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 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.
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.
Thanks to a very thoughtful comment by Fools Gold in an earlier post, I’m again really wondering about the math of the VC biz. Venture Capital for startups appears to be a game that is generally misunderstood by most as a sort of insider mafia “cash machine” for the rich when I think the evidence would support the idea that startups are a losing bet on average and are for the most part the product of honest dealings rather than back room gangsterism.
After a Don Dodge article I think it was Jeff Clavier who told me that only about a fourth of VC firms were delivering positive returns – that was about a year back I think and I know Jeff was doing very well with a lot of winners – he was NOT talking about his own great results. Fred Wilson was also getting very positive returns for his firm, though I remember he was giving enough information about the time frames to get a good sense of how good the returns were. A key filter of course is the fact that firms with negative returns are hardly going to be blogging much or advertising that fact.
How to derive valuations? For new companies it is close to anybody’s guess. I think the market makers are driving pricing in very unnatural ways that look more like casino gambling than thoughtful investment. As I’ve noted before most VCs actually appear to *lose* money on average.
The game is certainly not “rigged” the way many think it is and my working hypothesis is that VC for startups is sort of like Arabian horse farms – it loses money for most but is a very fun hobby for many who effectively build relationships and contacts that help maintain their wealth and control over things indirectly. Sounds ominous but this is actually a pretty functional environment because it keeps the best innovators well fed and productive even as their startups mostly fail at the expense of people who can afford to lose a few million here and there in exchange for the fun of an infrequent big payoff.
Update: Silicon Valley Insider is reporting that there is an additional 75MM in the deal as an “earnout” over the next several years. That may make this deal sweeter than it appears at first.
At first glance you’d think the sale of website COMPETE.com, which measures web traffic, for 75MM must have been a big payday for a lot of folks. However as Venture Beat notes some 43MM of venture capital had been poured into COMPETE over the past 8 years.
Assuming most of this came at the beginning of the cycle, and assuming most of the 75MM is going to the VCs, the return on this VC investment would be a very modest 8-10%. If the founders and workers also had a decent stake in the sale this return could be lower – approaching what the VCs might have realized with long term CDs over the same time period. Break out the champagne?
I’ve noted before the dirty little secret of many “successful” venture capital deals – they often make a very modest return when time is factored in properly. In fact it appears that *most* VC deals lose money for the players. Data is sketchy, and obviously only the winners are happy to share the details making it very difficult to analyze this since many (most) of these deals are not in the public record.
Sure there are VC winners like Fred Wilson and Jeff Clavier, both very clever VCs who blog some of the details of their failures and successes. However I think this is not typical, as Jeff even suggested here at the blog some time ago.
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.
What a GREAT blog post from Fred Wilson as he flew to Portland! He rapid fires 30 things including his thoughts on the bubble 2.0 (maybe about to pop, maybe not), and most importantly offers up this billion dollar company idea:
15) Why hasn’t anyone been able to aggregate all of my comment activity across the entire web and turn it into a feed that I can put into my lifestream on Tumblr? There are a bunch of companies working on it, but I don’t think anyone has nailed it yet. And I am not just talking about blog comments, I am talking about ratings and reviews on Amazon, Yelp, Menupages, Digg, etc, etc.
Fred, I don’t get this either because the technology is definitely in place and although I think this would take a pretty substantial server infrastructure – to cache and search a lot of content regularly – it seems like the payoff would be the best social networking environment out there.
I’m saving up my money so, someday, I can be a cool VC guy like Fred and ride coach class even though I don’t *have* to ride in coach. Kudos to him for that. Frankly, I have a feeling the people back there are more interesting anyway.