greater than 10x return for us. Techstars (which we helped start) have also had a steady stream of significant exits, including local Boulder companies like Filtrbox, GoodApril, and SocialThing. And then you’ve got plenty of Boulder / Denver monsters on paper – some in our portfolio (like SendGrid and Sympoz) and others like Zayo, Ping, Logrhythm, and Datalogix. Finally, if you look across the country, the exits have been awesome the past three years.
It keeps going. There’s talk about the “angel cliff” (e.g. we need funds to invest between angels and VCs – nope, been there – remember “gap capital” – not so effective) and the SBA rules and regulations (which I believe are toxic and inhibiting to a successful VC fund.)
One of the other problem is SBA and SBIC’s behavior in governance of the fund. The paperwork is silly and the overhead is non-trivial. The control over distributions and negative incentives to hold or distribute capital often generates bad decisions when companies go public. And at least one close friend who is a partner in an SBIC fund has now found a new LP to buy out the SBIC so they could actually invest capital in their winners, rather than be limited by the SBIC’s constraints on the amount of capital you can invest in any particular company.
The SBIC could be a powerful force for good in the venture capital industry. But it has to approach things very different and based on my experience with the SBA over the past decade, I don’t see it happening unless there is real leadership somewhere in coordination with leaders in the VC industry. I’m certainly willing to help, if only someone bothered to reach out to me.
UPDATE: It turns out my partner Seth Levine had met with Matthew a while ago. Seth said “Your blog was right on and much of the type of thing I related to Matt and some senior guys he brought in. The gist of my conversation with them was pushing them to consider a different model – that the current one basically led to lowest common denominator GPs and sub-optimal returns. Plus the SBIC leverage could be crushing. I don’t think they have a ton of flexibility around this but they at least listened to the feedback. I’m going to see a bunch of them in a few weeks – I agreed to help judge a business plan competition they were hosting. Like you I’m not a huge fan of the program as it has existed but I give the new guys some credit for both reaching out and trying to be proactive about thinking through this.”
UPDATE 2: Matthew Varilek reached out to me and we are setting up a time to talk.
I was in the bathroom this morning catching up on all the blogs (via Feedly) that I hadn’t read this week since my head was in a bunch of other things. I came across one from Nic Brisbourne (Forward Partners) titled I’m a stock picker. I wish he had called it “This Unicorn Thing Is Bullshit For Early Stage Investing” but I think he’s a little more restrained than I am.
My original title for this post was “How Can This Be A Billion Dollar Company and other bullshit VCs ask early stage companies.” It was asked by VCs to several companies I’m involved in last week. While I get why a late stage investor would ask the question when the valuation is in the $250 million range, I really don’t understand why a seed investor would ask this question when the valuation is in the $5m range.
Now, I’ve invested in a few unicorns in my investing career, including at least one unicorn that went bankrupt a few years later (I guess that’s a dead unicorn.) But I’ve also invested in a number of companies that have had exits between $100m and $1b that resulted in much larger returns for me, both on an absolute basis as well as a relative basis, than unicorns have for their later stage investors.
I’ve never, ever felt like the “billion dollar” aspiration, which we are now all calling “unicorn”, made any sense as the financial goal of the company. Nor have I felt it made sense as a VC investing strategy, especially for early stage investors. We never use the phrase “unicorn” in our language at Foundry Group and while we aspire to have extraordinarily valuable companies, we never approach it from the perspective of “could this be a billion dollar company” when we first invest.
Instead, we focus on whether or not we think we can make at least 10 times our money on our investment. Our view of a strong success in an investment in a 10x return. Our view is simple – we don’t really view anything below 3x return a success. Sure – it’s nice, but that wasn’t a real success. 5x – now that’s nice. 10x – ok – now we are in the success zone. 25x – superb. 50x or more – awesomeness.
