Thinking About Thinking

Single Unit Value Is More Important Than Growth

Posted in Growth Equity, Venture Capital by larrycheng on March 11, 2010

The pressure for revenue growth has hurt a lot of young companies.  It starts with an entrepreneur representing a growth story to an investor.  Then the investor represents the growth story to his firm to gain support for the investment.  And then the investment happens.  Then the company takes the investment, invests in sales and marketing, and the company grows.  Everyone is committed to growth, gets used to growth, and expects more growth in the future.

This is all well and good – if and only if – the single unit value is there, especially in mass market companies that service consumers or small/medium size businesses.  There are two aspects to single unit value: (1) single unit satisfaction and (2) single unit economics. 

Single Unit Satisfaction

The fundamental question is if you take a single customer, do they derive sufficient value from using your product or service? 

  • For a consumer social web service, maybe the key value measure is whether a user will tell two friends about it. 
  • For a SAAS company, the key value measure might be renewal. 
  • For a transactional company, the key value measure might be a repeat transaction rate. 

This is not intended to be rocket science.  Companies need to focus on a single customer, that is in their target market, and make sure they can deliver sufficient value to that customer to drive the right behaviors (referral, renewal, repeat usage).  It goes without saying, trying to build a great business on the backs of customers that don’t perceive sufficient value in your product or service is impossible. 

Single Unit Economics

The fundamental question now is if you now take that satisfied customer, can you make money based on your business model?  Companies need to fully burden the cost of servicing a single customer to understand single unit profitability.  This includes marketing, sales, cost of goods, capex, servicing, overhead, etc.  The question therein is whether that single satisfied customer is profitable given all that it costs to acquire and service them?

  • Many online video sites excelled at single unit satisfaction, but they got hammered on the economics because they didn’t generate enough ad revenue to cover  a single cost component such as bandwidth to deliver the videos. 
  • Some mass market companies that can cover sales and marketing costs, get caught up in the cost to service customers on the back-end.  The old local food delivery service, Kozmo.com had this issue. 
  • Infrastructure oriented companies, like wireless service providers, that have up front capex to deploy new customers, need to be crystal clear on lifetime value of customers – to cover capex.  Otherwise growth is in fact detrimental.
  • It goes without saying that if your selling your product for less than what it costs you – some of the early online retailers like MotherNature.com faced this.  You can’t make up negative gross margins with volume.

Sometimes the pressure for growth obscures the importance of single unit value.  In reality, there is no reason to invest for growth if the single unit value is not there.  It’s more prudent to wait, get customer satisfaction and economics nailed right, and then push for growth.  Pushing for growth prematurely at best will waste money unnecessarily, and at worst, will accelerate the demise of the company.  On the flip side, if the economics and value are there, rather than tiptoe forward on the growth plans, it’s prudent to invest aggressively for growth.  That’s when great companies are built, but it often requires patience in the early days. 

Independent Firms With Single Limited Partner Histories

Posted in Venture Capital by larrycheng on March 5, 2010

A breakfast conversation with Fred Wilson this morning prompted the thought of how many independent venture firms come directly or indirectly from firms that had a single or captive limited partner structure (one source of capital).  Just thinking out loud:

  • Union Square Ventures was formed by Fred Wilson and Brad Burnham.  Fred came from Flatiron which at the time was all J.P. Morgan money.  Brad came from AT&T Ventures which was all AT&T money.
  • Bessemer Venture Partners through most of its history was Phipps family money through Bessemer Trust.
  • Venrock was historically all Rockefeller family money.
  • Norwest Venture Partners was and may still be Wells Fargo money (not sure). 
  • Flybridge Venture Partners came from IDG Ventures previously captive to IDG.
  • Fairhaven used to be TD Fund which was captive to TD Banknorth.
  • Scale used to be BofA Ventures which was captive to Bank of America. 
  • And, of course, Volition Capital was formed by the U.S. team of Fidelity Ventures. 

I am sure there are many others if I just thought about it more.  I think if I continued to think about it – I’d probably be surprised at how many independent firms today have some roots in the single LP model, and I’d also probably be surprised at the consistent quality of the independent firms once they are formed.  We can only hope and expect that Volition will follow in the footsteps of some of these fine firms.  If there are others firms you know of, I’d be interested to hear about it. 

