Posts Tagged ‘bubble’

Pattern recognition

VC’s love to talk about their pattern mapping abilities. “We add more value because we’ve seen so many companies go through all sorts of situations before and we can quickly map whatever’s happening at your business to what we’ve seen in the past and leverage this experience.” Or so the logic goes. But what’s going on right now with early stage company valuations suggests that VCs may be poor judges of at least some of these patterns. Or at least that they’re incredibly human when it comes to estimating the likelihood of certain events actually happening.

In 2002 a series of random shootings rocked the Washington DC area. For a period of about two weeks, an unknown assailant killed 10 people in a sniper like fashion. Many people in the area were panicked at the possibility of being subject to such a random act of violence and drastically altered their behavior to avoid putting themselves in situations that they perceived to be potentially dangerous. In reality, DC is a city of over 600,000 people. And while the events of those two weeks were certainly shocking, the average citizen was significantly more likely to be killed in an automobile accident than by the DC sniper. But that certainly wasn’t how serious most people perceived the risk to be. Because fundamentally humans are extremely poor judges at predicting the likelihood of outlier events.

Fast forward to today’s funding environment and I believe a similar mindset is taking place. Companies like Facebook, Twitter, Zynga and Groupon are attracting so much press that investors are misjudging the likelihood that their next investment will turn into something similar (or even into something in the next tier or two down in terms of outcome). In reality, since Facebook’s first venture round in 2005 over 10,000 different businesses have received venture funding. And history suggests that the vast majority of these companies will see outcomes of less than $1BN. Actually of less than even a few hundred million. And that’s the very best of this group. The majority will either fail completely or barely return capital.

Market deviations are driven by a fundamental imbalance between two sides of a marketplace. And we’re seeing a classic case of that now in the venture capital market. Unfortunately these market deviations tend to feed themselves – at least for a while. Company X raises money at a high valuation and the markets shift their perception of the clearing price for deals of that type. Perhaps the company raises another round at an even higher valuation, validating (at least temporarily) the first investment decision. Maybe there are a handful of high profile exits that, at least in those cases, justify the high valuations paid by their investors.

Eventually, however, the markets face their moment of truth. And there will be one (as there always has been) for the current venture climate. And while I’m sure that there will be some great businesses created in this market I think we’ll look back on this time period and again be reminded that the more things change in venture, the more they stay the same.

June 15th, 2011     Categories: Uncategorized     Tags: , ,

The real bubble

Great business plan tweet

While there’s been plenty of discussion and debate about whether we’re in some kind of valuation/venture bubble right now for early stage tech, there is one bubble that I’m pretty sure of. I’m seeing more great business ideas right now than I can remember seeing at any time in my 10 year venture career.

We typically see around 1,500 business plans a year at Foundry (we actually see more than that, but this is the approximate number that are relevant to our investment focus). On average we’ll take a meeting with somewhere around 10-15% of these and hear a bit more than what was in the introductory email or initial business plan. And we typically invest in 8 (our Foundry blog does a pretty good job of tracing our investment history and pace if you flip through our old posts). These numbers work for us and for our strategy and part of our operating philosopy is not to deviate significantly from our investment pace (depending on the mix of seed investments this number could go up or down in any given year but overall we’re comfortable at roughly the 6-10 new investments per year pace).

But something isn’t right with the early stage world right now. I’ve said a few times in the last 24 months what a great time it is to start a company and clearly more and more people are believing that because we’re seeing a significant uptick in the number of investment opportunities we see here at Foundry (I’m sure we’ll be well above 2,000 for the year). More importantly, we’re seeing many many really good, interesting ideas. I’m blown away by it. And it’s frustrating, because I can only spend time on so many things and we’re still only going to make 6-10 new investments in any given year. But never before have I had to say “no” to so many businesses that 1) I thought were super interesting; 2) were clearly going to get funded by someone; and 3) in another time/market I’d love to spend more time with.

To be clear, I don’t see anything to suggest that traditional venture math won’t continue to hold true (a good performing venture fund will still see about 1/3 of their investments fail, another 1/3 do only “ok” and 1/3 do better than that – with maybe 5-10% becoming real stars). And, of course, I recognize that part of our job on this side of the table (at least in venture funds with our investment strategy and not one of making 20 or 30 investments a year to spread around) is to make the hard choice of which of a number of great companies really has the chance to be outstanding.

But wow – is it a fun time to be in venture! And perhaps even more so, a fun time to be an entrepreneur…

March 4th, 2011     Categories: Company Creation, Venture Capital     Tags: , ,