We also know that when we invest in three people and an MVP, we have absolutely no idea whether this can be a billion dollar company. Nor do we care – we are much more focused on the product and the founders. Do we think they are amazing and deeply obsessed with their product? Do we understand their vision? Do we have affinity for the product? Do we believe that a real business can be created and we can get at least a 10x return on our investment at this entry point?
I recognize other VCs have different strategies than us, especially when they are investing at a later stage. Applying our model, if the entry point valuation is $100m or more, then you do have to believe that the company is going to be able to be worth over $1 billion if you use a 10x filter. But in my experience, most later stage investors are focused on a smaller absolute return as a threshold – usually in the 3x to 5x range. And, very late stage / pre-IPO investors already investing in companies worth over $1 billion are interested in an even smaller absolute return, often being delighted with 2x in a relatively short period of time.
So, let’s zone this in on an early stage discussion. Should the question “how can this be a $1 billion company” be a useful to question at the seed stage? I don’t think so. If it’s simply being used to elicit a response and understand what the entrepreneurs’ aspiration is, that’s fine. But if I asked this question and an entrepreneur responded with “I have no fucking idea – but I’m going to do everything I know how to do to figure it out” I’d be delighted with that response.
Almost exactly a year ago I wrote a post Your Words Should Match Your Actions. It was a generic rant that resulted from me watching a couple of VCs blow up their reputations with entrepreneurs I know because of how they treated them.
This morning I ended up on an email thread about this. I’m going to anonymize it, but you’ll get the point. The two people (who I’ll call “Entrepreneur” and “VC”) are both very successful, extremely smart, and very visible.
Entrepreneur: Thread below is 2+ years old, but resulted from VC asking me similar questions. Interestingly, when I (a year later) pinged VC about my new company, not even the courtesy of reply from him. Bad mojo.
Me: Welcome to the “assholeness-VC-factor.” Hey – I’m important – give me info. Oh – you are now raising money – fuck off.
Entrepreneur: I’m amazingly appreciative to short, polite “no thank you’s”. I don’t know whether VCs think that’s too much work, or whether they want to leave open the possibility of the “must have been caught in my spam filter” excuse when the startup becomes a rocket in 2 years?
I then went on a more serious rant explaining what I think is going on.
It’s worse that that.
In my book Startup Life (that I wrote with my wife Amy) I said that one of the key things that has made our relationship work is that I realized “my words had to match my actions.” After about decade of telling her she was the most important person in my life, and then being late to dinner, canceling things at the last minute because something else came up, or taking a phone call without even looking at who was calling when we were in the middle of a conversation, she’d had enough and our relationship almost ended.
My biggest behavior change 14 years ago was to focus hard on having my words match my actions, and my actions match my words. Simple to say, really hard to do.
Of course, it also works in a business context. I’ve learned, and deeply believe, that it’s the essence of being authentic. You can have any style you want – these two things just have to match up.
Sadly, many very successful people simply don’t understand or appreciate this. They put huge amounts of energy into developing a public persona. It could be PR, it could be speeches, or writing, or systematic campaigns over a period of time about themselves and their businesses.
But then their words and their actions don’t match up. Over and over again. It can be subtle or overt. It can be mild or jarring. It doesn’t matter – if they haven’t internalized the idea of their words and actions matching up, there is a long negative reputational effect.
And, as our email exchange demonstrates, it lingers. I have heard the same thing about that VC and I’ve experienced it personally. Yet his public persona is “entrepreneur friendly”, “very accessible”, “incredibly smart”, and “highly capable.” Yet, he completely blew you off, after asking you for something when you were a powerful and well-connected executive at a large company. Stupid behavior on his part.
Oh, and in addition, this VC missed a chance to invest in what is now a rocket ship. And the entrepreneur didn’t go back to him for the Series B because he got blown off the first time, so the VC missed two chances to invest.
Do your words match your actions? If you don’t know, ask yourself at the end of each day “did my words today match my actions.”