May 25, 2011

Dispatches from the Disruption, Part 2

Here's the second half of last week's post:

Now, let's get back to one of my favorite topics: disregard for convention. A wise man once told me that most investors follow a set of rules that typically make them middle-of-road, B-level investors, but in breaking their rules they can become either A-level investors (rarely), or (more frequently) C-minus investors. And indeed, I've always been a bit insouciantly petulant about rules, but as far as guidelines go, but I've got to give James Montier from GMO a tip of the cap for The Seven Immutable Rules of Investing:

1. Always insist on a margin of safety

2. This time is never different

3. Be patient and wait for the fat pitch

4. Be contrarian

5. Risk is the permanent loss of capital, never a number

6. Be leery of leverage

7. Never invest in something you don't understand

And, generally, those are pretty darn good rules. The value investor in me swoons. But the Californian in me wonders if these rules are little more than a wind-break against the perennial gales of creative destruction? In this zip code, after all, those rules are more honored in the breach than in the observance. And surely, if investors had followed those rules exclusively all along, we'd still be communicating via horse-mounted couriers as we farmed the Appalachian Watershed with oxen, oppressed by the inexorable tyranny of the seasons and the immutable fright of nightfall. Instead, we live, work, and play in ways that are scarcely recognizable to our parents and would've been unimaginable to our forebears. Much of that progress was financed by the investors who broke their rules; some made mints while most didn't.

Now, I don't mean to critique value-oriented investing, as assets need an anchor around which to contextualize their valuation. But if the last century, with its optimists triumphant, suggested anything to us, maybe it's that the value of businesses isn't really the discounted value of their dividends? Perhaps businesses are better thought of as portfolios of options, some of which are very long-dated and way out-of-the-money. And maybe the central wonder of the American economy, with California as its exemplar, is that it offers the best framework for capturing the random forward lurch of progress? After all, the US economy, more so than that of any other nation, seems geared around exercising profitable options while letting unprofitable ones expire, often (and hopefully) cheaply. This asymmetry is getting even more acute as value chains continue to fragment and the cost of hatching and nurturing an idea continues to drop. The resulting left- and right-tail opportunities may be hard to differentiate from each other, but those who are unafraid of being wrong and alone will give themselves the electric opportunity of being right and alone.

I love working on a street thick with start-ups and it's been fun to watch these companies strive and stumble and pivot and grow. I love visiting them when engineers are piled up on top of each other in a too-cramped space; its a visceral and sensory experience when a startup finds its cadence. The old east coast value investor in me wonders aloud, "who would invest in this stuff? It's bananas! These guys are violating at least four of The Seven Rules!"

But the west coast Chris hears an echo of Steinbeck's description of Cannery Row: "[Silicon Valley] in California is a poem, a stink, a grating noise, a quality of light, a tone, a habit, a nostalgia, a dream."

May 16, 2011

Dispatches from the Disruption, Part 1

[Apologies for the self-indulgent post, back to investment soapboxing next time!]

Three years ago, I moved to California to open a new office in Palo Alto for my firm. (You'll notice I never name my outfit in the blog; that's not because I'm trying to be coy or an attention-hog. Rather, I've always tried to keep the blog "personal" so as not to run afoul of some regulatory trap for the unwary and embroil my employer in undeserved controversy.)

Anyhow, I'd already been spending 80 days a year on the west coast, meeting with entrepreneurs and investment managers, so it just made sense to make the leap. When a then-six year-old Miss LP started matter-of-factly calling me "Weekend Dad," I knew it was time to gather up the brood and light out for the territories to follow in the footsteps of pioneers, gold rushers, dust bowlers, and dot com-mers. At the time, I told our CEO that when our lease was up in three years time, either we'd need a lot more space because we'd been able to plant a potent seed in a fertile landscape, or we'd need no space at all, because the experiment hadn't succeeded.

Turns out that the truth lies somewhere in between, boring as that sounds. California may forever be a sunny and ample land, but for a dynamic investment firm with a global, multi-asset class perspective, other coasts and climes beckon and geographic footprints need to be reassessed from time to time. And in our reassessment as the lease-end approached, we decided to close the office . . . and I decided to stay out here and, sadly, part ways with my firm in doing so.

