I thought this was a poignant observation by Fareed Zakaria in his book, The Post-American World:
“Hyperinflation is the worst economic malady that can befall a nation. It wipes out the value of money, savings, assets, and thus work. It is worse even than a deep recession. Hyperinflation robs you of what you have now (savings) whereas a recession robs you of what you might have had (higher standards of living if the economy had grown). That’s why hyperinflation has so often toppled governments and produced revolution. It was not the Great Depression that brought the Nazis to power in Germany but rather hyperinflation, which destroyed the middle class by making its savings worthless.”
There used to be a single playbook in the NFL built around a simple philosophy – running and defense wins championships. The entire operating approach of teams was centered on this singular belief. The prototypical example of this was the 1986 Chicago Bears – think Buddy Ryan-coached defense with Mike Singletary and William “The Refrigerator” Perry. Think about a running game led by none other than Walter Payton. That was a dominant team with the right playbook for that era.
But the rules of the NFL have changed – literally. The rules have slowly been re-engineered in the league to preferentially protect wide receivers and quarterbacks. Hit a quarterback the wrong way, and you’ll get a penalty. Touch a wide receiver after 5 yards, and you’ll get a penalty. Literally, the rules have changed, to support a more exciting brand of football that revolves around the passing game. It’s no wonder that four of the best teams in the league – Indianapolis Colts, New Orleans Saints, New England Patriots and San Diego Chargers are pass first teams led by quarterbacks Peyton Manning, Drew Brees, Tom Brady, and Philip Rivers, respectively.
Over the last several years, some NFL teams have learned a new playbook because the rules of the game have changed. Others have not adapted. I have always thought that this was a great analogy for the technology landscape and the executives that operate in this world. I’d argue that in the world of venture-backed technology companies, the rules of the game change dramatically faster than in the NFL. That puts a burden on executives living in this world to adapt.
Beware of the “single playbook” executive. They have one blueprint and they apply that blueprint for any situation they’re in. They use that blueprint because they’ve had success with it – maybe great success with it. They bring in the same people that were succesful with that blueprint. But, it’s dangerous to be a single playbook executive if the rules of the game are changing all around you. Therein lies the lesson I think that executives in venture-backed companies can learn from NFL coaches– your playbook has to take into account the changing rules of the game.
Now, don’t get me wrong. I, like many VCs, love to back successful executives who have a proven and successful playbook. But, there is a reason that many new entrepreneurs are finding great success without a proven historical playbook– it’s because their playbooks are being built for the rules of the game as it stands today. Successful venture-backed executives have to adapt their playbook or they should beware of the up and coming executives who don’t care how things were done before and only care about how to win today.
I’ve had the opportunity to invest in two companies that I’d describe as having a “potential single point of failure”. I chose to invest in one – Verid. And decided, unfortunately, to pass on another – Mint. Verid was ultimately sold to EMC/RSA less than two years after our investment for several multiples of our capital. And Mint was recently acquired by Intuit. I thought it was interesting how they were both sold for similar exit values given that both had the uncommon distinction of having a point of single dependency. Here are their stories and a couple thoughts:
Verid provides knowledge-based authentication services. You’ve probably run into the service if you’ve ever tried to open an account online and been prompted to answer questions about yourself to prove that you are who you say you are. Verid’s potential single point of failure? Their entire authentication service was built leveraging a single data aggregator on the back-end. If that data provider decided not to work with them one day, there would be no questions and no answers in this authentication service. Verid’s entire service depended on a single data contract.
Mint provides an online financial management service for consumers. They help you manage and identify ways to save money through one online console that sees across all of your financial accounts. Mint’s potential single point of failure? They rely on Yodlee as the account aggregator to bring together all of the data from the different financial accounts for a consumer. Absent Yodlee, there would be no data in Mint’s service, which means there would be no service at all. Mint’s entire service depended on a single technology relationship.
While I don’t know Mint’s situation, I suspect both companies mitigated this risk by signing long-term deals with their respective partners. I imagine both were among the largest customers for their respective partners and felt like they had some leverage in the other direction. Nonetheless, I suspect both companies wanted to hedge their bets by cultivating other partners, but ultimately were growing too fast to seriously contemplate using another platform. I also imagine that both sold to their respective acquirers with one eye looking at an attractive valuation and the other eye looking at a substantial unknown after the terminal year of their partner contracts.
