Venture math fun from Fred’s fund


Two of very interesting posts about VC fund economics are over at Fred Wilson’s joint:
First “Venture Fund Economics” Second

A challenge is that my understanding is that Union Square fund has done *much better than average* and therefore you would not want to make generalization about the VC industry from their experiences.    I also need to get some feedback from Fred regarding the time frames he is discussing in the specific example he gives of a fund’s projected performance.

As I noted about some of his Venture Capital observations some time ago it’s very important to make sure you are factoring time into these equations, especially when the time frames are in decades or many years.

Fred points this out in the first post as well, noting that doubling your money is not really that impressive if it happens over a ten year time horizon.    It is critical to always recognize how the current value of money is greater than the future value – the gist of the notion of how “discounting” affects investment and other economic decisions.

More bad news for Startups and Venture Capitalists


More bad news for Startups and Venture Capitalists from the New York Times “bits” section about technology trends.    Not only is the number of IPOs falling (zero in Q2 of 2008), but it also the number of mergers or aquisitions of startups appears to be way off as well.

Venture capital folks look to the most favorable “liquidity event” and generally that is an IPO where they may realize tens or even hundreds of times their original investments.    Also favorable though generally offering less profit than an IPO is an aquisition or merger where other companies take over the startup without it going public.

I found this number very interesting and potentially alarming for Venture investors:  An average of 8.6 years from startup to IPO, the longest in some time.    Given that the present value of money is greater than future value, time horizons this long suggest, for example, that even a doubling of your VC money over that long period of time would represent only a “fair to poor” return compared to alternatives.   Given that most startups never go IPO anyway it would seem that the risk factor is going way up for these investments.

No VC for you! Zero IPOs in Q2 2008


The New York Times is noting that there have been no VC funded IPOs in this second quarter of 2008, which appears to be the first time that has happened since 1978. I haven’t done enough research to suggest this is a huge anomaly but I think it is another mildly ominous happening in the world of US business economics. Last night on Charlie Rose a key guy a Llyods of London Insurance was suggesting that in his view the mortgage crisis here in the USA is not at all over, and also noted how business things are blooming and booming in Asia and India while they appear to be wilting here in the USA and Europe.

In my opinion the best we an hope for is a fairly soft landing as China, India, Vietnam, and other parts of the developing world take their (rightful) place as players in the global economy. We’ve had it pretty easy for the past 60 years after WWII reconstruction rescued many economies from post-war ruin. Unfortunately that beneficence has been long forgotten (and it helped our economy along anyway).

So tighten up that belt and start spending less, because business isn’t what it used to be and it’s not going to be back anytime soon – perhaps forever.

Countrywide v. Congress and the China Connection


Today CSPAN had the congressional hearings with Mozilo, who has a 40 year tenure with Countrywide as founder and CEO.  He presided over Countrywide’s meteoric rise and much of the meteoric fall.    I hope people hurry up and wake up to the significance of the events underway in housing right now.    The mortgage meltdown is likely to become the greatest loss of wealth in human history.    CEO pay is a mostly trivial aspect of this situation.I think we’ll see another 10-20% loss from current values and I think we are already down some 4 *trillion*  2+ trillion  in housing value (need to check this, but the number is staggering).    A discussion of the amount is HERE.   Housing is a major depository of American wealth and prosperity, and the recent boom in values has led to various forms of reckless spending by individuals as well as the usual wild, stupid, and reckless spending suspect: the Government.   This is especially true of our unconscionable  and totally indefensible levels of mililtary spending.  Note that you *cannot* be a fiscal conservative and support the current military budget.     $550,000,000,000 to the military and fiscal conservatism are mutually exclusive positions.The impact of the meltdown and the reckless spending will be felt forever because in addition to direct housing problems that we are only starting to feel, I think all this will to depress our economy for several years and thus accelerate the shift of business to China.     This last notion is speculative, but I think it is now pretty clear that the Fed will keep rates low for many years in an effort to fend off an even more disastrous housing and credit situation.    This means China will be buying less of our debt, but I think will switch to investing more*directly* in US companies, and thus owning more and more of the American empire.      Russia’s leader and architect of communism Vladimir Lenin is famous for saying  “The Capitalists will sell us the rope with which we will hang them.”  But he was dead wrong.     The “Communists”, to the extent that term has meaning anymore, have no intention of destroying the USA.   In fact they want to keep us in good shape for as long as needed.  Now it is China who is making the rope, buying the rope, and learning the capitalistic ropes so they can slowly and gradually replace us as the empire of choice on the global landscape. A few things I noted during the Countrywide questions and testimony:

 * Probably Mozilo was just a high powered opportunistic guy and probably was pretty much within the law with his trades and pay, however he must have known things were poised to melt down to some degree.      

* Our congressional system is failing to produce people who are worthy of ruling the amazing American empire.      I don’t think there is much corruption but these guys sure are uninspired.  The congress-as-corrupt view is a “naivety of the skeptic” idea that is not based on a study of the money flow, personalities, and history of public servants who for the most part are bright, helpful people.   However they are mostly lacking in the key skill sets required for innovation and smart reform.   In short:  American politics selects for the wrong skill sets. To wit:  

* Republicans can’t see past Ayn Rand’s ass.   They understand the virtues of capitalism, but simply refuse to focus any attention on the key topic of how our brilliant capitalisic experiment has *failed* in many ways to deliver enough products to the neediest folks and how many capitalists are mostly focused on the creation of opportunistic business structures that are exploitable by the clever and the wealthy to the detriment of the greater society. .