And here’s another boredom-inducing tidbit: there's no drama or backstory to tell. My firm tried to lure me back East; I thought about it, talked to the family, gazed for a while at a nearby grove of redwoods imperial — as a son of Whitman's Brooklyn, I'm endlessly captivated by the stalwart trees of the West — and politely declined.

I've had a blast working for my company; they're good people pursuing an important mission. It's been a great seven years, but the allure of California is just too strong; I've been mesmerized by this magical place, and I don't think I'll ever leave.

I don't really know what did it: the weather is the easy throw-away answer, but maybe I've been beguiled by the succession of start-ups that I've hosted here in the office? Or it could be the open architecture of relationships out here. People seem to network for sport, and, if you're at all credible, you're a phone call or two away from anyone. Perhaps I've been enchanted by my neighbor who walks his home-built robot each morning, or that Miss LP asked me to clean out the garage because she wants to invent something in there? But, ultimately, it's the energy and intensity of the people here. Everyone seems to be Working on Something Disruptive. And it's not just the entrepreneurs, it's the investors, too. There's a disregard for convention that seems to define the Very Idea of California; we're not only struggling over the size of the slices of the pie, but we're also trying to figure out how to make the pie bigger. Hector St John de Crevecoeur could've scarcely imagined California when he wrote Letters from an American Farmer in 1782, but his words seem to presage all the Golden State would offer: "Here individuals of all races are melted into a new race of man, whose labors and posterity will one day cause great changes in the world. Americans are the western pilgrims."

The inquiring reader asks: "what's next?" Here's the best answer your humble narrator can offer: I'm not sure yet. I've got a bunch of plates spinning, some of which could be really interesting, and I'm spending time with as many smart people from as many different walks of life as I can get plugged into. The blank sheet of paper beckons and Walt Whitman's words echo: "I, now thirty-[nine] years old in perfect health begin / Hoping to cease not till death."

November 10, 2010

Private Equity Lessons from the Subway

So I've been riding the New York subways pretty frequently lately. Between annual meetings, conferences, and the entrepreneurial scene, there's been a lot to do in The Big Apple this fall. And every time I hop on the train, it takes me back to my childhood. You see, a quarter-century ago I rode the subway to middle school. Imagine that: a 12 year old with an overdeveloped sense of adventure and a transit pass that offered unlimited access to the lurid expanses of Metropolis!

(Let me take a moment to apologize to Mr. Criscuolo and my other afternoon-class teachers. A fake bellyache and a hangdog look was all I needed to get permission from the school nurse to go home after lunch. And as my time in middle school began to wane, I started scooting out about once a week in an effort to see the entire city, one subway stop at a time . . .)

But, despite my school-skipping, I actually did learn stuff on the subway, my very own classroom on rails. And who knew I could apply those lessons to private equity and even investing more broadly? Only recently have some of those lessons come into focus. Let me run you through five scenarios and their associated learnings in what may be the first in a series of "Lessons From The Subway":

* * *

Scenario #1: Have you ever been barreling through a tunnel on the local train as an express pulls up alongside you between stops? For several seconds, the two trains hurtle down the tracks together side-by-side before the local starts its inexorable deceleration into the next local station while the express pulls away, charging ahead to the next express stop. For a moment, there's an intimacy with some of the passengers in the express train. It's almost a voyeuristic feeling, like looking into someone's living room window; sometimes you even make eye contact with one of the passengers in the other train. Do not give that person the finger or stick your tongue out or make menacing gestures. There's a chance that they will get off at the next stop, wait for the local to pull in, and kick your behind.

Lesson: Life is a multi-period interaction. What happens at one moment resonates into the next. Even the most random encounters can presage subsequent ones. Don't be a jerk and always have integrity. Why soil the canvas?

Scenario #2: Your train pulls into the station on one of those muggy summer days that seem all the hotter and more acrid below ground. Car after car blurs by, stuffed with people; as the train starts to slow, one car is nearly empty. But hold on a second; today's not your lucky day, the day you get a seat for the long ride. Rather, the odds are that the air conditioning simply isn't working and that car is hotter and stuffier than August in Houston.