Verid and Mint both deliver superb products and ended up being great investments for their investors. Both probably could not have been huge companies without mitigating that potential single point of failure. But, both showed that despite that issue, with astute management, you can still have a very successful outcome.
I’ve been looking unsuccessfully for an article that succinctly lays out both sides of the debate on whether gold is a good asset to own. So, I’m here to ask for your assistance in pulling together an article that outlines the key points on both sides of the debate. I have some ideas, but I’m sure you have more. Just leave any points of view, good articles or predictions in the comments an they will be added to the article. I hope that this article proves to be useful to readers regardless of your current point of view on the topic. If you’re formulating your own opinion on a given topic, hopefully it’s helpful to get the full spectrum of opinions on the topic. And, if you already have a strongly held point of view, surely it’s good to pressure test your convictions with an opposing view every once in awhile. So, here we go:
The Case For Gold
- The devaluing of fiat currencies around the world through unprecedented fiscal stimulus will cause an increase in the price of gold.
- Gold is a safe haven currency that tends to rise in precarious economic times like these.
- International governments will diversify out of their US dollar reserves and buy gold thereby driving demand.
- Hyperinflation is on the horizon – and that drives gold prices.
- The growth of institutional and retail investment demand for gold.
- Lack of growth in the supply of gold from mines.
- Fiat currency has no intrinsic value.
The Case Against Gold
- Gold doesn’t pay interest.
- Gold goes up when there’s inflation, and deflation is the far greater risk today.
- A safe haven asset like gold goes up when Armageddon hits, and we have avoided that.
- Over the long run, history shows that gold is not an appreciating asset.
- Asset prices are inflated by the dollar carry trade – gold will come crashing down
- Too much hype – sell high, buy low.
- Gold has no intrinsic value.
The Price of Gold/Oz.
- $1,141.70 (11.19.09 – date of post)
One of my partners led an impromptu game in our team meeting today which illustrates the emotional tension of cutting your losses. For any investor or operator who takes risk with capital, the concept of cutting your losses comes into play at some point.
The simulated game had these ground rules:
- Everyone would have the chance to make monetary bids for a prize.
- You could always increase your bid after hearing other bids. There is no limit to the number of revised bids you could make.
- The highest bid after everyone had finalized their bids would get the prize – in this case my partner offered to pay $20 as the prize.
- The catch is if you are not the highest bid – you would have to pay him the amount of your highest bid. So you could lose money.
- He guaranteed he would theoretically make inordinate amounts of money through the simulation.
So in a room of around ten folks, we started lobbing in hypothetical bids:
- I started with a bid of $5.00, just to see how things would go.
- Another person bid $7.00.
- Then another person offered $19.99 thinking that he could short circuit the whole process.
- Not wanting to lose my $5.00, it immediately occurred to me to offer $20.00 – which I did.
Then all of us had the aha moment that for the person who bid $19.99, if he thought he could win the “auction” by bidding $20.01 – he would certainly rather lose 1 cent than lose $19.99. And, then if he bid $20.01, I would have to decide if I was going to bid $20.02 for the chance to lose 2 cents rather than lose $20.00. But, what if then the person who bid $7.00 decided to bid $20.03 for the chance to lose 3 cents instead of $7.00. And, eventually you could imagine a scenario where everyone in the room bids above $20.00 for what amounts to be a foregone conclusion where everyone loses money (except my partner of course).
In a very simple way, this game illustrates the challenge of cutting your losses. Investors face this in situations when they have to decide whether to invest more money behind a company that is decreasing in value. Managers often have to face this when continuing to invest in business initiatives that are not tracking, but have taken substantial time and resources. I think the lesson learned from the game is if you’re in a no-win situation, cut your losses immediately. But, as the game illustrates, that is easier said than done. And in the real world, it’s often hard to know if you’re truly in a no-win situation or not.
By the way, I would not have bid $20.02.
I was reminded today of the commonly held belief that since the advent of mass media – good looks is a critical advantage in winning the Presidency of the United States. So out of sheer curiosity (a common refrain in this blog), I pulled together the images of all 42 Presidents courtesy of the White House website. Are the Presidents of the mass media generation better looking? Who is the best looking President of all-time? Judge for yourself…
This is the purest business idea of all time – give me a dollar and I’ll give you 90 cents (or something less) back. Ridiculous, right? Yet, it happens in so many different forms that it’s somewhat surprising. Why would anyone in their right mind give someone a dollar just to get less money back? And, I’m not talking about you giving someone a dollar so that they give someone else 90 cents back. That’s money movement. I’m talking about a direct trade – you give someone money just for the privilege of getting less money back. It happens a lot and we’ve all participated in it.
