Silicon Valley Needs Startup Drano(bloomberg.com)
bloomberg.com
Silicon Valley Needs Startup Drano
https://www.bloomberg.com/gadfly/articles/2017-01-11/silicon-valley-startup-pipeline-needs-shot-of-drano
110 comments
I'm an LP in three venture funds. Typically there's an initial capital call when we commit to the fund, then 25% per year (you can end up with two capital calls in the first year depending on timing). The funds I invest in focus on very early rounds (seed or Series A) for initial investments, keeping $ in reserve for follow–on investments.
After about 18-24 months they raise the next fund.
With the GP I work with there's almost no overhead, just two GPs and the annual accounting. The annual accounting and tax filings can cause additional capital calls (small amounts, US$1500-2000).
As an LP (and a tiny one at that), one of the problems I'm seeing is that companies are raising ever larger up rounds at ever increasing valuations, giving away massive preferences to the later investors. This boxes the companies into seeking either grandiose exits justifying the valuations, or they wipe out the early investors (and employees) because of the preferences overhang with the finial investors (typically institutional money).
It's been an eye opening experience, I've learned a lot. Unsure how much more money I'll commit to investing this way though.
After about 18-24 months they raise the next fund.
With the GP I work with there's almost no overhead, just two GPs and the annual accounting. The annual accounting and tax filings can cause additional capital calls (small amounts, US$1500-2000).
As an LP (and a tiny one at that), one of the problems I'm seeing is that companies are raising ever larger up rounds at ever increasing valuations, giving away massive preferences to the later investors. This boxes the companies into seeking either grandiose exits justifying the valuations, or they wipe out the early investors (and employees) because of the preferences overhang with the finial investors (typically institutional money).
It's been an eye opening experience, I've learned a lot. Unsure how much more money I'll commit to investing this way though.
Could you speak more about why re-investments cannot be made? It seems the inability to re-invest would skew decisions towards 10x and 100x returns rather than a series of 1.5x returns done many times. My background is mostly Wall St, and for us, a 1% return on a small horizon is great -- since you can just keep repeating it. Why would GPs be blocked from doing something similar where they aim for quick base hits rather than a grand slam?
I honestly don't know except from my experience that the goal is to keep the fund as low cost as possible: invest in a bunch of companies early, invest in follow-on rounds over next couple of years, and otherwise keep overhead down.
The funds I'm in don't take board seats, though they do offer access to its network of investors and contacts to the companies it invests in. Different funds are run different ways. The GPs of the funds I'm in do not do this as their primary job, other funds have principals (GPs or other forms of partners) who draw their income from the funds in one way or another.
Other considerations: the funds have a limited lifespan (I believe each of the three I'm in are 10 year limited partnerships with an option to extend by simple majority vote of LPs). Because they're limited partnerships, the returns get reported as income to the IRS, and I'd owe taxes on them, even if they were not distributed, which is another reason not to re-invest returns (if the returns were re–invested, you could potentially pay taxes on income which then gets "lost" when re–invested in a startup which fails).
I commented elsewhere in this thread that so far across three funds we're seeing the 33% fail, 33% break even (modest returns) and 33% either have returned the fund or have potential to do so, which is a pattern I've seen repeated by many venture funds over the years I've been following or investing in them.
The funds I'm in don't take board seats, though they do offer access to its network of investors and contacts to the companies it invests in. Different funds are run different ways. The GPs of the funds I'm in do not do this as their primary job, other funds have principals (GPs or other forms of partners) who draw their income from the funds in one way or another.
Other considerations: the funds have a limited lifespan (I believe each of the three I'm in are 10 year limited partnerships with an option to extend by simple majority vote of LPs). Because they're limited partnerships, the returns get reported as income to the IRS, and I'd owe taxes on them, even if they were not distributed, which is another reason not to re-invest returns (if the returns were re–invested, you could potentially pay taxes on income which then gets "lost" when re–invested in a startup which fails).
I commented elsewhere in this thread that so far across three funds we're seeing the 33% fail, 33% break even (modest returns) and 33% either have returned the fund or have potential to do so, which is a pattern I've seen repeated by many venture funds over the years I've been following or investing in them.
I can't speak to the reasoning, but that's exactly the impact. I was at a start-up that needed bridge financing to pay off some debt; we had a customer placing orders and we were literally months from being insanely profitable. It was late 2008 - early 09, in the depths of the financial crisis. No bank would touch us, and VC's wanted a minimum 2x return on their investment. We ultimately ended up having to sell the company.
Because of the rate of failure for early stage startups are high, the need for individual winning investments to make up for the other losses AND generate the required returns for both the LPs and the carry for the fund managers would require that base hits for winners are not sufficient. The wins need to be much more significant to allow the portfolio as a whole to have acceptable returns. In general I agree with you -- I prefer shorter-horizon lower-scale repeatable wins over longer-horizon, high-risk, potentially greater returns. I honestly think venture investing is successful for only a small number of entities who happen to either have some sort of inside track into superior deal flow, and ability to CREATE winners by influencing markets (exit markets especially), or some sort of strategic advantage in their industry. Otherwise it's 100% luck. As an individual investor, I think angel investing is very much an easy way to part with a lot of money. I stopped angel investing when I realized it was high-risk gambling/speculation combined with some sort of philanthropy combined with ego-centric elbow rubbing with others. I've got a stock-based swing strategy I'm working instead. Lower downside risk, with equal potential gains at scale.
How do you get into this line of business, do you need to have a lot of connections to Wall Street already?
In my case: I knew a guy who wanted to start a venture fund, and he focused on an area that appealed to me (mix of IOT, healthtech, weird stuff). I qualify as an accredited investor (in the US). And I have a small amount of money I'm willing to set fire to in the hope that a chunk of it has excellent returns. So far across three funds (with same GP), Fred Wilson's 33/33/33 split is holding true.
An individual LP in a fund is typically just a wealthy person. Historically the term was an accredited investor which was a legal definition that set minimum wealth/income standards. This changed recently with the JOBS act but I haven't kept up with the latest requirements. Often times they are former entrepreneurs or high income individuals (lawyers, doctors, corporate VPs, senior engineers etc).
In practice, this is not the major pain point I think you are calling it. The letters I read often have variants of "We've returned [0.8-2.5x] capital and still have [Uber] in the portfolio!"
