Category Archives: venture capital

A trip down memory lane — Robertson Stephens commercials from 2000

RobertsonStephensLogo

(Note: there seems to be an intermittent WordPress problem displaying these YouTube videos on the main blog site. If you have trouble, you can access them directly here.)

I remember seeing this commercial in December 2000 (nine months into the dot com nuclear winter). I was a venture investor at the time, getting my ass kicked as my portfolio turned into a toxic sludge. One or two of the investments were sourced from Robbie Stephens. The irony was deep.

Robbie was out of business by 2002.

And there are others:

 

 

 

I happened to find this collection on the Errol Morris’ site (the agency that did these ads) where this gem of a collection still exists. I’ve done the internet a favor and put them on Vimeo and YouTube. Enjoy.

Where the unicorns are

A328dc559e1fceca19c8787be41094cfUnicorns — private companies that have a valuation over a bill — are not just in the US (the whole unicorn phenomena is a new one, part of the bubblelicious experience.)

CB Insights has some interesting information on where the mythical unicorns actually are; Silk mada a nifty interactive chart.

Digging into the data, you would think that the Unicorn phenomena is relegated to the Silicon Valley/SF Bay area. Not so lad! While 62 are located in the U.S., there are 11 in China, 10 in Europe and 6 in India. There’s even a couple in Canada!

What we can see is the power shift from Silicon Valley to San Francisco. Out of the 62 companies in the list, I counted 25 in San Francisco. 21 are not in the SF bay area at all — there’s New York (WeWork, Vice, MongoDB, AppNexus, Oscar Health,  Warby Parker, Sprinklr, Gilt); SoCal (Snapchat,SpaceX, Legendary, JustFab, Razer); then a surprising number are in Utah (Domo, Qualtrics, Pluralsight, InsideSales); trailed by the Boston area (Moderna, Actifio and SimpliVity). Florida makes an honorable mention with the mysterious (and probably real unicorn), Magic Leap.

Just to have some fun, here are the SF based-unicorns:

uber
Pinterest
Dropbox
airbnb
Square
Zenefits
Stripe
Slack
Lyft
Instacart
Prosper Marketplace
Docusign
Deem
Social Finance
Sunrun
Automaticc
Twilio
Nextdoor
Docker
Cloudflare
EventBrite
CreditKarma
LookOut
AppDynamics
Kabam

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h/t

Of course we’re in a bubble. Duh.

Phases-bulle-speculative

Of course we’re in a tech bubble. But at what part? The early part? The late part?

What concerns me is that the biggest argument I hear for the “it’s not 2000” is this one:

Back then, those were not even real companies — today we’re investing in real companies.

WTF? Tulips were real in 1637. Houses were real in 2007. The companies being invested in the wild bull market of the 1920s were real (as were the companies in the Japanese bubble economy in the 80s).

It’s a completely illogical statement.

Every bubble needs a narrative. It needs a story. This “today these are real companies” is part of the story, the narrative.

Money money money
The Fed has been printing money at a mad rate for years. We haven’t seen serious consumer inflation because the money hasn’t crept into the general marketplace (increased money supply equates to inflation, but money supply is created through debt, and there’s not a lot of the right type of lending). Instead, the money finds its way into the public equity and debt markets, which reflects in a) lowered bond rates and b) higher equity premiums. Both low bond rates and high equity premiums are the fuel for private investments through a number of factors (wealth created by the public market looks to reinvest, private money wants to buy an option on a impending IPO by buying late stage, low bond rates creates an aggressive private equity market, etc., etc.).

What happens in Wall Street does not stay in Wall Street
So with this orgiastic money-love fest on Wall Street, you get a situation like this chart in the private company space:

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(Source)

That’s Series A valuations. Yeah.

As one VC told me a while back: “The exits are great. The entries are tough”.

Okay, there’s controversy.
There are plenty of statistics one can point to either way. PE ratios are way too high for comfort. The bubble proponents all have their theories — Bill Gurley and Michael Moritz (it’s these late stage companies — the unicorns), Mark Cuban (it’s the explosion of angels), Jeff Reeves (look at post-IPO performance) and Adam Lashinksy (the subjective reality, just look around) are all raising the alarm.

I was a professional investor between 1999–2002, working at a hedge fund and investing in private companies. I lived through that last tech bubble intimately. This one is different. There were complete douchebags with no business sense starting companies that were ridiculous. And there were idiots like me investing in them.