Here are some ways this model exists in business – and I’ll rank order them by the models that give you the most money back to the ones that give you the least. I’m going to spend a little extra time on the last business which I think is the most onerous of them all. Here we go:
1. ATMs. The most obvious model – you give the bank a dollar, and they give you 98%-100% of it back every time you withdraw it from the ATM. Their service: accessibility and interest.
2. Travelers Checks. We all know that companies like American Express have made a great business in taking your money, and giving you 96%-99% of the value back in the form of a less liquid travelers check. What’s the embedded service? Insurance.
3. Check Cashing. Companies like Western Union will take your check and give you cash worth about 95%-99% of the value. Their value: liquidity, especially to the unbanked.
4. Currency Exchange. Companies like Travelex have made a great living taking your money, and giving you 90%-98% of the value back in the form of another currency. The implied service: local purchasing power.
5. Coinstar. These guys own the kiosks you see at the grocery store where you put in a bag of coins and they give you 90% of the value back in the form of cash. It’s an amazing business to say the least. What’s their underlying service? Money portability.
And last but certainly not least:
6. Gold Buyers. These companies allow you to trade in your gold jewelry, and they give you cash for the gold. Not a fair example you say? I think it’s very fair – gold is a currency and so are the dollars you’re getting in return. Their true service: liquidity.
Here’s why I think the gold buying services are truly the worst economic deal of them all. There are two compounding issues. First, these companies are not giving you anywhere close to value of your gold, dollar for dollar. While the above businesses give you 90%+ of the value of your dollar, some people who have used these gold buying services have calculated that they have received 17%-18% of the value of their gold. That’s an 80%+ tax right there. (UPDATE: This CNN report that came out today says gold buyers pay between 18%-60% of face.) But, let’s not stop with that. There’s a second compounding issue that can be material. Gold is an appreciating asset. The US Dollar is a declining asset.
Here’s the historical price of gold:
Here’s the strength of the US Dollar over the same time period:
[UPDATE: Just a note – past performance is not indicative of future returns. Either currency could go up or down from here. It’s unlikely that any currency fluctuation up or down would make up for the initial 80% tax though.]
Here are the real economics: let’s just say you sold your gold jewelry in 2003 where the actual gold value is $100. Let’s say you got $18 for that $100 of gold. And then let’s just say you held that cash until now. The purchasing power of that $18 has declined to ~$14 since 2003. Meanwhile, if you just held the $100 of gold in the form of the jewelry, it would now be worth over $350. I’m not exactly sure how to properly index two bifurcating currencies, but in a nominal sense, you traded something worth $350 for $14. You got paid 4 cents for your dollar. Instead of saying “We Pay Top Dollar” – these companies should say we pay you cents on the dollar.
[UPDATE: This is what happens when you whip together a blog post late at night. Since the gold is priced in dollars, the depreciation of the dollar is embedded in the gold price. So, I didn’t need the second chart so I double counted the impact of the dollar depreciation.]
Now to be fair – most gold sellers probably don’t hold their cash so the separation from gold’s appreciation and the dollar’s depreciation may not actually have time to play out. The seller gets the value of instant liquidity and they probably use it. In addition, the gold buyers do need to have infrastructure to appraise, melt, and monetize gold if they do it themselves. Nonetheless, the tax these companies charge to give you your money back is pretty onerous no matter how you cut it. But, it just goes to show, there’s always ways to get people to give you money in exchange for less money back.