What may be painful is not being able to at least return capital by the end of the fund without a WONDERFUL story about coming liquidity.
Current industry average 10 year IRR is 10% according to Cambridge Associates. You've really fucked things up badly if you can't return capital in year 9/10 on a 10% IRR.
What may be painful is not being able to at least return capital by the end of the fund without a WONDERFUL story about coming liquidity.
Current industry average 10 year IRR is 10% according to Cambridge Associates. You've really fucked things up badly if you can't return capital in year 9/10 on a 10% IRR.
To save others the trip to Wolfram Alpha:
Assuming money is put into the fund in year 0, a return of 2.35x capital in year 9 or 2.6x capital in year 10 is required to get a 10% IRR.
Assuming money is put into the fund in year 0, a return of 2.35x capital in year 9 or 2.6x capital in year 10 is required to get a 10% IRR.
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Distributing shares of a private company at fund liquidation is not unheard of either. In some cases (Box, Groupon, LendingClub) distributing early at private valuations allows to record a better IRR than subsequent public valuations.
Is that real return? (i.e. adjusted for inflation)
Or even better, is that comparative performance, i.e. 10% better than a vanguard index fund?
Or even better, is that comparative performance, i.e. 10% better than a vanguard index fund?
> It's also going to be a tough road show if your story is that you invested millions of dollars in your last fund and it's all still tied up
Depends on what you promised those investors and how the fund is doing. Nobody complains about being in SpaceX or Uber.
Depends on what you promised those investors and how the fund is doing. Nobody complains about being in SpaceX or Uber.
For others wondering what an LP is: http://www.investopedia.com/terms/l/limitedpartnership.asp
I've had this thought in my head for quite some time about what I call "bottom line companies" - That is, companies that add "substance" to the bottom line of society. When I think about bottom line companies, I think about GE, AT&T, CN, JetBlue, Mondelez International (Kraft) and the like. I often wonder about how these ventures got started. Over the past 20 years, have we seen many bottom line companies founded? Also, tangentially but interestingly: http://www.inc.com/magazine/19850501/495.html
These are all brick-and-mortar companies that were built around a single product (electricity, telephone, railways, airlines, dairy roll-up) and later expanded by merging with competitors or expanding into related fields. You can also add P&G, General Mills, Johnson & Johnson, PepsiCo, and many more.
In each and every case, these companies delivered a product or service in exchange for the customer's cash. This is the key distinguishing factor between companies like IBM, Microsoft, Apple, who deserve to belong on that list, and companies like your hyped SV unicorn that has no business model besides "eventually we'll introduce ads".
In each and every case, these companies delivered a product or service in exchange for the customer's cash. This is the key distinguishing factor between companies like IBM, Microsoft, Apple, who deserve to belong on that list, and companies like your hyped SV unicorn that has no business model besides "eventually we'll introduce ads".
"If we don't want to look like we are harvesting data for ad networks, we'll just sell to Google."
If someone wanted to start a company with a definite product (not ads), maybe even a brick and mortar product, how does the process differ with starting a garden-variety startup?
It doesn't, really. It's just that these companies tend to draw more modest valuations, generating a more subdued kind of excitement. Forbes just wrote about how VCs should invest more in B2C startups [1]. A different piece from CB Insights last year [2] argues the same point. There are some VCs who specialize in B2C stuff, Maveron [3] being notable on the West Coast. Mostly, though, this capital does not concentrate in a small area like SV.
[1] http://www.forbes.com/sites/chrismyers/2017/01/09/why-entrep... [2] https://www.cbinsights.com/blog/vc-investing-in-consumer-goo... [3] https://en.wikipedia.org/wiki/Maveron
[1] http://www.forbes.com/sites/chrismyers/2017/01/09/why-entrep... [2] https://www.cbinsights.com/blog/vc-investing-in-consumer-goo... [3] https://en.wikipedia.org/wiki/Maveron
Conventional wisdom says you should only go with VC money if you have a rapid scaling step that requires astronomical burn rates while you capture market share. Usually rapid scaling like that comes from some sort of network effect (you will switch to facebook because everyone you know is).
Brick and mortar products are less likely to have this property than social-network-of-the-month, so the process can be very different.
Brick and mortar products are less likely to have this property than social-network-of-the-month, so the process can be very different.
Chinese can rip it off, or one of the big players just subsumes your idea in some way. Or it ends up trivialized as "as seen on tv"
What about Tesla, SpaceX and even Airbnb. Shouldn't those be allowed on the list as well? They have very clear business models and don't have to get acquired by anybody and are providing tremendous value.
Absolutely. Would you put companies like Facebook, Twitter, or companies that may struggle to fix unit economics like Uber or Lyft on this list?
In my opinion, Facebook yes [1][2][3][4][5], Twitter no [6][7][8][9][10][11][12], Uber probably (because the laws of the land only bark and rarely bite hard enough) [13][14][15], and because they have less cash-on-hand than Uber, Lyft no [15].
[1] https://news.ycombinator.com/item?id=13332005#13333251 [2] https://news.ycombinator.com/item?id=12313908#12314672 [3] https://news.ycombinator.com/item?id=11962282 [4] https://news.ycombinator.com/item?id=12089604#12089686 [5] https://news.ycombinator.com/item?id=12799794#12800418 [6] https://news.ycombinator.com/item?id=12514062#12519121 [7] https://news.ycombinator.com/item?id=12514062#12515149 [8] https://news.ycombinator.com/item?id=12784274#12784601 [9] https://news.ycombinator.com/item?id=13166882#13168804 [10] https://news.ycombinator.com/item?id=12904216#12905032 [11] https://news.ycombinator.com/item?id=12888287#12893852 [12] https://news.ycombinator.com/item?id=12784274#12784473 [13] https://news.ycombinator.com/item?id=12187262#12188289 [14] https://news.ycombinator.com/item?id=13234265#13234809 [15] https://news.ycombinator.com/item?id=12354407#12355656
[1] https://news.ycombinator.com/item?id=13332005#13333251 [2] https://news.ycombinator.com/item?id=12313908#12314672 [3] https://news.ycombinator.com/item?id=11962282 [4] https://news.ycombinator.com/item?id=12089604#12089686 [5] https://news.ycombinator.com/item?id=12799794#12800418 [6] https://news.ycombinator.com/item?id=12514062#12519121 [7] https://news.ycombinator.com/item?id=12514062#12515149 [8] https://news.ycombinator.com/item?id=12784274#12784601 [9] https://news.ycombinator.com/item?id=13166882#13168804 [10] https://news.ycombinator.com/item?id=12904216#12905032 [11] https://news.ycombinator.com/item?id=12888287#12893852 [12] https://news.ycombinator.com/item?id=12784274#12784473 [13] https://news.ycombinator.com/item?id=12187262#12188289 [14] https://news.ycombinator.com/item?id=13234265#13234809 [15] https://news.ycombinator.com/item?id=12354407#12355656
I don't know how this fits in with your "bottom line" concept, but the purpose of a business is to create some amount of value for its customers _and_ retain some amount of that value for the business owners.
