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."

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.

CD @ HMB 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."


Party Like it’s 1998!

So there I was, reading the announcement of the Skype IPO filing and scratching my head.  After all, a $100 million offering doesn’t sound like all that much when the current investors bought in at a $2.75B price a little while back.  How tiny a share of the company were they going to offer?  Two percent?  Three percent?

And after all, don’t you need some float for institutions to be interested?  And indeed, some industry watchers had previously speculated that the company might seek to raise a much larger offering: think north of a billion (one beeeeeeeeellllion dollars – said with pinky to corner of mouth.)  I was even bouncing it around with a banker buddy who suggested that institutional public market investors today demand 10-20% of the shares to be floated as part of an initial offering; if he saw a random company executing a $100M offering, he’d said his guess of the total market cap would be in the $500M-$750M range.  There’s no way that’s the case with Skype, particularly if they company is doing a couple of hundred million a year in “adjusted EBITDA” (also known as EBBS, Earnings Before, ahem, Bad Stuff.)

Now in fairness, I’m neither an investor in any fund that invested in Skype, nor am I a banker, so there may be a backstory to which I’m not privy.  And who knows: that $100M offering amount may even be a placeholder for another, larger, offering amount.  But the lunchtime conversations here in Silicon Valley keep coming back to the modest offering size.

But for me, it’s a case of deja vu all over again: it’s all about the magic of the thin float.  You see, I still bear scars from having been a fundamentally-oriented equity analyst at a hedge fund of sorts in the late 90s.  During that time, it was almost impossible to perform fundamental analysis and keep a beta-neutral book.  There was just so much liquidity in the system that things like sector rotation and technical factors almost always trumped hard-nosed, Graham and Dodd, old school analysis.  Try adding any short names to the portfolio!  If something had a whiff of broken-ness, it was cheap and anything that was cheap was an acquisition candidate for firms flush with cash and inexpensive public currency.  It seems that all of one’s short sales would get bought at a premium, wrecking performance.

And then, starting in earnest in 1997, the emerging tech firms got in on the action: pretty soon bankers figured out that floating only a tiny portion of a company set the stage for the stock to jump as retail investors would gladly pay up in the after-market, just to get in on the new, new thing (and the banks proudly touted their post-IPO performance in their pitchbooks).  Things didn’t catch fire for fundamental reasons, they burst into flame because the thin float acted as both the ignition source and the accelerant.  Just ask the guys at the Globe.com who priced at $9 and opened in the $80s.

And once the price got fixed at a certain level, existing holders could trickle out their shares at inflated prices.  Of course, as we all know, that strategy worked until it didn’t.

Now, let’s be clear.  I’m not being crabby about Skype.  I’m keen for them to have a successful offering (if for no other reason, because their recent announcement of expansion plans in Palo Alto is probably good for my home value.)  But if we learned any lesson from the late ’90s (and, more recently, the late ’08 action offered a similar lesson on the downside,) it’s that stock prices are only vaguely related to fundamentals; it’s supply and demand that sets the price.  Maybe Old Man O’Malley’s Brooklyn wisdom had something to offer the public markets: “youse guys would pay twenny bucks for the last slice of dollah-fitty pizza at tree-toity in the morning when youse got your drink on . . .”

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]

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Waking Up In Woodside [REPOST from PEHub]

[Originally posted over at PEHub as the guest column on July 2, 2010]

So there I was, listening to the infectiously giddy (and, indeed,
bittersweet) Katy Perry tune “Waking Up In Vegas.” Now, I realize that
I’m probably more than twice the age of the typical Katy Perry
listener, but the ditty struck a chord. There’s a great moment about
halfway through the song in which Katy seems to be at the bottom of her
stack of chips, and she urges her gambling partner to “Send out an
S.O.S.” But, then, as she pauses to inhale, the momentary silence is
filled with an ethereal, angelic sigh, perhaps portending a change of
luck. With the wheel of fortune finally spinning her way, she changes
her tune and exhorts her sidekick with renewed optimism: “and get some
cash out!”

Maybe it was because I was driving back from an annual meeting
during which I’d heard some GPs describe a great year after a period of
difficulty, but the first time I heard the song on the radio I thought
it was a must-add to my mental soundtrack of the VC world. After all,
the way some people think about venture and its potential for
discontinuous outcomes (and punishing loss rates) makes it akin to
gambling; I’ve always thought of Curtis Sharp as the patron saint of
some venture investors, no?

Anyhow, as I thought about it a bit more, I re-envisioned the song
as a lament from entrepreneurs to venture capitalists who sit on their
Boards. Spoofing the song, I’ve replaced Vegas with Woodside, a tony
Silicon Valley hamlet that’s home to many VCs and entrepreneurs.
Keeping true to the original, there’s little rhyme and funky meter, but
here it is for your enjoyment:

Waking Up In Woodside

We’ve got a Board meeting
Last quarter’s all a blur
We need a term sheet ‘cause you’re under-reserved — and we’re broke

I lost my sales VP, but you lost a key LP
Spare me the lessons from G-S-B
or Mike Porter
You just want to sneak out and get to Tahoe

Don’t be a baby
Remember what you told me:
Sometimes the guys at TechCrunch can be such haters
That’s what you get for waking up in Woodside
We need some cash to get us out of beta
That’s what you get for waking up in Woodside

OK, we’ll cut our burn
Why do you act so stern, dressed up like Steve Jobs?
And why, why did you drop us from your firm’s website?
Call up your partners
‘Cause now we need a bridge loan

Don’t be a baby
Remember what you told me:
Sometimes the guys at TechCrunch can be such haters
That’s what you get for waking up in Woodside
We need some cash to get us out of beta
That’s what you get for waking up in Woodside

How do we all get out of this?
Capital efficiency, intellectual property
Send out a press release
And get a slot at DEMO
We’re gonna file an S-1!

Don’t be a baby
Remember what you told me:
Sometimes the guys at TechCrunch can be such haters
That’s what you get for waking up in Woodside
We need some cash to get us out of beta
That’s what you get for waking up in Woodside

We’ll make the quarter; make, make, make the quarter!
Let’s file for IPO, baby
Let’s get some cash out, baby