The Money Behind The Money

Posted in Growth Equity, Venture Capital by larrycheng on February 25, 2010

Where does the money come from that private equity (venture capital, growth equity and buyout) firms invest?  It might indirectly come from you.  Key constituents include the likes of government employees, employees of large corporations, trade organizations (e.g. teachers) and wealthy families.  Here’s the quick synopsis:

Wealthy Families / Foundations. The original investors in venture capital firms were wealthy families.  The Phipps family was behind Bessemer.  The Rockefeller family was behind Venrock.  These wealthy families often invest out of vehicles like family offices or foundations.  From those roots, many wealthy families have played impactful roles in backing some of the best names in private equity.  As the asset class has became more known and attractive, the sources of capital grew to include more institutional sources.  But, behind every institution are regular people.

Endowments. One of the most aggressive investors in venture capital has historically been school endowments.  When you make that annual class gift to your college, if you designate it for the endowment, some of your gift just might be put into various venture capital and buyout firms.  Typically, universities are charged to protect your endowment gift, so they invest it, and use the returns generated from the investment to fund various school initiatives.  Major universities like Harvard, Yale, Stanford, MIT, etc. have been big proponents of investing some of that endowment principal into private equity firms.

Pension Funds. Another prominent investor in venture capital has been corporate and public pension plans.  Pension plans (of the defined benefit variety) are just another type of retirement plan used by state governments, labor/trade unions, and large corporations.  As you work at a company or state government and thereby accrue pension benefits, the company or organization funds a pension account based on actuarial models tied to its potential pension payout obligations.  A portion of these funds are often allocated to the private equity asset class.  Major states investing in this asset class include New York, New Jersey, California, Oregon, etc.  Major corporations like AT&T, General Motors, etc. have also been active investors.

Fund of Funds. Many foundations, endowments, and pension funds lack the capacity or resources to evaluate and monitor different private equity firms.  Hence, the fund of funds industry has sprung up to pool capital from these sources into funds and then invest on their behalf.  Unlike the other sources of capital, fund of funds have to raise their capital from third party sources, just like the firms that they invest in.

So, if you follow the money through, your child’s college financial aid package or your pension plan – might be tied to a couple engineers working on some project in Silicon Valley or tied to the big buyout you read about in the Wall Street Journal.

If A Board Meeting Was Like The State Of The Union

Posted in Venture Capital by larrycheng on January 28, 2010

The CEO would make his way to the board room through a processional in the company’s hallways, flanked by clapping employees, shaking hands and giving thumbs up to the staff along the way.

The meeting would start with the CFO announcing the entrance of the CEO, and all board members standing and applauding.

The CEO would stand at the head of the table, with the CFO and CTO sitting in oversized chairs on a raised platform behind him.

All powerpoint slides and the projector would be replaced with a teleprompter.

When the CEO talked about cutting spending, lowering the burn and a hiring freeze, investors on both sides of the table would stand up and applause.

When the CEO talked about changing the healthcare plan to cover all employees and shareholders, the investors on the left side of the table would stand up and applaud while the other investors sit stoicly.

Thereafter, the CEO would have to remind all investors that their job is to represent the shareholders, not their own partisan interests.

Rather than talking during the meeting, the CTO and CFO would convey their opinion by smirking, giggling, and giving standing ovations as the CEO spoke.

Meanwhile, outside legal counsel, sitting in the first row facing the CEO, would never applaud and would be generally expressionless throughout.

At the appropriate time, the CEO would give a carefully calculated shout out to his wife who is sitting at the outer edge of the board room next to some carefully selected key partners and customers.  She waves at the mention of her name.

The CEO closes the meeting by saying God Bless this company.

Time Horizon Does Matter

Posted in Philosophy, Pop Culture, Venture Capital by larrycheng on January 28, 2010

Ever since I started in the investment business, entrepreneurs would often ask in meetings, “What’s your typical time horizon for an investment?”  To be candid, I never thought this was a particularly relevant question.  No institutional VC or growth equity firm will say we’re trying to flip our investments in a year.  And, no firm will say we’re looking to hold every company for 15 years.  Though every firm with some history will have examples of both taking place.  I’d guess that most firms will say their typical holding period is in that 3–6 year range with flexibility above and below that.  To that end, I have always thought that time horizon was never that distinctive or critical of an attribute when selecting a firm.