Subjective reality
However, I’m seeing the signs:  The age of unicorns (I mean, come on! This isn’t something to be alarmed about?) Billions raised in crowdfunding, with virtually no oversight. The explosion of angels. The explosion in the cost of living and doing business in the valley and the city. The incredible challenges hiring new people. And, oh, it’s starting to get really hard to get a hotel in San Jose (not as hard as in 2000, when I literally stayed in a bug-ridden “motel no-tell” as my only option).

It’s simple to observe that as more money chases fewer deals, deal quality goes to crap. Just because some dude with a lot of cool talk is launching a tech company does not mean he has a clue as to how to actually run the tech company (something many learned very painfully back in the last bubble).

I got a lot of flack years ago when I wrote a similar blog post about oil prices. I was right then, maybe I’m wrong now.

The San Francisco effect
Several years ago, the “center of power” in tech moved from the Valley to the City. This has resulted in some fairly astounding increases in rent and housing costs.

In addition, we see the center of creative power moving from Hollywood to San Francisco. Who sets the design trends now? Not Hollywood, but San Francisco.  Instagram, Twitter and Facebook can have more impact on a trend than the latest movie. Our design philosophy has even become bay-area centric. Look at sites like Canva: the designs are all SF. Ugly stock photos are now replaced by hip (and free) sites like Unsplash.  It’s like the world is awash in misty mornings and cloud afternoons looking over the San Francisco Bay.

Case-Shiller_from_1990

This factor is squirreling the discussion, because people still keep talking about “the valley”. It’s not the valley anymore, it’s the city. 

Now, the good news
The tech economy goes through massive secular disruptions every 20–odd years. In corporate America, the age of the mainframe went to the age of the minicomputer in the 70s, which went to the age of the microcomputer in the 80s , which went to the age of LAN networked PCs, which went to the age of Windows NT-based systems, and to now, what I call the age of heterogeneity. This is an age where devices are dislocated from each other in many ways: people bring devices of whatever type into organizations; people are working on various devices throughout the day. Consumer trends have been similar. There’s a freedom and there’s a whole new world of technology around it.

This is a major disruption and great companies are being built minute-by-minute.

It’s not a disaster and I’m still optimistic. But it’s bound to end. The problem is one runs out of buyers. All bubbles end in a parabolic blow-off. Perhaps we are in the parabolic blow off. Perhaps not. It’s possible, as past history has shown, a correction will hit in the fall. Who knows.

Just watch for when people just go into a frenzy of buying, believing it’s not going to end.

Because that’s when it ends.

Tech company valuation for noobs, and how to sound cool when talking about it

I recently had a conversation which seems to repeat itself time and again — an entrepreneur wants to start a business, calls me for some basic advice, and then we get into some of the details.  Invariably, we get around to the subject of valuation.

Since this is a blog where you can feel comfortable asking “stupid” questions, I’ll make it safe for you. So, here’s the reality: Your high-tech business is worth as much as you can get for it.

There’s no formula.  There’s no cash flow model which can justify a startup’s valuation.  There’s just what you can get.

Jim Clark, after successfully starting Silicon Graphics, went on to start his next venture, Netscape.  He arbitrarily set a valuation in the mid-teens (I recall it being around $15 million, but my memory is a bit vague).  Of course, this is a ridiculously large valuation, but he could get it.  He did the same thing again with WebMD.  He got the most he could get from the market.

Others may not be so lucky.

How it all happens is the art of raising capital, and for better or worse, a major job of the entrepreneur.

Pre- and post-money
As you probably know, key terms are pre-money and post-money (often referred to as the “pre” and “post”). Pre-money is the valuation before you raise money. Post-money is the valuation after you raise money.

It’s dead simple: Your dilution (how much of the company you give away) is simply determined by dividing the amount raised by the post-money valuation. Let’s say you value your business at $4 million (the “pre-money”).  You raise $1 million (the “raise”).  You now have a $5 million post-money. Divide $1 million by the post-money ($5 million) and you see that you gave away 20%.

Often, for pre-revenue startups, founders raise angel money first, which then converts at the valuation of the Series A. The Series A is the first real round of funding, and startups hope that it is an institutional round. In my opinion, it is more favorable for the entrepreneur to raise angel money to convert at the Series A valuation. However, angels sometimes would rather go straight into a valuation discussion.

Valuing a tech business that has revenue
After your business is running a while, you will likely want to look for an exit.  If you’re like most entrepreneurs, you’ll tell your investors that you want to go public, but really, most tech companies get bought rather than go through the cumbersome IPO process.

What valuation you get is, again, a subject of some considerable subjectivity.