As a big positive, we have seen large strides taken in SV on the former part the past 10 years. Creating value for your users / customers is standard advice pounded into entrepreneurs by YC and everyone else these days. This is great.
The problem is the latter half, capturing some of that value. Some of it is structural; many industries do not lend themselves well to wild profitability. Other is cultural; startups like building White House replicas in the lobby of their expensive new building.
We have seen many companies that create a great amount of value, and can even retain some of it, but unfortunately not enough to meet investors' expectations. Twitter, for example. Medium, for another more recent case, would be a great small business, but can never live up to a $100M+ investment. They definitely create value, it's just questionable exactly how much, and it will be very difficult for them to retain a worthwhile portion of it.
As a big positive, we have seen large strides taken in SV on the former part the past 10 years. Creating value for your users / customers is standard advice pounded into entrepreneurs by YC and everyone else these days. This is great.
The problem is the latter half, capturing some of that value. Some of it is structural; many industries do not lend themselves well to wild profitability. Other is cultural; startups like building White House replicas in the lobby of their expensive new building.
We have seen many companies that create a great amount of value, and can even retain some of it, but unfortunately not enough to meet investors' expectations. Twitter, for example. Medium, for another more recent case, would be a great small business, but can never live up to a $100M+ investment. They definitely create value, it's just questionable exactly how much, and it will be very difficult for them to retain a worthwhile portion of it.
The purpose of a business is to create value (usually financial) for its owners. Creating value for its customers is a means, not an end.
Over the last 20 years, thousands of these bottom line companies have been founded. You may not familiar with all of them, because much like AT&T or GE, they take decades to get big enough to show up on the radar of a distant viewer.
Take this guy for example, the pillow king (as bottom line as Oreos):
https://www.bloomberg.com/news/features/2017-01-11/the-prepo...
Or Chobani, which most know about now:
https://www.bloomberg.com/news/articles/2013-01-31/at-choban...
Or Manoj Bhargava of 5 hour energy fame:
http://www.inc.com/ilan-mochari/5-hour-energy-billions-in-ch...
Or Monster Beverage (reinvented in the early 1990s), which has become, well, a monster ($25 billion market cap):
https://en.wikipedia.org/wiki/Monster_Beverage
Or Under Armour, founded in 1996, on its way to being a giant potentially.
Or Lululemon, founded in 1998.
Netflix and Tesla are also both bottom line companies.
Tory Burch is an example, as is Sara Blakely & Spanx. Fashion has a lot of significant bottom line stories from the last 20 years. Hard to tell which might grow into the next big fashion conglomerate, or just be acquired (as with Burch apparently).
There are a lot of these types of stories roaming about, and far more of them that have yet to break the media surface but will in the next five or ten years. You often don't hear about them until they get big enough to be picked up by the likes of Bloomberg, Forbes, Fortune, et al. It's also next to impossible to tell which one of them will go on to become a big conglomerate like Mondelez; we'll find out in 30 or 40 years.
Take this guy for example, the pillow king (as bottom line as Oreos):
https://www.bloomberg.com/news/features/2017-01-11/the-prepo...
Or Chobani, which most know about now:
https://www.bloomberg.com/news/articles/2013-01-31/at-choban...
Or Manoj Bhargava of 5 hour energy fame:
http://www.inc.com/ilan-mochari/5-hour-energy-billions-in-ch...
Or Monster Beverage (reinvented in the early 1990s), which has become, well, a monster ($25 billion market cap):
https://en.wikipedia.org/wiki/Monster_Beverage
Or Under Armour, founded in 1996, on its way to being a giant potentially.
Or Lululemon, founded in 1998.
Netflix and Tesla are also both bottom line companies.
Tory Burch is an example, as is Sara Blakely & Spanx. Fashion has a lot of significant bottom line stories from the last 20 years. Hard to tell which might grow into the next big fashion conglomerate, or just be acquired (as with Burch apparently).
There are a lot of these types of stories roaming about, and far more of them that have yet to break the media surface but will in the next five or ten years. You often don't hear about them until they get big enough to be picked up by the likes of Bloomberg, Forbes, Fortune, et al. It's also next to impossible to tell which one of them will go on to become a big conglomerate like Mondelez; we'll find out in 30 or 40 years.
I think another good example would be the craft beer industry. The brewers association directory[1] lists around 200 regional and large breweries in the US, and somewhere around 5000 microbreweries and brewpubs.
Granted, some of these are more than 20 years old, but the movement grew the most through the early 90's[2].
[1] https://www.brewersassociation.org/directories/breweries/
[2] https://www.brewersassociation.org/brewers-association/histo...
Granted, some of these are more than 20 years old, but the movement grew the most through the early 90's[2].
[1] https://www.brewersassociation.org/directories/breweries/
[2] https://www.brewersassociation.org/brewers-association/histo...
Book suggestion: "beyond the pale" by Ken Grossman, founder of Sierra Nevada. Probably my favorite book about a startup ever. Great example of both bootstrapping and also a founder knowing his craft completely.
Your analysis is essentially a different spin on "The US doesn't manufacture anything anymore." When you say "substance" what you mean is physical goods (edit: or infrastructure) - and the number of service companies founded is outpacing physical goods companies by far.
So when we say that "services" industries are growing faster than industrial manufacturing, this is exactly what we're talking about. It's not just dog walking, it's pinterest.
So when we say that "services" industries are growing faster than industrial manufacturing, this is exactly what we're talking about. It's not just dog walking, it's pinterest.
> When you say "substance" what you mean is physical goods
The citation of AT&T and JetBlue by OP seems to disagree with this, so I don't necessarily agree with this reinterpretation of the OP's analysis.