As the years have gone by, and I’ve been exposed to different investment philosophies – financial or otherwise – and I’ve come to appreciate that in many ways, time horizon can be a driving force in one’s strategy or even ideology.  Though in my vocational world, time horizon isn’t that distinctive because most firms are within a similar band, in the broader world, time horizon is profoundly implactful.  Here’s what I mean…

On investments: What if a firm came along with the resources and focus to invest in companies with a 10–30 year return on investment?  All the traditional defining attributes of a firm – stage, sector, geography, etc. – are subjugated to the outstanding fact that this firm is optimizing for the 20 year return, not the 5 year return. 

An example of this might be Google.  Google bought YouTube for $1.65B in 2006.  Since that investment, they have taken much criticism because YouTube continued to burn cash and the business model hadn’t been proven to work.  In other words, the YouTube acquisition didn’t make sense if your investment horizon was 3–5 years.  But, what if Google’s horizon was 10–20 years, and that’s what they were focused on?  What if they didn’t care as much about the economics and importance of video over the near-term, but just wanted to make sure they were dominant 10–20 years later in video?  Google is one company that can afford to do that, and a different time horizon leads to a different set of actions.

On economics: Let’s say that you are sitting in Tim Geithner’s seat (U.S. Treasury Secretary) at the start of his term last year.  And, he has a simple question – do I bail out the banks?  I would argue that the question to drive the answer is – what’s your time horizon?  Are you aiming to stabilize the U.S. economy in the 1–4 year horizon – over Obama’s term, or is your priority to create the stage for a strong and vibrant economy over the 20–30 year horizon?  Clearly the nature of politics dictates a nearer-term horizon, and hence, the logical decision is to bail out the banks and deal with the consequences later.  But, if your primary objective is to optimize the long-term (20–30 years) health of the economy, one could make a strong argument that bailing out the banks is not the right thing to do.  This is not about big or small government, left or right ideology, populist or otherwise – this is simply about time horizon.

On poverty: Let’s say you want to help the homeless in Boston.  Again, I’d argue that time horizon is a big driver.  If your objective is to help today – you’d probably walk outside and lend a helping hand through money, food or clothing.  If your objective is to help this year, maybe you’d support or volunteer at a homeless shelter.  If your objective is to help over the 20–50 year horizon – then you’d probably focus all of your energies on a structural issues like education and jobs.  Sometimes I wonder if different ideologies on poverty (e.g. Democrats and Republicans) are really just differences in time horizon rather than core philosophy. 

If you look at all different aspects of life – career decisions, child rearing philosophies (think about sleep training), relationships, etc. – different time horizons leads to different decisions.  Hence, while I tended to be dismissive about time horizon in the past, now in many ways, it’s a starting point for making decisions.  I’ve come to appreciate that it’s a healthy thing to ask in any decision making process – what’s my time horizon?

Global Venture Capital (VC) Blog Directory – Ranked By Monthly Uniques

Posted in Technology, Venture Capital by larrycheng on January 13, 2010

It’s exciting times these days after we launched Volition Capital on Monday (01/11/10).  Commensurate with that launch, we also launched the Ask Volition blog – which is a Q&A blog that is authored by various folks at Volition.  The first post on the blog is: Why did you choose the name Volition Capital? 

Despite all that’s going on, I decided to publish the 3rd version of the Global VC Blog Directory (v1: May 2009, v2: Sept 2009).  The past two versions have been based on Google Reader subscribers.  Some requests came in to do a ranking via monthly uniques to better show current readership – so this edition is ranked by monthly uniques according to Compete.  The specific number is the average monthly uniques in Q409 [(Oct+Nov+Dec)/3].  While Compete does have data for well trafficked subdomains (e.g. blogname.wordpress.com), approximately 50% of the lesser trafficked blogs on subdomains did not register unfortunately.  I also couldn’t isolate traffic statistics for blogs embedded into a broader site (e.g. www.firmname.com/blog).  Blogs without traffic stats are on a separate list below.  Apologies to those I couldn’t get data for.  Interestingly, lesser trafficked blogs with their own distinct domains did seem to get picked up more reliably.  Give me feedback on whether you prefer the ranking on subscribers or monthly uniques – I’m not fully committed to either yet.  Expect version 4 of this directory in April 2010 based on Q110 data.  As always, if I’m missing any new or existing VC/PE blogs, please leave it in the comment field.   