The acquirer (and the bankers), will typically go with a combination of models that justify the valuation.

There are three primary models used in valuing companies:
–  Discounted-cash flow
–  Comparable public company valuations
–  Precedent transactions

Discounted-cash flow (DCF) — if you don’t know what this is, let the banker worry about it.  In tech company valuations, it’s not a vital model, but it’s heavily used in non-tech industries, where the business is predictable and well-established (or, similarly, in tech companies where there is an established and predictable business). The DCF simply presumes a set of cash flows occurring annually over a future period of time, assigns a terminal (end) value of the business, and then discounts the cash flows to the present (because cash in the future is worth less than cash today).  How it discounts is based on old mathematical models dating back literally 150 years, but is now automated in any spreadsheet program.  Again, it’s not worth worrying about too much.

Comparable public company valuations — A more important metric, this method uses the valuation of public companies in your space to determine how the broad market is valuing the business. In technology, there are a number of multiples that are used, but often, a multiple of revenue is employed.  You can get an idea yourself of comparable public company valuations by assembling a list of public companies in your space, and looking up the multiples on any major finance website (Yahoo has a nice section that shows the key multiples for any company, under “key statistics” on any public company quote page).

What companies you choose for your valuation has an impact, but be careful not to BS too much by only selecting the hot companies in your space, as any reasonably intelligent acquirer knows very well what companies are comparable to yours.

So, for example, if you’re in the security space selling an advanced firewall product, you might choose Symantec, Palo Alto Networks, Fortinet and FireEye (not the best examples, but I’m just giving examples here).   Take the core valuation metrics (multiples of cash flow or EBITDA, multiples of revenue, etc.) and then calculate the average and the median, and apply it to your own numbers.

Key multiples typically used are multiples of revenue and multiples of EBITDA.

EBITDA is a very important metric for some buyers, in particular private equity and growth equity investors. [As a side note, I will add that Cash Flow is not the same thing as EBITDA, and this is important to remember for working through your financials and your strategy. I got caught in a trap years ago between Cash Flow and EBITDA. I was heavily Cash Flow focused (specifically, Cash Flow From Operations — CFFO). For technical reasons not worth getting into here, my EBITDA was poor, but my CFFO was wonderful.  I thought I could explain it away to investors. I couldn’t: they simply cared about the EBITDA.  It was shortsighted on their part, but in the end, it was my fault for not realizing just how important EBITDA was to these institutional buyers. I’ll never make that mistake again.]

Plenty of bankers publish information on financial metrics for prospective clients; Pacific Crest Securities has one of the better models, published every few weeks. I’m sure if you contacted them, they’d be delighted to put you on their mailing list.

Precedent transactions — this is the most important valuation metric, as it is what other companies in your space are being acquired for today.  Any banker has access to services which provide this vital data, but you’ll likely have your own list of companies that have been acquired, what they got acquired for, and what the multiples were.  Again, you’ll apply this to your own numbers. Keep track of deals in your space.

Muddling through
After looking at precedent transactions and comp public multiples, you’ll have an idea of what your company should get valued at. A good banker is very, very useful in this process.

Now, different buyers have different metrics.  Financial buyers typically pay on a multiple of cash flow (perhaps 3–6x cash flow for a highly leverage acquisition, perhaps 7x-10x cash flow for a non-leveraged situation, sometimes more for something that’s important to them).  Strategic buyers (in other words, non-financial buyers) are all over the map.  If they believe it’s strategic, the sky, literally, is the limit.  I’ve seen numbers that are stratospheric.  I’ve also seen numbers that are surprisingly low.

In the end, get what you can get. This is where the art of negotiation really, really matters.

Of course, never lie and fudge your numbers.  You can get in awful trouble post-acquisition, and besides, do you really want to make all that money in a sleazy way?

So good luck and feel free to contact me if you want any advice in this process.

Term Sheet Math — When Is Your 66 Percent Really 52 Percent

Good overview of dilution by my friends at Foley.

When negotiating valuation for a financing, an investor may conduct detailed due diligence and then present you with a term sheet that reflects multiples, discounts, comparables, and so forth. In the end, you are negotiating for percentage — how much of the company will the investor get, and how much will you keep? Your investor is focused on maximizing return on investment. You are focused on keeping meaningful upside for your innovation and hard work.

For example, if you raise $5 million on a $10 million pre-money valuation, you will be giving the investor 33 percent of your company. You keep 66 percent. But that 66 percent may not be really be 66 percent even before you take into account any later dilution by subsequent rounds of investors. There are at least three reasons why.

Link here.