As an example, one could argue that companies involved in self-driving R&D could very easily meet this definition as a provider to the bottom-line of society as transportation to/from a location is a service not terribly dissimilar to providing data and communication. By that token, Tesla and soon Uber could soon fit this bill as service organizations (disregarding Tesla's manufacture of vehicles).
The citation of AT&T and JetBlue by OP seems to disagree with this, so I don't necessarily agree with this reinterpretation of the OP's analysis.
As an example, one could argue that companies involved in self-driving R&D could very easily meet this definition as a provider to the bottom-line of society as transportation to/from a location is a service not terribly dissimilar to providing data and communication. By that token, Tesla and soon Uber could soon fit this bill as service organizations (disregarding Tesla's manufacture of vehicles).
I agree although I also don't know what "substance" is. If they're contributing to the monetary value of goods and services being sold to an end user, they're contributing to GDP. If they're not, they're not.
Other than that--or by explicitly considering only manufactured goods for example--you're effectively making value judgements about what products and services contribute to society and which don't. You could equally as well argue (though I wouldn't) that the 50th new rebranded and repackaged laundry powder doesn't contribute either.
Other than that--or by explicitly considering only manufactured goods for example--you're effectively making value judgements about what products and services contribute to society and which don't. You could equally as well argue (though I wouldn't) that the 50th new rebranded and repackaged laundry powder doesn't contribute either.
Yes I think it is a value judgement, hence it's just a silly theory that lives in my head. :)
One definition of "substance" might be consumer surplus. Electricity provides massive utility to society, despite its relatively cheap price. Consumer surplus is not reflected in GDP, but it is certainly real and important.
AT&T is fundamentally infrastructure, not just service. JetBlue while yes it is service, is also closer to infrastructure than it is concierge.
I distinguish services vs infrastructure based on if they are fundamental needs, not how they are provided. So water treatment is technically a service, but it's a fundamental piece of life so it's infrastructure.
I distinguish services vs infrastructure based on if they are fundamental needs, not how they are provided. So water treatment is technically a service, but it's a fundamental piece of life so it's infrastructure.
Are telecommunications and flight fundamental needs? Humans lived for hundreds of thousands of years without them. Yet I agree that they are infrastructure. On the other hand, humans have not lived for hundreds of thousands of years without food, yet I would consider McDonalds a service.
Personally, I think the distinction is in how it is provided. The copper/fibre line to your home is what AT&T has to bring to the table. JetBlue brings their fancy flying machine. The water treatment plant has their water treatment system. While people are certainly involved in the process, the defining feature of these businesses are related to the machines/technology that they possess.
On the other hand, McDonalds certainly has a kitchen, but so does everyone else. They are literally found in almost every home. What McDonalds, and restaurants in general, bring to the table is a person willing to do the cooking and other related activities for you. Because the defining feature is related to human labour (for now, at least), these are services.
Personally, I think the distinction is in how it is provided. The copper/fibre line to your home is what AT&T has to bring to the table. JetBlue brings their fancy flying machine. The water treatment plant has their water treatment system. While people are certainly involved in the process, the defining feature of these businesses are related to the machines/technology that they possess.
On the other hand, McDonalds certainly has a kitchen, but so does everyone else. They are literally found in almost every home. What McDonalds, and restaurants in general, bring to the table is a person willing to do the cooking and other related activities for you. Because the defining feature is related to human labour (for now, at least), these are services.
Indeed, the comment above isn't quite what I meant. For example, one of the reasons I included Mondelez is that my theory includes the idea that in providing low cost commodity "food", families had other areas of the economy they could spend on (education, entertainment etc).
Societal benefits may be one thing, though I'd say for companies of this size it's only a side-effect of economies of scale, but as far as most of us experience them Mondelez is pretty standard CPG company.
https://en.wikipedia.org/wiki/Fast-moving_consumer_goods
https://en.wikipedia.org/wiki/Fast-moving_consumer_goods
It's not even true that the US doesn't manufacture; manufacturing output (by value) is the highest it's ever been[1]; it's just that far fewer workers are employed to do so.
(Same as the pattern with farming; there's a difference between "the US doesn't produce many crops" and "the US doesn't have a big fraction of workers in farming": the former is false and the latter true.)
[1] https://fred.stlouisfed.org/series/OUTMS
(Same as the pattern with farming; there's a difference between "the US doesn't produce many crops" and "the US doesn't have a big fraction of workers in farming": the former is false and the latter true.)
[1] https://fred.stlouisfed.org/series/OUTMS
Yes, well that's exactly my point. Plenty of startups are making stuff - so saying "where are all the real companies" is just paying attention to headlines. I have two friends that have CPG startups, and most SMB's are exactly that - so they are definitely out there.
Just to clarify, I was trying to support your point with that comment.
I would put Google in your list. Google search has been an amazing contribution to human productivity.
>> GE, AT&T, CN, JetBlue, Mondelez International (Kraft)
>> Over the past 20 years, have we seen many bottom line companies founded?
What's great about the list is that JetBlue was founded within the last 20 years. I would also consider Google (1998) and Facebook (2004) to be candidates for "bottom line companies" although I'm not 100% sure I know what you mean by that.
But yeah, it's hard to build a cash-spewing colossus with global reach in 20 years.
>> Over the past 20 years, have we seen many bottom line companies founded?
What's great about the list is that JetBlue was founded within the last 20 years. I would also consider Google (1998) and Facebook (2004) to be candidates for "bottom line companies" although I'm not 100% sure I know what you mean by that.
But yeah, it's hard to build a cash-spewing colossus with global reach in 20 years.
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I'm going to remember that term. Do you think it's possible to quantify that concept?
I'm a crappy economist. In theory I think it should be somewhat/somehow linked to productivity. If a company positively impacts national productivity the company would be a "bottom line" company?
I guess so. Seems like the companies you listed all deal with 'basic human survival' - in 1st world countries, things people need in order to achieve an above average financial state. So not google, facebook, uber, etc. because you can do really well without them. And the ones you mentioned, GE, AT&T, CN, JetBlue, Mondelez International (Kraft), are much closer to to providing actual necessities - you can't do a ton without household machinery (e.g. food prep equipment), or cheap food; cheap long-distance transportation can be crucial to success, as would be phones.