Links to subscribe to the Global VC Blog Directory in bulk via Google Reader (RSS/OPML) – will be updated, but still based on v2: Sept 2009:

 

The Global VC Blog Directory (Avg. Monthly Uniques – Q409)

  1. Fred Wilson, Union Square Ventures, A VC (100,279)
  2. Guy Kawasaki, Garage Technology Ventures, How To Change The World (82,838)
  3. Paul Graham, YCombinator, Essays (71,924)
  4. Brad Feld, Foundry Group, Feld Thoughts (45,633)
  5. Mark Suster, GRP Partners, Both Sides of the Table (39,389)
  6. Bill Gurley, Benchmark Capital, Above The Crowd (23,084)
  7. Dave McClure, Founders Fund, Master of 500 Hats (21,462)
  8. Josh Kopelman, First Round Capital, Redeye VC (12,972)
  9. Bijan Sabet, Spark Capital, Bijan Sabet (12,451)
  10. Jeremy Liew, Lightspeed Ventures Partners, LSVP (12,097)
  11. Mark Peter Davis, DFJ Gotham Ventures, Venture Made Transparent (12,010)
  12. Larry Cheng, Volition Capital, Thinking About Thinking (11,851)
  13. Eric Friedman, Union Square Ventures, Marketing.fm (11,520)
  14. Multiple Authors, Union Square Ventures, Union Square Ventures Blog (11,408)
  15. Albert Wenger, Union Square Ventures, Continuations (9,729)
  16. Christine Herron, First Round Capital, Christine.net (9,561)
  17. Mendelson/Feld, Foundry Group, Ask The VC (9,270)
  18. Seth Levine, Foundry Group, VC Adventure (8,206)
  19. Nic Brisbourne, Esprit Capital Partners, The Equity Kicker (8,052)
  20. Fred Destin, Atlas Venture, Fred Destin’s Blog (7,928)
  21. Ryan Spoon, Polaris Venture Partners, ryanspoon.com (7,904)
  22. Jason Mendelson, Foundry Group, Mendelson’s Musings (7,763)
  23. Jon Steinberg, Polaris Venture Partners, Jon Steinberg (7,595)
  24. Marc Andreesen, TBD, Blog.pmarca.com (6,982)
  25. David Cowan, Bessemer Venture Partners, Who Has Time For This? (6,744)
  26. Roger Ehrenberg, IC Capital Ventures, Information Arbitrage (6,396)
  27. Dan Rua, Inflexion Partners, Florida Venture Blog (6,278)
  28. David Hornik, August Capital, VentureBlog (5,920)
  29. Stewart Alsop, Alsop-Louie Partners, Alsop-Louie Partners (5,346)
  30. Ted Rogers, PPI Ventures, Venture Capital Brazil (5,146)
  31. Ed Sim, Dawntreader Ventures, Beyond VC (3,973)
  32. Jeff Bussgang, Flybridge Capital Partners, Seeing Both Sides (3,224)
  33. Ouriel Ohayon, Lightspeed Gemini Internet Lab, MYBLOG by Ouriel (3,102)
  34. Rick Segal, JLA Ventures, The Post Money Value (2,723)
  35. David Lerner, Totius Group, Columbia Venture Lab, David B. Lerner (2,627)