There have been a number of great venture-backed acquisitions recently, and WSJ.com does a great job outlining the Top 10 acquisitions that have closed this year. Here they are:
- Zappos ($847M)
- CoreValve ($700M)
- Pure Digital ($590M)
- Visiogen ($400M)
- SpringSource ($362M)
- BBN Technologies ($350M)
- Evalve ($320M)
- Ablation Frontiers ($225M)
- Mint Software ($170M)
- PayCycle ($170M)
Let me revise the list to add in a few more things. The list below includes deals that have been announced and not closed (AdMob, Playfish, RueLaLa). It also gives 100% credit for all earnouts ($300M+). And, it gives credit to Zappos for Amazon’s stock appreciation (an additional $300M+). Let’s consider this the fully loaded list. Here’s how the top 10 will look:
- Zappos ($1,200M)
- AdMob ($750M)
- CoreValve ($700M)
- Pure Digital ($590M)
- Playfish ($400M)
- Visiogen ($400M)
- SpringSource ($362M)
- BBN Technologies ($350M)
- RueLaLa ($350M)
- Evalve ($320M)
In aggregate, this is a whopping $5.4 billion in exit proceeds when you take the top 10 acquisitions this year. Most of these companies probably took investments from venture funds from the 2002–2006 vintage, when a typical large VC fund might be $750M. Now let’s say this fictional $750M venture fund invested in all of these companies – yes, one VC firm investing in every top 10 acquisition in 2009. And, let’s go further and say this VC firm got a very healthy 20% ownership in every single company. Since I’m being so generous, let me do one thing that is not so generous, which is presume these exits represent all the exits in the fund. Here’s what you’d get with some basic math:
That would lead to $1,084 million in gross proceeds back to this fictional large VC firm. Now let’s net out 2% fees over 10 years (to keep numbers simple) – that leads to $934 million of net proceeds. That’s a 1.25x net cash on cash multiple after getting the top 10 acquisitions in 2009.
Now, let’s presume a fictional small $100M VC firm made a bunch of bets and owned 20% of AdMob. And, let’s say they lost money on everything else in their portfolio. That would be a $150M gross return and $130M net of fees. That’s a 1.3x net cash on cash multiple from one great exit.
The fictional small VC firm made a better cash on cash return for its LPs through one winner, than the large VC firm could accomplish by getting all top 10 winners. That’s the law of large numbers in effect.
This post is for all of you out there who are both founder and CEO of your company. My simple question is this: which “title” resonates most with you – founder, CEO, or entrepreneur? Clearly, they’re all true, but let’s set aside the option to say all three. I am asking the unfair question of which one title best represents you and are you the most proud of being called? I’m also not asking which title should be on your business card, rather I’m asking how you view yourself. Which title best represents you?
Let’s look at these three statements:
- I am a founder.
- I am a CEO.
- I am an entrepreneur.
If you could introduce yourself as only one, which one would you choose and why? And, if there’s one that is better than these three, I’m all ears.
[UPDATE: I happened to be talking to a friend today who was the founder and CEO of a prior company – so I mentioned this post. He thought about it and talked about the experience of bringing in a CEO to run his company. He said he had no problems giving up the CEO role. But, the CEO had requested to also be titled one of the co-founders of the company. And, that he found violently objectionable. Maybe that’s another way to look at the question.]
I’m coming up on the six month anniversary of this blog, Thinking About Thinking. I’ve written 54 posts in that time, so about 2 per week. This blog was named after my favorite class in college – which was a multidisciplinary class on philosophy, science, and law. In that vein, I wanted this blog to be “one serving VC, one serving technology, and 3 servings of other stuff of varying degrees of randomness and interest”. Out of sheer curiosity (which is the genesis of most everything on this blog), I decided to look at my top 15 posts (by # of views) to see whether that ratio had held true. Here it goes:
- Global VC Blog Directory (16,349)
- Where In the World Is Eduardo Saverin? (7,362)
- The Most Expensive Commercial Real Estate In The World Is A Place For Computers, Not People (4,667)
- Missionary CEOs v. Mercenary CEOs (2,096)
- How Can We Double Down? (1,345)
- It’s Hard To Get The News From The News (1,181)
- Relative Value v. Absolute Value (958)
- Harvard Business School Is Taking Over Boston VCs – For Better or Worse? (954)
- College Optional (945)
- What If The Federal Government Was An Average Household (798)
- Cortera: Turning The Business Credit Rating Industry Upside Down (725)
- The Learning Test (709)
- 4 Questions and 4 Pressure Tests To Decipher A VC’s Interest In Your Company (673)
- The Categories of Risk In the VC Brain (660)
- How To Easily Subscribe to VC Blogs (548)
It looks like the real ratio is more like 3 servings VC/tech and 2 servings other stuff. Still enough variety to keep things interesting. Thanks for reading everyone.