The term you're looking for is "natural monopoly". These companies are all so large and old because they were the first players in markets where returns to scale are staggering, and barriers to entry are almost impossibly high to overcome.
Most of them were blocked from actually becoming horizontal or vertical monopolies by governments in order to protect consumers and foster innovation.
But that didn't stop them from acquiring tangential companies and becoming multinational conglomerates - every country in the world needs Kraft's consumer goods and GE's industrial equipment.
Software startups follow an entirely different business model - extremely low costs to entry, entering new markets with high rates of failure. Also, in many successful acquisition exits the startups are acquired and the brand disappears.
Most of them were blocked from actually becoming horizontal or vertical monopolies by governments in order to protect consumers and foster innovation.
But that didn't stop them from acquiring tangential companies and becoming multinational conglomerates - every country in the world needs Kraft's consumer goods and GE's industrial equipment.
Software startups follow an entirely different business model - extremely low costs to entry, entering new markets with high rates of failure. Also, in many successful acquisition exits the startups are acquired and the brand disappears.
> The term you're looking for is "natural monopoly".
Not really - a natural monopoly occurs where early entrants have such a huge advantage in providing goods or services that competitors are not able to sprout up. It may be due to high capital costs, regulation, distribution channels, or even controlling material supply. Companies like Jet Blue are clearly not natural monopolies - in fact as a relatively young airline they were able to establish that the Airline industry is not subject to natural monopolies (although the capital costs to start up are very high).
Kraft on the other hand has a ton of competition, with more new food producers popping up every year. The capital costs to start are not that high, and distribution channels are open enough that lots of smaller companies can get exposure to customers.
Not really - a natural monopoly occurs where early entrants have such a huge advantage in providing goods or services that competitors are not able to sprout up. It may be due to high capital costs, regulation, distribution channels, or even controlling material supply. Companies like Jet Blue are clearly not natural monopolies - in fact as a relatively young airline they were able to establish that the Airline industry is not subject to natural monopolies (although the capital costs to start up are very high).
Kraft on the other hand has a ton of competition, with more new food producers popping up every year. The capital costs to start are not that high, and distribution channels are open enough that lots of smaller companies can get exposure to customers.
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The downside of this lack of liquidity is the loss of fees flowing to the investment banks, the key constituency of Bloomberg.com. Oh no!
Most financing documents allow the preferred investors to force a registration. And of course the investors want liquidity. So if it's not happening it's because they believe (and can convince their customers, err, LPs to believe) that the return will increase significantly if they wait. I say "significantly" because volatility increases value in the Black-Scholes equation, so forgoing it better be worth it!
In the "old" days companies were essentially forced to do an offering when their staff got high enough, as they had enough shareholders that they had to file public reports anyway, so why not do a share offering and get some cash in return for the obligatory hassle. I say "old" days because this applied to FB.
Nowadays you can do quite a lot of business with fewer employees so this forcing function is not as powerful as it used to be.
Most financing documents allow the preferred investors to force a registration. And of course the investors want liquidity. So if it's not happening it's because they believe (and can convince their customers, err, LPs to believe) that the return will increase significantly if they wait. I say "significantly" because volatility increases value in the Black-Scholes equation, so forgoing it better be worth it!
In the "old" days companies were essentially forced to do an offering when their staff got high enough, as they had enough shareholders that they had to file public reports anyway, so why not do a share offering and get some cash in return for the obligatory hassle. I say "old" days because this applied to FB.
Nowadays you can do quite a lot of business with fewer employees so this forcing function is not as powerful as it used to be.
Another factor is that contemporary companies more often will issue RSUs instead of options. This (afaik) allows a company to avoid hitting the shareholder threshold which would require reporting.
IIRC, Facebook didn't have to go public when they did, but once they hit the threshold they would have to start reporting, and at that point there's not much reason to not be a public company.
(Another reason cited was allowing early employees to take advantage of the value of their shares without otherwise having to leave the company.)
IIRC, Facebook didn't have to go public when they did, but once they hit the threshold they would have to start reporting, and at that point there's not much reason to not be a public company.
(Another reason cited was allowing early employees to take advantage of the value of their shares without otherwise having to leave the company.)
> Most financing documents allow the preferred investors to force a registration
Registration rights are not a standard part of Silicon Valley financing. Voting rights agreements--which grant the Board or certain members of management your voting rights until IPO--are more prevalent.
Registration rights are not a standard part of Silicon Valley financing. Voting rights agreements--which grant the Board or certain members of management your voting rights until IPO--are more prevalent.
> Registration rights are not a standard part of Silicon Valley financing.
I am surprised that you write this. Demand registration rights have been part of every equity financing I've done for the last 25 years in the Valley and in NYC.
I am surprised that you write this. Demand registration rights have been part of every equity financing I've done for the last 25 years in the Valley and in NYC.
If the fed would raise interest rates, that'd go a long way to helping clear at least some of the backlog.
Right now you got a lot of dumb money behind a lot of startups with bad business plans because there's no other place for the money to earn reasonable yields.
Right now you got a lot of dumb money behind a lot of startups with bad business plans because there's no other place for the money to earn reasonable yields.
Higher interest rates aren't a magical elixir for investment returns though I agree that there's a lot of dumb money going into bad, me too business plans. However, the author seems to be most focused on how invested money gets out of the pipeline once it's in.
In may well be the case that there aren't enough worthwhile tech VC targets to absorb the money people want to put in. (see also the boatloads of cash some companies are sitting on.) But that's a different argument from companies unwilling/unable to exit.
In may well be the case that there aren't enough worthwhile tech VC targets to absorb the money people want to put in. (see also the boatloads of cash some companies are sitting on.) But that's a different argument from companies unwilling/unable to exit.
However, the author seems to be most focused on how invested money gets out of the pipeline once it's in.
The two problems are related. Money isn't being pulled out of the pipeline because investors are willing to let venture funds hold onto their cash for long periods of time. If investors had other opportunities for getting returns, they'd pressure venture funds to have shorter time horizons, and this, in turn, would lead venture funds to pressure companies to cash out or die.
The two problems are related. Money isn't being pulled out of the pipeline because investors are willing to let venture funds hold onto their cash for long periods of time. If investors had other opportunities for getting returns, they'd pressure venture funds to have shorter time horizons, and this, in turn, would lead venture funds to pressure companies to cash out or die.
They're not magical, but there's literally nowhere to safely save liquid cash these days.