  36. Rob Hayes, First Round Capital, Permanent Record (2,596)
  37. Rich Tong, Ignition Partners, Tongfamily (2,589)
  38. Mike Speiser, SutterHill Ventures, Laserlike (2,324)
  39. Will Price, Hummer Winblad, Will Price (2,066)
  40. Peter Rip, Crosslink Capital, EarlyStageVC (1,926)
  41. Rob Go, Spark Capital, robgo.org (1,908)
  42. Chris Fralic, First Round Capital, Nothing To Say (1,826)
  43. Matt Winn, Chrysalis Ventures, Punctuative! (1,757)
  44. Satya Patel, Battery Ventures, Venture Generated Content (1,744)
  45. Multiple Authors, Highway 12 Ventures, Highway 12 Ventures Group (1,700)
  46. David Beisel, Venrock Associates, GenuineVC (1,590)
  47. John Ludwig, Ignition Partners, A Little Ludwig Goes A Long Way (1,562)
  48. Sarah Tavel, Bessemer Venture Partners, Adventurista (1,518)
  49. Mike Hirshland, Polaris Venture Partners, VC Mike’s Blog (1,492)
  50. Martin Tobias, Ignition Partners, Deep Green Crystals (1,426)
  51. Christopher Allen, Alacrity Ventures, Life With Alacrity (1,283)
  52. Mo Koyfman, Spark Capital, Mo Koyfman (1,128)
  53. Derek Pilling, Meritage Funds, Non-Linear VC (1,090)
  54. Kent Goldman, First Round Capital, The Cornice (1,084)
  55. Greg Foster, Noro-Moseley Ventures, SouthernVC (1,082)
  56. David Aronoff, Flybridge Capital Partners, Diary of a Geek VC (847)
  57. Matt McCall, DFJ Portage Venture Partners, VC Confidential (844)
  58. Lee Hower, Point Judith Capital, Venturesome (802)
  59. Allan Veeck, Pittsburgh Ventures, Pittsburgh Ventures (789)
  60. Paul Fisher, Advent Venture Partners, The Coffee Shops of Mayfair (777) 
  61. Rob Finn, Edison Venture, Ventureblogalist (734)
  62. Jason Caplain, Southern Capitol Ventures, Southeast VC (723)
  63. Baris Karadogan, Com Ventures, From Istanbul to Sand Hill Road (712)
  64. David Feinleib, Mohr Davidow Ventures, Tech, Startups, Capital, Ideas. (709)
  65. Ryan McIntyre, Foundry Group, McInblog (675)
  66. Marc Averitt, Okapi Venture Capital, OC VC (654)
  67. James Chen, CXO Ventures, PureVC (551)
  68. David Pakman, Venrock Associates, A Venture Forth (646)
  69. Rachel Strate, EPIC Ventures, Wasatch Girl (528)
  70. Jeff Joseph, Prescient Capital Partners, Venture Populist (446)
  71. Max Niederhofer, Atlas Venture, Life In The J Curve, baby (445)
  72. Jason Ball, Qualcomm Ventures Europe, TechBytes (413)
  73. Pascal Levensohn, Levensohn Venture Partners, pascalsview (397)
  74. Saul Klein, Index Ventures, LocalGlo.be (102)

