Shall We Dance?

The greatest tension in a venture capital partnership is the debate between the risk of missing the next great opportunity and the risk of losing money. One of the complaints often expressed today is that the VC industry is too risk averse. Arguably there have been times – most notably late 1990’s – where capital has been too plentiful and risk aversion was virtually non-existent (and aren’t we still paying the price from that insanity?). Importantly the risk tolerance of the VC industry at large seems to track the capital in-flows into the industry – perhaps not unsurprisingly. This year VC firms are on pace to raise approximately $12 billion (as compared to nearly $30 billion only two years ago). The high water mark in 2000 when over $105 billion was raised is something we may never see again.

Is it oxymoronic to be a “value-oriented” VC investor? Certainly in the early stage marketplace there are no meaningful – perhaps sensible – historical financial results to which one can point to precisely determine fair value. And doing discounted cash flow analysis would be laughable. So how do we know when to pay up for a deal?

At Flybridge we are very energized by what we are seeing in the market today. We tend to frame the diligence around a basket of risks – and has the team developed plausible strategies to knock down those risks within a reasonable amount of time and capital. We back people first and foremost so the first risk item which we focus on is:

·         Team: How relevant is the team, particularly the CEO, as well as the VP’s of Marketing and Engineering? Has the team been successful before – ideally in a venture-backed company? Compelling teams command premium valuations.

·         Product Development: How developed is the product? How much is novel and patentable? We often have technical consultants go deep into the product development plan. Ideally good customer testimonials which endorse early versions of the product tend to support higher pre-money valuations.

·         “Go-to-Market”: For me this is the trickiest risk to assess; it is around the likelihood that the company will achieve “escape velocity.” Early customer traction is interesting but does it prove the case? How do we know that there is a large market just waiting to be built? The more precision one can provide around the sales cycle, channel strategy, having sales infrastructure in place, the greater the valuation. Pointing to analogous companies and business models helps.

·         Capital Formation and Liquidity: Great companies should always be able to attract capital. Being heads down building a great company more often than not will translate into value creation and liquidity. But these capital flows are cyclical and out of any of our control. Being able to handicap the next round and what the exit looks like is critical. VC’s love externally led “up financings.”

The lack of liquidity today has colored the decision-making processes in many firms. For the first time in a long time VC’s are being asked to be both effective portfolio managers and good “stock pickers.” How we think about capital reserves will weigh on any given investment decision and that is out of the control of the entrepreneur.

So where are we? Firms not worried about raising new funds are active and excited about the level of innovation across nearly every industry sector. Unfortunately too many VC firms have questions about their ability to raise a new fund and are therefore on the sidelines.

I am reminded of my ten year old son’s “social dance” class where the boys and girls are glued to walls on opposite sides of the gym – and no one is dancing.

3 Comments

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3 responses to “Shall We Dance?

  1. Your analogy of a dance is entirely appropriate and amusing. But it should be extended from the stage of dancing to dating to the clichéd but still appropriate comparison of marriage. Being on three sides of the table (as an entrepreneur, as an angel, and as an LP of VC funds in my capacity on the investment committee of a foundation), my desire to dance is less and less about how good-looking the partner is on the outside, and more on integrity and character, which are hard to determine from the average blog post.
    Savvy investment professionals, like those at Flybridge, blog with the intention that reaching the right readership will bring in deal flow and LP dollars. The question for the blogs’ intended audience (i.e., future portfolio companies and potential investors) is about the fit, since we’d be married to you for years to come with no way out. Just as your first questions of any startup will center on “Can they be as good as they claim” (e.g., team, market, credibility), we’re trying to learn the same about you. Are you sticking to your investment theses, or just following any hot trend? An entire industry of consultants has evolved to help pensions answer these same questions about investment managers.
    For me, wearing any of my hats, I really appreciate the ability to read these blogs. I’m looking to become excited and go across that dance floor…but fearful of being burned. What is most helpful to me is to see real points of view and differentiation come out in these blogs. It’s not a coincidence that my favorite two VC bloggers are Mark Suster and now Ben Horowitz. While neither were VCs a few years ago, it is the depth, not the frequency, of their writings that is building their brands. I’m hungry for VC bloggers to open up as fully as possible, writing of their mistakes and lessons learned, and not just bragging or name dropping. That’s what will make hesitant wallflowers like most of us walk across that dance floor if they are ready for a real relationship.
    FWIW–my favorite post to date: “What I like About You”. Even better, Jeff Bussgang’s book “Mastering the VC Game”. While it was instructional on revealing the tricks of the trade, for me the best parts were the behind-the-scene views of companies pivoting, and VCs sweating. Here’s hoping that Flybridge cuts that up and syndicates pieces of the book on its blog—it will be a pleasure to find such gems on my Google reader in the morning, and I’m sure it will be an effective way for your firm to get down to some serious tangos.

    • Thanks Ty for the great response – certainly will give me something to focus on. I hope to give some insights into what makes firms like ours tick – I take your comments to heart – will focus on some of teh mistakes which we made – maybe pull out some useful insights.

      It is important for people to appreciate the very harsh and scary forces many firms are now feeling – and how that impacts behavior.

  2. I really enjoyed this read. Although I’d imagine the risk basket varies from investor to investor, it’s helpful to hear all different framings used to identify value in an opportunity. I’d say as hard as it is for you to evaluate risk in the “go to market strategy,” it’s likewise difficult for early stage companies to evaluate their most efficient market channels. This is something my Company is trying to better understand about itself: what are the most meaningful sources of sales prospects, conversions, and more. If you have any specific advice re: the more compelling stories you’ve seen, I’d love to hear it. Further, re: lack of liquidity, I think it’s an interesting dilemma for institutional investors. I feel like cash flows and profitability, rather than merely utopian ideas, serve as more meaningful criterion for justifying an investment. But I’ve never been on the other side of the table🙂 so I say that humbly.

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