Thinking About Thinking

What Option Grants Tell Us About The US Dollar

Posted in Economy, Venture Capital by larrycheng on November 3, 2009

Let’s start with the obvious.  When you receive an option grant in a private company, you are told a number of options.  The absolute number of options you receive is not as relevant as the percentage of the company it represents.  Your option grant is the numerator, but the denominator is key.  The denominator is the total number of shares outstanding in the company.  Obviously, if you are granted 10,000 options and there are 1,000,000 shares outstanding, you have been granted 1% of the company.  You are probably a direct report to the CEO.  If you are granted 10,000 options and there are 100,000,000 shares outstanding, you have been granted .01% of the company.  You are probably in an entry level role of some capacity.  It’s the percentage that counts. 

The more a company raises money by issuing more shares, the larger the denominator grows, and the lower your percentage gets presuming your option grant does not change.   It’s basic math: if the numerator stays constant, and the denominator keeps getting bigger, the resulting percentage keeps declining.  This effect is called dilution – which is never a positive word in our world.  No shareholder wants to be diluted.   For the readers of this blog, I suspect this principal is relatively obvious since many of you have worked within or around private companies.  OK, enough with the obvious. 

This very same principal applies to the value of currency which is why it surprises me when people are nervous, they decide to keep their money in cash (US Dollar).  In the world of currency, your numerator is the amount of US Dollars you have in the bank.  People feel safe because they have $x in the bank.  That’s the equivalent of people feeling properly compensated because they have 10,000 options.  It’s an incomplete equation.  You need to know the denominator.  In the case of the US Dollar, the denominator is the money supply.  The money supply is the “total amount of money available in an economy at a particular point in time.”  Just like in the option example, if you have a certain amount of cash in the bank, but the government keeps “printing money” to expand the money supply, your percentage of the money supply is declining.  It’s the currency form of dilution.  And here’s what’s happened to the US money supply:


If I told you you could hold a fixed number of options in one of two companies: (A) a company that had to raise a ton more money and issue a ton more stock to do so, or (B) a company that is profitable and has to raise no more capital and therefore issue no more shares – all other things being equal, you’d take Option B every single time.  You’d take it because your ownership in the company would not be diluted.  But, why is the answer less obvious in currencies, when the principal is largely the same?  The US government is printing money and is the national equivalent of Option A.  It would seem more logical to look for the national equivalent of Option B and keep your money invested in that currency. 

Now there are lots of exogenous factors.  You can’t discount the fact that the US still has the strongest military on the planet.  And you certainly can’t discount enough the fact that I’m no economist and am probably missing many obvious points.  And, certainly, do not take this as investment advice.  This is just an exercise in thinking aloud which is what this blog is about.

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What If The Federal Government Was An Average Household?

Posted in Economy, Pop Culture by larrycheng on October 31, 2009

I’m not an economist.  So, it’s hard to make sense of the trillions of dollars that are thrown around when it comes to the federal deficit and national debt.  So, I thought I’d just normalize the federal income statement and debt statistics against a typical household since it makes more intuitive sense to me.  Here we go:

Federal Government (2009 Fiscal Year)

  • Income (Receipts): $2,104,613,000,000
  • Expenses (Outlays): $3,521,734,000,000
  • Surplus/(Deficit):  ($1,417,121,000,000)
  • National Debt:  $11,874,664,000,000

Now we take that data and normalize it against a household with $50,000 in income (which is the US median HH income):

  • Income: $50,000
  • Expenses: $83,667
  • Deficit: ($33,667)
  • Debt: $282,110

Now normalized against a household with $100,000 in income:

  • Income: $100,000
  • Expenses: $167,334
  • Deficit: ($67,334)
  • Debt: $564,221

Now normalized against a household with $250,000 in income (top ~2%):

  • Income: $250,000
  • Expenses: $418,335
  • Deficit: ($168,335)
  • Debt: $1,410,552

Looking at it this way, I have a couple of intuitive observations.  The $100k household is spending $14,000 per month.  Let’s just say they have $4,000/month in mortgage/auto interest expense.  That means the husband and wife are each running up $5,000 per month – each – on their credit cards if they charge everything.  That’s an average of $167 charged per day per person on their credit cards.  That’s hefty spending especially if you presume only modest savings which is probably a fair assumption given our near negative historical savings rates.

Prior to doing this analysis, I thought the normalized debt number would be outrageous.  It’s probably ~2x what it should be.  A $100k household through most mortgage calculators can probably afford a $300k-$350k mortgage.  So, $564k in debt for a $100k household is clearly too high, but not by several orders of magnitude which is what I though it would be.  Anyways, food for thought…

The Grassroots Deli Economic Forecast

Posted in Economy, Pop Culture by larrycheng on October 20, 2009

When the market crashed over a year ago, I got pretty motivated to stay on top of global macroeconomic research.  So, I started reading about 7 different sources of economic forecasts and analysis.  As the year has progressed, I have narrowed in on a couple that I think are keepers.  My two favorites are The High Tech Strategist by Fred Hickey and some of the commentary of Jurrien Timmer who runs the Fidelity Dynamic Strategies Fund.  But, neither of them has replaced my true source of grassroots economic information, from appropriately named, Grassroots Deli.