Additional VC Blogs (No Traffic Data)

  1. Multiple Authors, Volition Capital, Ask Volition (n/a)
  2. Tim Oren, Pacifica Fund, Due Diligence (n/a)
  3. Jeff Clavier, SoftTech VC, Software Only (n/a)
  4. Stu Phillips, Ridgelift Ventures, Soaring on Ridgelift (n/a)
  5. Scott Maxwell, Openview Venture Partners, Now What? (n/a)
  6. Raj Kapoor, Mayfield Fund, The VC In Me (n/a)
  7. Howard Morgan, First Round Capital, Way Too Early (n/a)
  8. Rob Day, @Ventures, Cleantech Investing (n/a)
  9. Steve Jurvetson, DFJ, The J-Curve (n/a)
  10. Philippe Botteri, Bessemer Venture Partners, Cracking the Code (n/a)
  11. Andrew Parker, Union Square Ventures, The Gong Show (n/a)
  12. Marc Goldberg, Occam Capital, Occam’s Razor (n/a)
  13. Allen Morgan, Mayfield Fund, Allen’s Blog (n/a)
  14. Daniel Cohen, Gemini Israel Funds, Israel Venture Capital 2.0 (n/a)
  15. Max Bleyleben, Kennet Partners, Technofile Europe (n/a)
  16. Jeremy Levine, Bessemer Venture Partners, Nothing Venture, Nothing Gained (n/a)
  17. Michael Eisenberg, Benchmark Capital, Six Kids and a Full Time Job (n/a)
  18. Sagi Rubin, Virgin Green Fund, The Grass is Greener (n/a)
  19. Vineet Buch, BlueRun Ventures, Venture Explorer (n/a)
  20. Richard Dale, Sigma Partners, Venture Cyclist (n/a)
  21. Steve Brotman, Silicon Alley Venture Partners, VC Ball (n/a)
  22. Ho Name, Altos Ventures, Altos Ventures Musings (n/a)
  23. George Zachary, Charles River Ventures, Sense and Cents (n/a)
  24. Jacob Ner-David, Jerusalem Capital, VC In Jerusalem (n/a)
  25. Ed Mlavsky, Gemini Israel Funds, GOLB: Is This Israel? (n/a)
  26. Michael Greeley, Flybridge Capital Partners, On The Flying Bridge (n/a)
  27. Sid Mohasseb, Tech Coast Angels, Sid Mohasseb (n/a)
  28. Peter Lee, Baroda Ventures, Seeing Eye To Eye (n/a)
  29. Ted Driscoll, Claremont Creek Ventures, Evolving VC (n/a)
  30. Justin Label, Bessemer Venture Partners, Venture Again (n/a)
  31. Adam Fisher, Bessemer Venture Partners, Savants in the Levant (n/a)
  32. Gregoire Aladjidi, Techfund Europe, Investing In What’s Next (n/a)
  33. Todd Dagres, Spark Capital, Todd Dagres Tumblelog (n/a)
  34. Santo Politi, Spark Capital, This and That (n/a)
  35. Robert Goldberg, Ridgelift Ventures, Tahoe VC (n/a)
  36. John Abraham, Arrowpoint Ventures, JMA’s Views On Everything (n/a)
  37. David Dufresne, Desjardins Venture Capital, Dav-Generated Content (n/a)
  38. Brad Burnham, Union Square Ventures, Unfinished Work (n/a)
  39. Brian Hirsch, Greenhill SAVP, New York VC (n/a)
  40. Multiple Authors, Foundry Group, Foundry Group (n/a)
  41. Charles Curran, Valhalla Partners, VC Blog (n/a)
  42. Multiple Authors, Brightspark Ventures, Let the Sparks Fly! (n/a)
  43. Jon Seeber, Updata Partners, Jon’s Ventures (n/a)
  44. Todd Klein, Legend Ventures, Media VC (n/a)
  45. Multiple Authors, True Ventures, Early Stage Capital (n/a)
  46. Adi Pundak-Mintz, Gemini Israel Funds, Adisababa’s Weblog (n/a)
  47. Don Rainey, Grotech Ventures, VC in DC (n/a)
  48. Art Marks, Valhalla Partners, Entrepreneurial Quest (n/a)
  49. Rob Schultz, IllinoisVENTURES, Go Big or Go Home (n/a)
  50. Tony Tjan, CueBall Capital, Anthony Tjan (n/a)
  51. Cem Sertoglu, Golden Horn Ventures, SortiPreneur (n/a)
  52. Larry Marcus, Walden Venture Capital, Walden Venture Capital (n/a)
  53. Anupendra Sharma, Siemens Venture Capital, So Little Time, So Much… (n/a)
  54. Steve Jurvetson, DFJ, Uploads from Jurvetson (n/a)
  55. Gil Debner, Genesis Partners, TechTLV (n/a)
  56. Multiple Authors, Tech Capital Partners, Tech Capital Partners Blog (n/a)
  57. Simon Olson, FIR Capital Partners, Venture Capital Thoughts and Reflections (n/a)
  58. Josh Sookman, RBC Ventures, Startup Life (n/a)
  59. Vishy Venugopalan, Longworth Venture Partners, Longworth Venture Partners Blog (n/a)
  60. Chip Hazard, Flybridge Capital Partners, Hazard Lights (n/a)
  61. Ed French, Enterprise Ventures, TechGain.net (n/a)
  62. David Stern, Clearstone Venture Partners, The Raging Insterno (n/a)
  63. Jonathan Tower, Citron Capital, Adventure Capitalist (n/a)
  64. Dan Parkman, Venrock, Disruption (n/a)
  65. Charlie Kemper, Steelpoint Capital Partners, Opine Online (n/a)
  66. Eric Ver Ploeg, Metric Ventures, Pocket Watch (n/a)
  67. Jeff Bocan, Beringea LLC, Jeff Bocan (n/a)
  68. Boris Wertz, w media ventures, w media ventures (n/a)
  69. Charlie Federman, Crossbar Capital, CosmicVC (n/a)
  70. Multiple Authors, Golden Horn Ventures, Golden Horn Ventures (n/a)

If you know of any other VC/PE blogs, please put the URL in the comment field.  It will be included no later than the next update.   