Lesson: There's information in crowds. While one never wants to be a lemming, there can be limits to being a contrarian. Sometimes, leaning against the gales can work, other times, it just gets you windburn and a face full of leaves and other wind-blown detritus.

Corollary / Scenario #2a: Speaking of reasons why cars might be empty, sometimes there's an, ahem, stinky dude on a train car that clears out all the people. Again, there's a reason that train car is empty and, odds are, that funky cat is going nowhere.

Lesson: If something stinks, it's likely that the stink will linger, no matter how you try to rationalize away that hinkey feeling about, say, the GP that does't feel right or the story that doesn't quite hang together. Trust your nose.

Scenario #3: Don’t give the finger to a policeman. Ever. Catch me sometime offline and I'll tell you a story . . .

Lesson: The people who make and enforce the laws know and understand them far better than you do. And even if they're wrong, they're right. And they can make your day a lot more aggravating than you can imagine. You get a lot further by smiling and saying "yes, sir" than you do by being petulant. This may be a good thing for our industry to remember as the shadow of regulation lengthens across our sun-kissed land of private investments.

Scenario #4: If someone starts talking to you on the train, it's likely that they're a looney toon, but there's a chance that they're lost or want to talk about something interesting. Subway philosophers end up having a lot of things to say, some of which are worthwhile. Once, though, I talked to old Brit about what to see on holiday and he gave me a 50p coin as a souvenir. It was the coolest thing I'd ever seen. Another time a kid told me about a pizzeria over on Ditmas Avenue that had a Space Invaders game that would give you 10 credits if you held the coin return while you put in your quarter. Needless to say, I became the master of Space Invaders that spring.

Lesson: Be generous with your time. You have to be careful, but you never know what you might find out.

Scenario #5: Every mass transit system seems to have a few stops that are central nexuses (nexi?) of the tangle of lines that ferry people to the disrparate and far-flung reaches of their city. At these stops the trains disgorge their contents and refil with cats connecting to elsewhere. Jay Street – Borough Hall in Brooklyn was the one that occupied my imagination (where exactly does that exotic A train go? Why do people write songs about it?) but 42nd Street/Grand Central and Fulton Street/Broadway-Nassau were other such network nodes, full of hurly-burly. Here's the thing: if you're leaning against the door and not paying attention as the train arrives at one of these stations, you're likely to get pushed out. And getting back in to your train can be as challenging as swimming upstream with the salmon.

Lesson: Don't block the exits! Sometimes, people need to get off the train. There may indeed be better connection options for them (like West 4th Street,) but sometimes people need a bird in the hand instead of two in the bush. This is a big concern right now, as I worry that GPs may be suboptimizing exits, but if there's an A train waiting at Jay Street, it probably makes sense to hop off the F train and change, because you never know if you'll wait in vain at West 4th for a delayed A train that never comes . . .

August 5, 2010

Summertime . . . (and micro-VC)

It's been a slow summer on the blogging front . . . but I've got a couple of posts on better articulating a fund's value proposition and surmounting fundraising challenges that I'm going to put up right after Labor Day. I'm just trying to be helpful . . . providing a public service and whatnot.

In the interim, I thought I'd share an iPhone pic that I took at a July 4th concert not far from St. Johnsbury, Vermont. Of course, that town is named for Hector St. John de Crevecoeur, author of the seminal 1782 work, Letters From An American Farmer. In that book, de Crevecoeur famously asks: "what then is this new man, this American?" His answer presages the two centuries of progress that followed:

"Here individuals of all races are melted into a new race of man, whose labors and posterity will one day cause great changes in the world. Americans are the western pilgrims."

* * *

Speaking of great changes in the world, here's a link to a Q&A at PEHub on micro-cap VC I did this morning: http://bit.ly/cTUPwB

From PEHub.com

Q&A on Micro-VC Funds, With Someone Who Actually Invests In Them

We’ve spent a lot of time lately discussing micro-VCs, including last week’s news on Floodgate ($73m fund close) and 500 Startups (new $30m fund being raised). So I spent some time discussing the phenomenon with Chris Douvos, who invests in mico-VC funds through his role as a managing director with The Investment Fund for Foundations:

How long have you been investing in micro-VC funds, or super-angel, funds??

We’ve been active in this space since around 2005, and have invested over time in several of the archetypal managers.