I have a 6% Capital One 360 CD that matured last year. My credit union is offering 2.75% auto loans on 2014 model year cars up to 72 months.
Clearly, money is too cheap when you're getting super low rates on terrible loan products.
I have a 6% Capital One 360 CD that matured last year. My credit union is offering 2.75% auto loans on 2014 model year cars up to 72 months.
Clearly, money is too cheap when you're getting super low rates on terrible loan products.
If the car lasts at least 72 months, and you stay ahead of the depreciation, it's not a terrible loan product. It's a benefit of the world being awash in capital.
Well, there is a way for invested money to get out, as she points out. It's just that the incoming money is too great in volume.
If we restricted the incoming money, the money in the pipeline would drain out the normal way.
If we restricted the incoming money, the money in the pipeline would drain out the normal way.
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S&P 500 returned an inflation adjusted 9% last year (Dec '15-Dec '16). If that's not a "reasonable yield," what is?
The S&P 500 returned 12.25% last year. Unless you're throwing money away, you have to count dividends, too.
https://dqydj.com/2016-sp-500-return/
https://dqydj.com/2016-sp-500-return/
The number you're quoting is pre-inflation adjustment, I think? Or maybe I used the wrong endpoints. I used the calculator on that site [1], with the setting being from December '15 to December '16 since I'm not sure what moment in January '17 they measured. If I go Jan '16 to Jan '17, then we end up with 17.952%, which doesn't sound right.
[1]: https://dqydj.com/sp-500-return-calculator/
[1]: https://dqydj.com/sp-500-return-calculator/
You're right -- 12.25 is nominal, not inflation-adjusted. But inflation was in the range of 1.5-2%, so even adjusted for inflation, the real return exceeds 10% any way to slice it.
I'm not sure what your calculator is measuring -- the date selection has a precision of one month. But swings of 5% in a month are common, so I would not immediately discount the idea that there are endpoint dates you could choose to get a 17% return.
I'm not sure what your calculator is measuring -- the date selection has a precision of one month. But swings of 5% in a month are common, so I would not immediately discount the idea that there are endpoint dates you could choose to get a 17% return.
For anyone not American: Drano is a drain cleaner brand common in the US.
As a developer and therefore a person who benefits when lots of companies have demand for the field I work in, it's unclear to me why I should want "Startup Drano". I'm not a VC nor an LP, I don't mind if VCs waste their money funding "Uber for dog food" or whatever.
People starting businesses with bad business models don't offend me on a moral level. It's their funeral, let them make bad decisions if they want.
People starting businesses with bad business models don't offend me on a moral level. It's their funeral, let them make bad decisions if they want.
> People starting businesses with bad business models don't offend me on a moral level. It's their funeral, let them make bad decisions if they want.
If you want a good explanation of why you should be offended and why you should want Startup Drano, try: http://idlewords.com/talks/internet_with_a_human_face.htm. Here's the key quote:
"But investor storytime is a cancer on our industry.
Because to make it work, to keep the edifice of promises from tumbling down, companies have to constantly find ways to make advertising more invasive and ubiquitous.
Investor storytime only works if you can argue that advertising in the future is going to be effective and lucrative in ways it just isn't today. If the investors stop believing this, the money will dry up.
And that's the motor destroying our online privacy. Investor storytime is why you'll see facial detection at store shelves and checkout counters. Investor storytime is why garbage cans in London are talking to your cell phone, to find out who you are."
When all the free money is chasing advertising-driven business models, the advertising has to get ever more invasive in order to justify valuations. I'm all for letting business stand or fail on their merits if no one but the investors are harmed, but this is a very destructive externality that affects everyone.
If you want a good explanation of why you should be offended and why you should want Startup Drano, try: http://idlewords.com/talks/internet_with_a_human_face.htm. Here's the key quote:
"But investor storytime is a cancer on our industry.
Because to make it work, to keep the edifice of promises from tumbling down, companies have to constantly find ways to make advertising more invasive and ubiquitous.
Investor storytime only works if you can argue that advertising in the future is going to be effective and lucrative in ways it just isn't today. If the investors stop believing this, the money will dry up.
And that's the motor destroying our online privacy. Investor storytime is why you'll see facial detection at store shelves and checkout counters. Investor storytime is why garbage cans in London are talking to your cell phone, to find out who you are."
When all the free money is chasing advertising-driven business models, the advertising has to get ever more invasive in order to justify valuations. I'm all for letting business stand or fail on their merits if no one but the investors are harmed, but this is a very destructive externality that affects everyone.
Hmm. Indeed that is bad, but I have a feeling what we're really talking about here is capitalism.
Eben Moglen said the same thing during the Q&A at his HOPE 2012 talk:
I don't think that the problem of collecting too much is now primarily a byproduct of careless regulation. The problem of collecting too much arises from the fact that the future of capitalism is in the data mining and control of its customers. When capitalist societies begin to depend more on consumption than they do on production for their overall economic health, and the GDP of the United States has been primarily consumption for more than 15 years now, then knowing how to control consumers becomes as important as knowing how to control productive machines was when the GDP was primarily based upon production rather than consumption. What is happening is that we are automating and instrumenting the portion of the economy which is most powerfully important, namely consumption.
Collecting information about consumers is the same thing as knowing how the mill machines worked to the capitalists of the 19th century. So what we are confronting is not the accident of perverse incentives created as a byproduct of unintended consequences of regulation. We are facing the fact that doing the wrong thing is the basis of future economic growth.
We are not trying to destroy future economic growth, we are trying to compromise among values. That's what regulation is. It's a messy process. Of course it has unintended consequences. Naturally it creates perverse incentives, because it's imperfect. But understanding the objective has to be clear: productive capitalism met ecological constraints. It dirtied the water too much, it dirtied the air too much, it created too many difficulties that had to be constrained as negative externalities produced by production. The attempt to regiment and govern consumption through data mining raises ecologic problems we must solve.
https://www.youtube.com/watch?v=vY43zF_eHu4 at 54:20
I don't think that the problem of collecting too much is now primarily a byproduct of careless regulation. The problem of collecting too much arises from the fact that the future of capitalism is in the data mining and control of its customers. When capitalist societies begin to depend more on consumption than they do on production for their overall economic health, and the GDP of the United States has been primarily consumption for more than 15 years now, then knowing how to control consumers becomes as important as knowing how to control productive machines was when the GDP was primarily based upon production rather than consumption. What is happening is that we are automating and instrumenting the portion of the economy which is most powerfully important, namely consumption.