The Magic Words

Posted in Venture Capital by larrycheng on January 5, 2010

I heard the magic words yesterday from a couple of my portfolio company executives that just warms my heart as an investor and board member.  Those magic words are: “I want to invest in the company.”  In a prior post, Founder Liquidity, I wrote about how founders/executives not selling shares when they have the opportunity is a big vote of confidence in the company.  But, an even greater vote of confidence is when founders and executives want to invest their own capital into the business.  I love it when a senior exec steps up and breaks out the checkbook ready to write a check.  I’m trying to think if there’s any gesture that gives me more confidence in a business, and it’s hard to think of one.  That’s the kind of alignment and confidence I like to see. 

As I think about my own portfolio, about 2/3 of the companies have taken some form of debt or equity investment from someone(s) on the founding or senior executive team.  While you don’t have want to have too many individual shareholders, key execs writing meaningful checks is a good thing in my book.

2010 Is A Tough Year To Budget

Posted in Venture Capital by larrycheng on January 4, 2010

In my 12 years of investing in private technology companies, I’m finding that 2010 is a uniquely difficult year to budget for our portfolio companies.  In many ways 2009 was an easy year to budget.  If you rewind to Q408, the global economy was on a precipice of collapse.  That made conservatism the principal theme for 2009 budgeting.  Everyone got conservative on operating expenses and top line growth.  The question wasn’t should we be conservative – the question was how conservative should we be?  In some ways, that made budgeting easy.

Now we look ahead to 2010.  The economy is not exactly in dire straights, but it’s not exactly healthy either.  The capital markets aren’t exactly frozen, nor are they robust.  There is some spending going on, but people are still cautious.  Should companies put their stake in the ground and say this is a great year to invest and really push top line growth?  The risk to that is you spend more, the top line doesn’t materialize and you burn more cash than anticipated.  Or should companies be conservative and measured in any incremental operating expense and top line growth projections?  The risk to that is you’re sitting on the sidelines and insufficiently aggressive as market growth returns.  This is a tough year to budget. 

Obviously, budgeting is a case by case exercise, but I’m seeing some common practices have emerge.  Note that these are common themes for several of our portfolio companies, a vast majority of which are between $10 million to $50 million in revenue. 

  1. Set a conservative maximum monthly opex.  Many companies get aspirational on the top line target which gives them budgeting freedom to increase operating expenses while only showing only a moderate burn rate.  Management and board are like-minded that their intent will be to lower expenses if revenue doesn’t materialize.  In reality – it’s never that simple.  It’s always harder in practice to lower expenses in the future than to simply wait and increase expenses in the future if business performance warrants further investment.  My suggestion is to set the monthly opex presuming conservative top line performance relative to historical norms.
  2. Commit to a minimum cash balance.  At the end of the day, cash is king.  Many of our companies are committing to a minimum cash balance for the year – i.e. we won’t go below $X million of cash in the bank.  As part of board approval of that budget, the Board and management agree to a re-budget if the company goes below that threshold cash balance.
  3. Set a top line growth goal that is realistic, but calls the company to perform.  With #1 and #2 in place, I personally think the top line goal should presume high performance by the people in the company.  If you don’t plan for and expect high performance, you’re less likely to get it.  Again, a stretch top line goal shouldn’t be used to increase underlying operating expense, but it should be used to challenge the company to peak performance.
  4. Set the key performance metrics.  Every company has the 3–6 metrics that determine the health of the business.  Agree in advance on what those metrics are and what numbers suggest different levels of performance.  Review those metrics every month to decide if the company is on the right track or not.  If appropriate, agree on what performance should point towards additional investment and what performance should suggest more conservatism on expenses. 
  5. Plan annually, revisit quarterly.  This is one year where it’s necessary to have an annual budget, but prudent to think about the budget quarterly to see if there is any new information that has entered into the equation that calls the company to be more aggressive of conservative.

A final point is not to put form over substance in the budgeting exercise.  The end goal is to build great companies and create shareholder value.  The budget should be used as a tool to achieve those goals not to distract from those goals. 

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Burn Rate Norms

Posted in Technology, Venture Capital by larrycheng on December 16, 2009

When investors and entrepreneurs talk about “burn rate”, they’re generally referring to the amount of cash a company consumes through its normal operations every month.  For many venture-backed companies, they have a negative burn rate meaning that they are expending more cash than they are collecting.  The obvious rationale to burn cash is that by spending more now, your company will be able to grow revenue faster, acquire market share and separate from the competition. 