Who are those archetypical managers?

Well, the main one is someone we actually haven’t given money to: Ron Conway. He’s created a fantastic ecosystem. But we’ve backed some of the people who have taken types of things he does and refined them a bit. For example, one of our earliest investments was in First Round. We think those guys have brought an aggressively thoughtful approach to the challenges of investing in seed-stage companies.

I love the O’Reilly AlphaTech guys, whose differential is that they’re leveraging the larger O’Reilly ecosystem. In the case of O’Reilly or First Round or Floodgate, they’ve created brands around themselves that magnetizes interesting people. That helps them punch above their weight.

How do you define a micro-VC fund?

I was at a Silicon Valley Bank shindig the other day, and people were talking about segmenting the space. “Who is a super-angel compared to a seed-stage VC, etc…”

To me, what initially attracted me to the space is that it was about people who had found that the arithmetic was on their side. They were recognizing some really meaningful trends at certain types of startups – capital efficiency and the fast cycling of ideas at IT/Internet companies – and were typically people with some sort of entrepreneurial background with a bit of investing experience thrown in. They saw a capital gap that they could fill by being nimble in the sense of traditional angels, but also bring a level of activity and DNA-setting that was the hallmark of more institutionally-focused funds.

The idea wasn’t necessarily to supplant VCs, but to be a value-added early processor of companies. The startups would be far better off for having this earlier participation, and then traditional VCs would bring their own skills to the table.

[remainder after the jump]

October 20, 2009

The Gatsby Funds

In my younger and more vulnerable years, I must have read The Great Gatsby a dozen times. Maybe more. And I loved and identified with the humble narrator, Nick Carraway. His thousand mile journey to New Haven from Minnesota was much further than my hundred mile one from Brooklyn, but we shared the same occasional outsider's bewilderment at the antics of the eastern elite.

And yesterday, as I sat out on the deck of the Rosewood Sand Hill gazing up at the thin wafer of the moon rising out of the verdant hills and ascending the sanguine sky I wondered what Nick would've thought of this place. Because sometimes I wonder if Silicon Valley is the modern version of Fitzgerald's Jazz Age playground. Call it East Egg 2.0.

But there are days on which it feels like there's a hush about the place; the raucous energy is muted and the punchbowls seem to have gone missing. Sure, the future's still under construction here; the quiet is punctuated by the staccato tap-tap of programmers and designers working on the new new thing as cooling fans whir in the distance. But there's a whiff of introspective stillness like that to be found on crisp autumn evenings after the grand shore places have closed for the season.

And maybe that stillness is the melancholy realization that the receding tide will beach some of the dinghies in the harbor. Some even suggest that the venture business should shrink by half. But which half? There's a pandemic of bellyaching about "the venture asset class" among LPs, but I suspect that most investors will keep coming back . . . remember, most Americans hate Congress, but love their Congressman. I think the venture business is the same way.

But I'm always asking myself, "what do I need to believe to believe that a particular fund will be successful?" There are a lot of good investors out there with compelling stories; in fact, there are probably more than I could invest in if I had three lifetimes. But there's a whole other swath of the business for whom heroic leaps of faith are necessary; the arithmetic of their funds doesn't quite work, or they need too many outcomes to come out just-so, or the IPO market needs to be bubble-icious once more. Like Jay Gatsby's, their reality is an idealized and stylized rendition of a sloppy present; it's not necessarily a false rendition . . . just a hopeful one. And it occurred to me as I pondered the imponderable future that the last few paragraphs of the book capture the challenge facing these funds, The Gatsby Funds, better than I ever could:

And as I sat there brooding on the old,
unknown world, I thought of Gatsby's wonder when he first picked out
the green light at the end of Daisy's dock. He had come a long way to
this blue lawn, and his dream must have seemed so close that he could
hardly fail to grasp it. He did not know that it was already behind
him, somewhere back in that vast obscurity beyond the city, where the
dark fields of the republic rolled on under the night.

Gatsby believed in the green light, the
orgastic future that year by year recedes before us. It eluded us then,
but that's no matter – tomorrow we will run faster, stretch out our
arms further . . . And one fine morning –

So we beat on, boats against the current, borne back ceaselessly into the past.

Super LP

Adventures in Investing

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