ArpexCapital

Dream, People, Culture

Focus

Filed under Entrepreneurship by

 
I have often counseled entrepreneurs to focus more. I have never counseled them to focus less.
 
Like so many things in venture capital, however, “focus” is easy to see but difficult to define.  How does one distinguish between an entrepreneur that is expanding intelligently and an entrepreneur that is losing focus?
 
Mostly, I think it is a function of timing and relevance. 
 
Regarding timing: at the beginning, keep your goals simple and singular. Prove and stabilize one business model in one vertical before expanding into another vertical.
 
Then, consider relevance.  Is the new vertical truly relevant to the core business? Ask yourself, how well do you know the new vertical? Are you a member of the ecosystem? Do you personally experience a pain point in that vertical that you can address? If yes, it’s relevant. If not, you are losing focus.
 
As an example, take one of our portfolio companies in the games space. They started as a developer of mobile games; for a year or two, they focused on churning out games. Over time, their games became more sophisticated and more successful and, eventually, they produced several massive hits on iOS and Android.
 
The company needed to use mobile ads to fully monetize their user base and they soon became experts in the mobile ad space, which led to a realization that a huge opportunity existed in mobile ads, especially connected to mobile games. They decided to dedicate resources to developing a mobile games ad platform.
 
So, a young company with limited resources pursued two lines of business simultaneously. Is there a focus problem? No.
 
There was/is no focus problem for two reasons: first, because the company won the market as a games developer first, before expanding into developing an ad platform. Second, the ad platform addressed need in a relevant market that the company understood extremely well.
 
Had the company STARTED by pursuing on two lines of business, there would have been a focus problem. They would have chased two rabbits at once and lost both of them. Instead, they caught the first rabbit (successful games development) then turned to the second (mobile ad platform). 
 
In sum, stay extremely focused in the beginning, then expand into new verticals only if they are highly relevant to your core business.
 
October 31, 2011 at 06:32 Comments (0)

Attack of the Clones

Filed under Brazilian Venture Capital by


Clones have overrun Brazil.


The country is currently awash in copies (“clones”) of US business models. 

As recently as 18 months ago, “cloning” in Brazil was still relatively new or, at least, much less widespread. Now, it is rare to find a Brazilian startup that is not an intentional copy of a company in the US (or, in some cases, Europe).

The speed at which US startups are cloned is remarkable: a company from Silicon Valley receives attention on Techcrunch one day, the next day two clones form in Brazil.

Is there anything wrong with this? Absolutely not. In fact, in many cases, a clone has less risk because the concept has already been proven in the US; even if the concept has not yet been proven in the US market, it often has the imprimatur of smart money investors.

In fact, one of the first questions VC investors ask a Brazilian entrepreneur is whether a version of their company exists in the US. If no model exists in the US or Europe, it raises a concern. This may be unfair but, because the pace of technological and business innovation is higher in the Valley and New York, it makes sense that good ideas would normally arise there first.

Here are the good and bad of clones as I see them.

Good:
  • Reduced concept risk: the clone starts out with a model that already has some market or investor validation.
  • Reduced strategic risk: a roadmap for market penetration has often been written by the initial innovators; the clone just needs to follow the formula.
  • Exit strategy: in many cases, the clone has a more obvious exit: in the event that the predecessor in the US wants to expand into Latin America, it will often be easier to buy the clone than start from zero in Brazil.

Bad:

  • Competition: there is a disadvantage to not having your own innovative idea. A truly innovative idea creates a distance between the startup and would-be competitors (example: Twitter) that can greatly increase the chances of success. By definition, clones don’t have that distance.
  • Execution: because the company does not have an innovation advantage, clone entrepreneurs have less “margin for error”: normal entrepreneurial mistakes can cost a clone its life. Just ask the dozens of "group buying" companies that started early enough to win the market but now are out of business. The best cloners are the best executors, the best executors are the best cloners.
  • Execution in Brazil: “Brazil is not for amateurs” and most foreign businesspeople learn the hard way that doing business in Brazil is very, very difficult.    For example, logistics and managing the supply chain for an ecommerce business in Brazil is much harder than in the US…
  • Capital: investment capital is a helpful weapon for startups but, in the case of clones, it is essential. Money pays for rapid expansion (marketing, hiring, etc.) that creates the needed distance from competitors.  Lack of money means you will be left behind.
  • Value: the most valuable companies are not clones. Apple, Google, PayPal, Facebook, Twitter: they were “derivative” – everything derives from something before it – but they were not clones. A clone is a copy: these companies innovated to win their markets.

Expanding on this point: the most valuable, sustainable companies tend to be platforms and platforms don’t lend themselves to cloning. Most clones choose B2C ecommerce businesses for a reason: they are relatively simply to copy. But that also means the barriers to entry are low: to win, you need to spend a ton money on marketing and execute, execute, execute.  Building a “platform” (see the companies in the previous paragraph) requires more than money and execution.

Exit type and value is also different: platforms can IPO, clones usually (not always) need to be acquired. The former usually results in greater returns than the latter.