Grassroots Deli is a hole in the wall deli across the street from my office on 183 Devonshire Street in Boston’s financial district.  They have great homemade muffins in the morning and a mean turkey platter for lunch.  The owner mans the register and she remembers everyone’s name and usual order.  It’s a little bit like Cheers – where everyone knows your name.  (BTW, this is for another blog post, but I think she’s cracked the code on customer retention in the restaurant business – good food and remember the customer’s name.)

Every once in awhile, I ask her how business is which is my gauge for the health of the economy.  Here are some tidbits of what she’s said over the past:

  • Summer 2008: She was feeling the effects of the vacancy level at 1 Federal Street.  She commented that the money managers spend a lot more money on lunch than the lawyers do – and it’s the money managers who left the building.  I guess money managers are OK paying $10+ for lunch which is important in her business.  She was also feeling the pain of the high oil prices which led to fuel surcharges tacked on by her food suppliers.
  • Fall/Winter 2008: Feeling the sting of many layoffs around the downtown – deer in headlights.  Even more infuriating was the continued oil surcharge from food suppliers despite oil falling from $100/barrel to $35/barrel.
  • Summer 2009: Business demand is still well below average, but what’s hurting her business is the price of sugar.  Sugar had climbed from $0.12/pound to $0.18/pound inside of a year.  Climbing commodity prices across the board are hurting her margins since she can’t raise her prices.  Profits are being squeezed at the cost of goods line – business is tough.

I got my latest update today:

  • Fall 2009:  Hopes of a pick-up in business after Labor Day have now faded.  Business is still very slow.  She said her paper supplier who has been working the Boston and Cape Cod region for 38 years said his business in Cape Cod fell by more than $1 million year over year.  It’s at it’s worst point in 38 years.

Well, the food is great at Grassroots Deli, but business is still challenging.  Her business is probably a microcosm of many different businesses as she is doing a great job servicing her customers but there are things out of her control.  Her little business illustrates the fundamental and wide-ranging impact of things like commercial vacancy rates, rising commodity prices, and high unemployment.  I’m definitely rooting for a better forecast next time.  Official Grassroots Deli Economic Forecast: not out of the woods yet.

Who Is The Venture Capitalist’s Customer?

Posted in Economy, Philosophy, Venture Capital by larrycheng on September 27, 2009

Venture capitalists always talk to their portfolio companies about how important it is to define your customer, understand their needs, and create a compelling value proposition for them.  Though, if you talk with enough VCs, we have a hard time defining the customer for our own business.  I was having a recent discussion on this topic with some colleagues in the industry and no unified consensus emerged.  It is always a debate between our limited partners (“LPs” – those who invest in VC funds) and entrepreneurs.  We all know that we ultimately get “paid” by LPs.  But, we also know we don’t survive if entrepreneurs don’t want to work with us.  So, who is the venture capitalist’s customer? 

To try and get some feedback, I decided to ask my twitter friends: Who is the VC’s customer?  I specifically asked VCs to respond.  Somewhat surprisingly, no VCs responded, but I got a slew of responses from entrepreneurs.  They were quite aligned:

  • apsinkus: “institutional investors are real customers of VCs (in my opinion).  Entrepreneurs are merely suppliers.  No LPs, no money.”
  • brandonhaskins: “Although not one myself, a VC is ultimately in investment management, so customers are investors – entrepreneurs are products!”
  • muhammadkassim: “VCs’ customers are investors into the fund. Entrepreneurs are VCs’ business partners.”
  • gmsheehan: “their investors”
  • AppStruck: “The VCs customers are the institutional investors you raise money from.”
  • meetthestreet: “LPs…pension funds and endowments are clearly VC customers. In money management the people who give you money are your customers.”
  • CameronHerold: “unfortunately for entrepreneurs the Investors are the VCs customers. The entrepreneur is the VCs product.”
  • EdLoessi: “the VC’s customer are the people who gave them the money the tool is the company invested in and sometimes you break your tools!”

I’d say 85%+ of the respondents said the VC’s sole customer is the LP.  Not a single responder said that the entrepreneur is the VC’s principal customer.  So, in an unexpectedly round about way, I got my answer from entrepreneurs, not from VCs.  If entrepreneurs are the VC’s customer, surely entrepreneurs would know that.  Since they don’t know that – either VCs are doing a terrible job taking care of their customer (which is possible) or in fact the entrepreneur is not the end customer of the VC. 

