For the Moment Mellow . . .

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Since I too often bellyache on these pages, I thought I’d share something I wrote for a quarterly letter at the end of last year.  Ironically, the poem I reference is called Temporary Well Being. Comments and feedback encouraged, just don’t harsh my mellow, as the kiddos say . . .

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Q4 Commentary:

A Kenneth Burke poem inscribed on a wall in New York’s Penn Station begins, “the pond is plenteous and the land is lush and having turned off the news, I am for the moment mellow . . .”

I’ve been thinking about this poem a lot recently, as Silicon Valley seems to be enjoying a sanguine moment. Although the tech world was consumed at the outset of the year by an unease that resulted from an investing pullback on the part of so-called Tourists – a cohort of large public market-focused investors who had become active in late stage private investing – the middle third of the year seems to have been marked buy a growing realization that the sky was not falling.   And by September, optimism engendered by a smattering of tech IPOs lifted spirits across the Valley.

Indeed, an uneasy truce between bulls and bears seems to have emerged as 2016 slouched to its conclusion. The headline of one of our favorite barometers, the Fenwick and West Venture Capital Survey, reported that, “valuation metrics were down modestly in the third quarter.” After all, the median round over round price increase among companies completing financings during the third quarter was 27%, down slightly from the second quarter’s 31%. While the Report noted that this was the lowest amount since Q4 of 2013, this rate of increase was right in line with the 10-year average calculated by the survey. Our conclusion, both from the data, as well as from our on the ground perspective, is that the entrepreneurial ecosystem seems relatively healthy; there are many great companies who are being rewarded by increased valuations for the progress they have made.

What has caused some consternation around the Bay Area, however, is the decline in mega-financings driven by the exit of the Tourists. The late-stage market, which had been defined by froth in recent years, has slowed. Financing used to be available to companies at levels that assumed perfect execution for the subsequent 18 to 24 months; there was a conceit that all of these companies would grow in to their valuations. Today, late stage investors are only paying for progress to date and acknowledging execution risk and uncertainty. As result, many venture capitalists to which we have spoken are suggesting to their companies that are fundraising to expect valuations that are 25 to 40% lower than they might have expected a mere 18 months ago.

This, of course, is good news for us. Buffet’s equation tells us that Opportunity equals Intrinsic Value minus Perception. As sentiment comes into line and folks acknowledge the reality of risk, prices should come down and our expected return should go up.

This new reality is being reflected in entrepreneur perceptions, as well. First Round Capital produces an annual survey of start-up founders and one of their typical questions is, “who has the power in fundraising negotiations?” In a 180° reversal of last years results, entrepreneurs this year’s survey said that power rests with investors by a two to one margin.

Of course, optimism is always empty without the prospect of healthy distributions. We are hopeful that the momentum of late 2016 will carry over into the new year and that both distributions and valuations will give us, the ultimate providers of the capital, reason for a continued excitement that we would have never thought possible at the outset of year.

As we look to 2017, the conclusion of that Kenneth Burke poem sums up our feelings nicely: “ . . . with my book in one hand and my drink in the other, what more could I want but fame, better health, and ten million dollars?”

 

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