Investors will talk about “high burn rate” companies, “capital efficient” companies, companies that are “burning too much”, etc.  But, how does this translate to hard numbers?  Here’s my rule of thumb:

  • Cash Flow Positive:  If the company is growing and cash flow positive – congratulations.  The model has been proven, you never have to raise capital again. 
  • $0–$250k burn rate:  This is still a “capital efficient” company – a $10M round could last 3–4 years which is an eternity.
  • $250k-$500k burn rate:  This is average.  Many young venture-backed companies are in this zone.  A $10M round lasts 1.5–2.0 years. 
  • $500k-$750k burn rate:  This is on the high side.  You could be accused of “burning too much”.  A $10M round lasts a 1.0–1.5 years.  That’s a tight timeframe to create value.
  • $750k-$1M burn rate:  This is a “high burn rate” company.  A $10M round doesn’t even last a year.  There’s no room for error.
  • $1M-$2M burn rate: Many investors won’t touch a company burning this much.  The exception is if the spend is due to aggressive marketing against a known acquisition model that is profitable against the lifetime value of a customer. 
  • $2M+ burn rate: Most investors will run like the wind. 

While some sectors such as biotech, cleantech and communications services don’t follow these norms – it’s a pretty good benchmark for most emerging technology companies.

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Founder Liquidity

Posted in Venture Capital by larrycheng on December 15, 2009

The sentiment towards founder liquidity among investors seems to swing back and forth like a pendulum.  Founder liquidity refers to instances when an investor invests capital to buy shares directly from a founder rather than or in conjunction with investing capital that goes into the company for traditional working capital purposes.  When capital goes to a founder rather than into the company, there is typically neither an economic benefit or an economic cost to the company (though there may be non-economic benefits and costs). 

Why would an investor be willing to use their capital for founder liquidity?  Typically it’s because they want more ownership in a company that already has sufficient working capital.  By acquiring shares directly from the founder, they can increase their ownership without increasing the post-money value of the company.  Often times, founder liquidity is used for more mature companies that are profitable and hence the only opportunity for a new investor to gain an ownership stake is by providing the founder or other shareholders with liquidity. 

Why don’t investors want to use their capital for founder liquidity?  The drawback of using capital for founder liquidity is that the capital does not go into the company and therefore has no impact on helping the company to grow.  Using a limited resource like capital in a non-accretive way is viewed quite negatively in bad economic times when capital is scarce or in situations where the company might need more working capital in the future.  Another issue related to founder liquidity is whether it impacts the motivation of the founder or is viewed negatively by other employee/management shareholders who do not get liquidity themselves. 

Why do founders want liquidity?  The most common reason is that they have bootstrapped the company, taken on substantial personal debt, and have foregone all other forms of wealth accumulation to take the company to it’s current state.  By taking some liquidity, they can strengthen their personal balance sheet and “go for a bigger win” at the company.  Other times founders want liquidity because they are no longer actively involved with the company and are seeking to clearly separate from the company.  In this instance, it’s of value to the company and investors to not have any possible dissident shareholders involved as well. 

What’s my take on founder liquidity?  Using capital for founder liquidity is a viable use of proceeds for more mature companies but it has to be done in a disciplined way.  It has to be the right kind of company and, as importantly, the right type of founder.  The right kind of company is one that does not need additional working capital and is highly predictable in nature.  The right kind of founder is one whose focus, energy, and motivation will remain productive and positive despite a suddenly improved personal balance sheet.  The two must be in place: right company, right founder.   

I have seen a number of examples where founder liquidity has been a positive instrument for all parties involved.  So, I have and will continue to support using capital for founder liquidity in very specific instances.  That being said, I think a great predictor of success for a growth stage company is when a founder who could take liquidity – chooses not to.  There may be no more significant of a vote of confidence a founder can give his or her investors than to forego liquidity and press ahead.  While I don’t know for sure, I doubt that luminary founders like Steve Jobs (Apple), Jeff Bezos (Amazon.com) or Larry & Sergei (Google) took liquidity while their companies were private.  If true, it’s a fact pattern worth emulating because in their case, it turned out to be the best financial decision they could have possibly made. 

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