Collecting information about consumers is the same thing as knowing how the mill machines worked to the capitalists of the 19th century. So what we are confronting is not the accident of perverse incentives created as a byproduct of unintended consequences of regulation. We are facing the fact that doing the wrong thing is the basis of future economic growth.
We are not trying to destroy future economic growth, we are trying to compromise among values. That's what regulation is. It's a messy process. Of course it has unintended consequences. Naturally it creates perverse incentives, because it's imperfect. But understanding the objective has to be clear: productive capitalism met ecological constraints. It dirtied the water too much, it dirtied the air too much, it created too many difficulties that had to be constrained as negative externalities produced by production. The attempt to regiment and govern consumption through data mining raises ecologic problems we must solve.
https://www.youtube.com/watch?v=vY43zF_eHu4 at 54:20
> People starting businesses with bad business models don't offend me on a moral level.
In a pure sense, I'd like to agree with you, but there are a couple of things I see as being problematic at the moment:
1/ In many countries businesses or investors are often able to aquire political support to prop up failing businesses at the expense of broader society. When my pirate-themed restaurant goes broke, well, such is life. When someone like, say, a venture capitalist with the ear of the president of the US has a bunch of endangered investments you may well find your pockets being picked to prop up his bank balance.
2/ The trend for "disruption" means that the failing businesses may well have already destroyed previously-viable businesses (often as a result of running at a huge loss, not necessarily because they offer better product); that's an especially huge hazard in areas like education. The collapse of the VC-funded punt after it's already demolished what already existed leaves a smoking hole in the ground. If that's "one less restaurant in town", that's one thing. If that's "we ran down public transport and education because unicorns told us they'd solve the problem and now we have neither transport nor schools", well, that's a bit different.
In a pure sense, I'd like to agree with you, but there are a couple of things I see as being problematic at the moment:
1/ In many countries businesses or investors are often able to aquire political support to prop up failing businesses at the expense of broader society. When my pirate-themed restaurant goes broke, well, such is life. When someone like, say, a venture capitalist with the ear of the president of the US has a bunch of endangered investments you may well find your pockets being picked to prop up his bank balance.
2/ The trend for "disruption" means that the failing businesses may well have already destroyed previously-viable businesses (often as a result of running at a huge loss, not necessarily because they offer better product); that's an especially huge hazard in areas like education. The collapse of the VC-funded punt after it's already demolished what already existed leaves a smoking hole in the ground. If that's "one less restaurant in town", that's one thing. If that's "we ran down public transport and education because unicorns told us they'd solve the problem and now we have neither transport nor schools", well, that's a bit different.
Because you're an engineer in a boom-bust industry that hasn't had a real bust in a long time, and is about due.
75% of startups today are at best Facebook features. Engineers get fucked hard when that happens. Ask a former aerospace guy what the 90s were like.
75% of startups today are at best Facebook features. Engineers get fucked hard when that happens. Ask a former aerospace guy what the 90s were like.
If all you want to do is acquire money in the short-term that makes sense.
Startups take several years to exit.
So isn't it perfectly normal that it also takes several years for the total value of IPOs and acquisitions, i.e. money that flows out of startups, per year to catch up with the rising trend of total startup investment, i.e. money that flows into startups, per year?
So isn't it perfectly normal that it also takes several years for the total value of IPOs and acquisitions, i.e. money that flows out of startups, per year to catch up with the rising trend of total startup investment, i.e. money that flows into startups, per year?
Much more than a few years these days. So there should be at least a 3 to 5 year offset between comparing money in to money out.
I'm surprised the author didn't mention anything about megarounds. I thought most of the increase in venture capital has been going to megarounds, and that these rounds are being raised exactly because companies want to delay their IPO and remain private longer. That would perfectly explain why there's a lag in the returns on these VC funds, right?
You wouldn't expect the uptick in venture financing to immediately result in an uptick in venture exits. Using the 'pipe' metaphor, the flow takes time. The pipe has nonzero length.
In fact, the pipe's length should be roughly the length of the average time to exit for a startup (weighted by exit size). So the latency in the system should be much longer than one year.
This is the problem with semi-quantitative thinking. And lazy journalism. Then again, I did click on the link and read the article, so maybe I'm misunderstanding the point: the author got what she wanted out of me.
In fact, the pipe's length should be roughly the length of the average time to exit for a startup (weighted by exit size). So the latency in the system should be much longer than one year.
This is the problem with semi-quantitative thinking. And lazy journalism. Then again, I did click on the link and read the article, so maybe I'm misunderstanding the point: the author got what she wanted out of me.
I feel like I've read this same "there aren't enough IPO exits" about the startup scene since at least 2002. What periods of time in the last twenty years have been considered good for tech VC IPOs?
I think the period between and including Google and Facebook's IPOs were considered good.
This is called the 'free market' in action.
With very low interest rates, and ridiculous Fed policies (QE) designed to 'reinvigorate the economy', but which really just pumped tons of extra cash into stocks and bonds (i.e. mostly the 1%, and institutional holders like pension funds) - you have tons of liquidity chasing value creation.
It'd rather seem that 'the power' is now in the hands of those who can create value.
Or more cynically: money goes to those who can convince others that value is being created so they can 'collect money' for their product/service.
There's nothing inherently wrong with this situation, it just means VC's are getting squeezed, and their 'amazing skill' of being able to 'spot the best opportunities' might be being commoditized a little bit.
The 'risk' really is a sudden change one way or the other, i.e. fed-rate change, china-flop, tump-risk or just some general fear based panic causing a bubble burst.
With very low interest rates, and ridiculous Fed policies (QE) designed to 'reinvigorate the economy', but which really just pumped tons of extra cash into stocks and bonds (i.e. mostly the 1%, and institutional holders like pension funds) - you have tons of liquidity chasing value creation.
It'd rather seem that 'the power' is now in the hands of those who can create value.
Or more cynically: money goes to those who can convince others that value is being created so they can 'collect money' for their product/service.
There's nothing inherently wrong with this situation, it just means VC's are getting squeezed, and their 'amazing skill' of being able to 'spot the best opportunities' might be being commoditized a little bit.