* Democratic congresspeople are overwhelmed by math and economics.  They concentrate on people, “good vs bad”, “rich vs poor”.  * People want to find bad guys rather than find the obvious.   In the case of mortgages  the system as a whole incentified unwise practicies.     Reminds one of the savings and loan debacle although I think government regulations (loan guarantees) were clearly at fault with S&Ls were the mortgage crisis cannot be blamed mostly on the government.

* Is there a simple legal remedy for all the CEO pay and stock manipulation issues?    I propose a  “Captains go down with the ship” law.    If a company you founded fails you lose everything you made from that company except some modest monthly stipend.    This would incentify stability over pump and dump strategies.   I don’t think it would inhibit founding quality companies.   What unintended consequences would this law bring to the business landscape? 

Venture Capitalism – luck or science?


Over at his excellent blog, A VC, Fred Wilson is bearing his Venture Capitalist soul and offering a lot of insight into his very successful VC firm.     Today, his analyses of why some startups fail sounded really compelling to me in the same way many stockpickers sound compelling.    Yet in the stockpicking world it’s common knowledge that past performance is no measure of the future.   In fact a lot of the ideas about “good” vs “bad” analysts are bogusly based on after-the-fact analysis of records.    Predictions, not after the fact stuff, are what we need to test hypotheses about what works and what does not.

Fred also has this post suggesting VC is not like stocks, but I’m not seeing data to support this.  In fact if he’s right – that the top VC funds can pick a lot more winners than losers – then why doesn’t *all the startup biz flow to them immediately?*.

My working hypothesis is turning into the following ideas:

Winning VC firms are like winning stock pickers – they for the most part are the firms  hat were at the right place at the right time.   The winning record is NOT the product of conscious, clever, consistent application of any sets of rules.    It is simply the product of math – you’ll have a top tier by definition.  

I also apply this rule to my own successes and failures in biz and life in general, though I always catch myself thinking I can “outwit” chance.    I think egos get in the way of good analysis about the world, which suggests a lot less control over things than we’d like to think.    This is still in the working hypothesis stage and I have not reconciled that fact that I can predict with enormous accuracy that, for example, I’ll be drinking coffee tomorrow morning, yet I can’t even tell you if Google stock will be up or down tomorrow.

NO – you can’t time stocks either, and I’ve got huge money to bet you if you think you can predict stock up and downs even slightly better than chance. 

With stocks when you use a performance record you don’t find good predictive relationships between the past and the future.   Many people think they *do* understand those past to future issues, but in the stock world this does not hold up to scrutiny.  If it did, staggeringly huge returns await anybody with even very modest  level of long term predictive power and a modest initial stake.   How?   

If you could predict the daily up or down movement of any stock  with even a modest level of accuracy you could use options (or buying short and long) to quickly turn a buck.  If the stock was highly volatile and options were available your leverage would turn a few thousand into a few million in a year thanks to leveraging of your success percentage predicting the up or down movement.   If you could predict things with high accuracy – well above chance – you could turn thousands into millions every month.    This does not happen.  

I’m open to a disproof or alternative hypothesis for VC firms.   But don’t tell me about successes and failures  – I want predictions.   There will  *always* be a top tier of winners.   What supports my hypothesis is that those winners change over time and past does not predict future (in Stocks – I’m really not up on VC stats except that the average returns are negative).  

I think VC may have more of a schmoozing human component than stock picking so that may play a role here.   I’ve noticed from the few Venture Capital folks that I know how they tend to be very bright and personable.    Yet even this is somewhat conspicuous given that average VC return is negative, where the average bright personable person is doing well.

Venture Capital: Fred rules but his 3x rule is too optimistic! ?


Fred Wilson’s got a fascinating post about his history of investments over at Union Square Ventures.   Of course he’s got every reason to post his results, which appear to be exceptional although he has left out a key factor in his little analysis, which is time.  I note over there:

Fred, these are impressive results and to my understanding much better than average VC returns, which are negative, right? Don Dodge posted min-analysis some time ago where he wound up concluding there was a lot more VC failure than is normally thought.

There are elite guys like you and Jeff Clavier who “beat the averages”, but isn’t “making money” with startups an unrealistic expectation, since those VCs and companies that succeed are still around to talk, but those who fail are not blogging about the burgers they now flip to pay the bills?

I’m also noting that without “time” as a factor the return is not meaningful. 3x is easy….if you use a 15 year horizon!

At a very modest annual return of 7.33% one would expect to triple an investment in 15 years.     A 10% return will leave you with 4.5x your initial investment in that same time frame.    More dramatically, if time is not a factor then I’m happy to guarantee you a return of, say, a million percent.  It’ll just take a while.

This isn’t to suggest Fred isn’t a great investor because I think he is the exception to the normal rule in Venture Capital, which are low returns.   After I wrote about Don Dodge’s suggestion that average VC returns appear to be negative  Jeff Clavier also suggested in a blog comment here that only the top 25% of VC firms are averaging positive returns, and this really shook up my understanding of things.