In sum, there is absolutely nothing wrong with clones. Clones can make great investments for VCs and many clones in Brazil will make a ton of money. We will be investors in some clones.  There are downside risks to cloning, however, and an entrepreneur should understand them before launching a clone.


October 22, 2011 at 07:43 Comments (4)

It’s Not Different This Time, It Never Is

Filed under Brazilian Venture Capital by

 

I thought I'd share an internal email that I sent to the Arpex team today — it was in response to a longer email from one of our partners in which he shared his perspective on venture investing in today's environment.

 

I agree with what __ said and would add the following perspective:

– venture capital investment works in cycles — the current cycle in Brazil is becoming a bubble, in the US it is already a dangerous bubble

– in a bubble environment, there is a deal frenzy, with VCs scrambling to invest in the latest hot company without full consideration of business model or valuation

– i remember very well the "Dot-com" bubble and can name 30 companies from Web 1.0, with great teams, great investors and a lot of "buzz" — these were companies I wished I could invest in — that went bankrupt within two years (2000/2001)

– now, in Brazil, there are many companies that have investor interest and lots of buzz.  As opposed to Web 1.0, these Web 2.0 tend to have less capital requirements and burn less cash — this is a good thing BUT, in many cases, these companies are not truly companies, but rather a single application or feature masquerading as companies.  This means that it is unlikely that they will ever grow to a size necessary to achieve a meaningful exit.  They are especially unlikely to achieve a meaningful return if we invest at a high valuation.

– in bubbles there are always many smart people who say there is no bubble and explain why "it's different this time".  It is never different.  Yes, technology changes, business models change, tactics changes but business principles don't change — a good business is a good business, a weak business is a weak business.  the former will survive and the latter will eventually die.

– the best investments are in companies that don't need investments

– the best investment are in verticals that we understand well — become an expert in a given vertical and you will find (or create) good businesses in that vertical

– Arpex's managing partners are different people and therefore sometimes we do not think exactly the same about what deals we like –that is a good and important thing.   We will always, however, come to an agreement before we allow Arpex to invest.   So, while I probably take a more US/Silicon Valley perspective in the style of prospecting and the type of deals I like, we all agree on the companies that we invest in.  

– I learned this principle some years ago and it has ALWAYS been true and always will be true — it is probably the most important principle of investing:  Great deals don't find you, you find them.  

Abs,

T

October 20, 2011 at 06:22 Comments (2)

It’s All About Growth, Except When It’s Not

Filed under Brazilian Venture Capital, US Venture Capital by


Last week I wrote that, out of the universe of good companies, only a tiny percentage make a good investment because most companies lack the potential for rapid growth.

That said, here are some exceptions/qualifications to the "rapid growth" requirement.

 

1.  Growth Is Insufficient — a Company Needs "Scale".

Rapid growth implies speed but "scale" implies speed, breadth and efficiency.  For example, a popular restaurant can "grow" extremely quickly — as quickly as a web-based business — but most VCs don't invest in restaurants.

Why? Because restaurants don't "scale": it's complicated to open new restaurants — to identify the right location, renovate the physical space, hire a new staff, etc.  Each new restaurant requires a significant investment.

On the other hand, internet-based businesses can expand rapidly, efficiently and broadly with relatively little additional investment.  Another way of saying it is that internet businesses have much less "friction" than offline businesses (e.g., restaurants).

 

2.  Market Size Matters.

It is possible for a business to have excellent growth and a scalable infrastructure but still not make a good investment.  For example, a company that drop-ships books written in the Tongan (south-Pacific) language can grow efficiently and quickly — assuming a sufficient demand for books in Tongan.

The business, however, will never get large enough to achieve a significant exit because the market for books in Tongan is too small (there are about 200,000 Tongan speakers).   The small market size prevents the company from being investible, despite the potential for rapid efficient, growth.

 

3.  Gross Return Matters

This point relates to #2.  Let's assume that a $50,000,000 fund makes a seed investment of $30,000 in the Tongan bookseller. 

In two years, the bookseller is acquired for $90,000.  The investment achieved a 83% IRR — excellent — and yet the investment was a complete waste of time and money. 

Why?  Because an investment that returns $90,000 for a $50,000,000 fund is meaningless.  It represents 0.18% of the fund. The investor would need 555 of these investments just to "return the fund", i.e., to generate $50,000,000.

Most VCs look for an investment to return a minimum of 50% of the fund. Any investment that, even if successful, would return less than 50% of the fund is not considered.

This is not always true but it is a good rule of thumb.

 

4.  Risk Matters.

Simply put: the higher the risk of an investment, the higher the IRR required in order to compensate for that risk.  The lower the risk of the investment, the lower the required IRR.

A social network that has already captured 50% of its addressable market is a lower risk — and therefore demands a lower IRR — than a clean energy startup that wants to turn coconuts into jet fuel.  

That said, early-stage VC investing is inherently risky and therefore, in my opinion, a minimum anticipated IRR of 50% is required to justify almost any investment.

October 14, 2011 at 04:15 Comments (4)

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