The 'risk' really is a sudden change one way or the other, i.e. fed-rate change, china-flop, tump-risk or just some general fear based panic causing a bubble burst.
I hear QE being disparaged a lot, but I'm not sure why. The world economy has been in a doldrums, and QE was the only monetary lever left to pull (given that fiscal tightening, rather than expansion, was the political calculation).
Look, interest rates are low because the world has a deficit of assets that offer a good return. More to the point, dollar-denominated interest rates are low because the world seeks stability in the dollar. Capital flows reflect this, and Fed policy is only a tiny input to the overall system. In fact, QE and fed policy in general is reactive to global macro; we assume it has much more influence than it does, particularly when much of the developed world is in a liquidity trap.
There are serious macro debates going on (secular stagnation? decreasing productivity returns from tech?). But whether or not QE is "ridiculous" isn't actually a serious debate. Unless you care more about equity prices than overall growth -- but I think that's missing the forest for the trees. Railing against QE without understanding the context (including the lack of alternatives) isn't particularly illuminating.
Look, interest rates are low because the world has a deficit of assets that offer a good return. More to the point, dollar-denominated interest rates are low because the world seeks stability in the dollar. Capital flows reflect this, and Fed policy is only a tiny input to the overall system. In fact, QE and fed policy in general is reactive to global macro; we assume it has much more influence than it does, particularly when much of the developed world is in a liquidity trap.
There are serious macro debates going on (secular stagnation? decreasing productivity returns from tech?). But whether or not QE is "ridiculous" isn't actually a serious debate. Unless you care more about equity prices than overall growth -- but I think that's missing the forest for the trees. Railing against QE without understanding the context (including the lack of alternatives) isn't particularly illuminating.
Employees are also getting forced to wait much longer before their equity stakes become liquid. It can be tough on an employee if they cannot leave their job without either losing all their options or paying a large upfront tax bill to exercise options (which may not be liquid for a while longer).
> (which may not be liquid for a while longer).
(Or ever)
(Or ever)
I disagree. The article isn't at all about the returns that people are getting on their investments. It's more about the fact that there's a normal lifecycle for venture-backed companies that ends with going public or being acquired. That lifecycle seems to have stalled out with mega-companies staying private for long periods of time.
It's still highly likely that Uber's investors will make tons of cash when the company finally decides to go public, whenever that is. It's just that the VC money is staying locked up much longer, so that it's not available to fund other early-stage start-ups.
It's still highly likely that Uber's investors will make tons of cash when the company finally decides to go public, whenever that is. It's just that the VC money is staying locked up much longer, so that it's not available to fund other early-stage start-ups.
I still don't get the hype aroumd Uber or why would they IPO as they are not profitable at all, prevent the creation of proper public transport and helped destroy the otherwise profitable taxi business and weakened the unions? http://www.wired.co.uk/article/uber-finances-losses-driverle...
"It's more about the fact that there's a normal lifecycle for venture-backed companies that ends with going public or being acquired. That lifecycle seems to have stalled out with mega-companies staying private for long periods of time."
No. There is no 'normal'.
There was X money going in Y coming out.
Now there is 2X money going in, and still Y going out.
It means a lower rate of return for those putting money in.
As for 'money not available to fund other startups' - clearly it is - the charts show actual investment is still high.
No. There is no 'normal'.
There was X money going in Y coming out.
Now there is 2X money going in, and still Y going out.
It means a lower rate of return for those putting money in.
As for 'money not available to fund other startups' - clearly it is - the charts show actual investment is still high.
You are missing the fact that the amount of money tied up in the companies is growing. 2x is going in, x is coming ng out, but the missing x is still (mostly) in there tied up in unicorns. The rate of return is dropping, but not because the money is gone, just because it's taking longer to come back.
If those untested valuations are correct.
Your second paragraph completely contradicts your first. Our very low interest rates are anything but free market. They are a Fed monetary policy.
Is this not what a bubble burst looks like? It's still easy to pour money into the bubble, but it suddenly gets a lot harder and a lot less certain to pull that money back out?
I'm not sure it's that wise to look at this years money in and this years money out. Wouldn't it make more sense to look at say the last 5 years of money out and the last 5 years-X of money in (X being 6-10ish, whatever the average time to exit is)?
I also only realized what Drano is halfway through the article (non-US guy). Why not use a more generic title that more of the world understands like "Silicon Valley Needs a Startup Plunger"?
I also only realized what Drano is halfway through the article (non-US guy). Why not use a more generic title that more of the world understands like "Silicon Valley Needs a Startup Plunger"?
The pipe is too short in those graphs. I think 10 years would be better than 5
Looks like data mining by the author to skim though 5 years of data and extrapolate a single inference from it. Just because something seems like something doesn't mean its important or significant or predictive of anything.
tl;dr: plugs ears and closes eyes "there is no bubble, there is no bubble, there is no..."
The author does not once address the possibility that less money is flowing out the other side of the pipe because so much of the money going in is being spent on companies that provide no value and will never be profitable.
The author does not once address the possibility that less money is flowing out the other side of the pipe because so much of the money going in is being spent on companies that provide no value and will never be profitable.
Your comment is spot on with my experience with clients from Silicon Valley. When they bring up their product, there is absolutely no sense of responsibility that their product might fail.
Not sure if its a result of entitlement, or living in Silicon Valley for too long. Come to think of it, one might be causing the other.
Not sure if its a result of entitlement, or living in Silicon Valley for too long. Come to think of it, one might be causing the other.
[deleted]
In brief: Most venture funds are closed-end funds, with a certain amount committed up front from LP's, where each dollar can only be invested once. The fund stops making investments after 5-7 years, then closes down entirely after 10 years. After 10 years, the managing partners stop collecting their 2% management fee, and any additional returns aren't typically included in the performance of the fund.
As such, there's a huge incentive for fund managers to invest early, and find an exit within the time horizon of their fund. A VC who pumped a ton of money into an early stage Uber in 2014 in year 6 of their fund, is going to be pretty screwed if Uber decides not to go public for another 5 years from now.
Where this could go sour is that these same fund managers are spending years 9-10 passing the hat to raise money for their next fund. If the typical pool of investors still have a lot of money tied up in previous funds, then they're going to be less likely to ante up for the next fund, since they'd have to double down on VC as a proportion of their portfolio. It's also going to be a tough road show if your story is that you invested millions of dollars in your last fund and it's all still tied up ...