My personal belief is that the VC’s primary customer is the LP.  There is a clear and constant relationship between VCs and our investors which is consistent with the traditional definition of a vendor/customer relationship – they pay us for providing a product/service to them.  We have to provide a great product/service to our LPs and service them well as our customer or they can take their business elsewhere. 

Then what are entrepreneurs to VCs?  First of all, entrepreneurs should be no less important to VCs than LPs.  Without LPs, VCs are out of business.  Without entrepreneurs, VCs are out of business too.  Entrepreneurs can take their capabilities elsewhere, same as LPs.  So, while entrepreneurs and LPs are equal in importance, it is a different relationship.  I do not have a vendor/customer relationship with the entrepreneurs I work with.  In my mind, the entrepreneur is not the VC’s customer any more than the VC is the entrepreneur’s customer.  Nor do I think describing entrepreneurs as the VC’s product or supplier is accurate.  Neither of these lines of thinking fit for me as the right way to describe the relationship. 

I think the best term to describe the relationship between VCs and entrepreneurs is partners.  The official definition of partner is: “a person who shares or is associated with another in some common action or endeavor”.  I view the entrepreneurs I work with as my partners.  I think they view me as their partner as well.  I am sure that any of my CEO’s will tell you the effort that I put in towards being a value-added partner to them.  We partner together for the common end goal of building great companies and creating value for shareholders.  So entrepreneurs are not customers, suppliers or products for VCs, they are partners.  We work side-by-side as partners at the end of the day.  I wouldn’t have it any other way. 

Cortera: Turning The Business Credit Rating Industry Upside Down

Posted in Economy, Technology, Venture Capital by larrycheng on September 22, 2009

Days like today are one of the reasons I love being in the venture business.  I love investing in companies with great people, doing very innovative things that can completely disrupt large, stodgy industries.  I love the idea of bringing millions of customers and users real value that they couldn’t imagine before.  I love any innovative service that creates transparency, levels the playing field, and lets the little guy win.  It’s all about putting the slingshot in David’s hand – and going after Goliath.  Today, Cortera is doing just that with their launch of the Cortera Credit Exchange at DEMOfall 2009.  Congratulations to the team at Cortera for their amazing effort. 

What does Cortera do?  The most impactful and disruptive innovations are often the simplest.  This is no different.  At its most basic level, Cortera’s service enables any business to rate any other business on how they pay their bills.  We think of it as Yelp for business credit.  In today’s launch, there are already over a million ratings on businesses like yours and mine.  There’s a lot more data on top of the ratings on virtually every company in the United States.  Why is this such a big innovation?  It puts power back in the hands of small businesses around this country in a couple of really critical ways:

Firstly, it enables the voice of the small business to be heard in the business credit world.  Traditionally, commercial credit ratings are driven by payment data contributed from a few thousand large companies.  While Cortera has included that data as well, there are tens of millions of smaller companies whose payment experiences have been left out until now.  On Cortera, the payment rating of a small business matters just as much as the payment rating of a large company.  Any business can go online at Cortera, right now, and enter a payment experience they are having with one of their customers.  The playing field has been leveled. 

Secondly, by leveraging the Internet for user generated ratings, Cortera can now offer commercial credit data for prices unheard of in the business credit industry.  Basic credit information and user ratings are now available for free.  Free is a term that has rarely been uttered in this industry.  And while traditional business credit reports from incumbent vendors can cost $50–$150 per report, you can now subscribe to Cortera for near-unlimited data access for most companies in the United States for as low as $29–$49/month.  This is a game-changing innovation to price structure of the business credit industry. 

Finally, Cortera enables small businesses to build a credit rating based purely on the ratings of its partners and vendors on Cortera.  Lots of small businesses have trouble building credit ratings because the payment data for traditional ratings come from big companies.  What if your business principally works with small companies?  The old model can leave a creditworthy small business on an island.  Now any business can take control of their credit reputation, and build a credit rating on Cortera directly through the feedback of the businesses it works with.  We hope to enhance the credit reputation of millions of small businesses. 

As we all know, it’s credit that makes the economy run.  Every accounts receivable (AR) is a form of credit one business has extended to another.  Every accounts payable (AP) is a form of credit received by one business from another.  Nearly every business on the planet has both AP and AR on their balance sheet.  Business transactions big and small are done on credit every day.  But, how does a business know if the party they are transacting with is credit worthy?  Cortera now makes it drop dead simple and cheap.  Type in the company name on Cortera, click on the right company, and you’re there. 

The world is changing.  You don’t go to a movie without looking at the ratings online.  You don’t go to a restaurant without checking ratings online.  You don’t book a hotel or plan a vacation without pouring over ratings online.  But, you’d give someone 30 day terms on a $50,000 order without checking credit ratings online?  Not any more, not with Cortera.  Congratulations to the entire team at Cortera for introducing a truly disruptive service to an industry in dire need of change. 

(Disclosure: Cortera is a Fidelity Ventures portfolio company, and I sit on the Board of Directors.)