Posted: May 15th, 2012 | Author: Ted Rogers | Filed under: Macro Environment, US Venture Capital | 1 Comment »
The venture market in the United States is in a bubble. In the US, including (especially) in SV and NY, valuations for companies at every stage are way too high. Because most of these companies have no revenue, it is not possible to quantify how high but, if you do the math, there will simply not be enough exits at a high enough multiples to provide sufficient returns in exchange for the risk being taken.
Yes, the problem is worse in basic consumer businesses (B2C) than in enterprise businesses (B2B) but the problem is in pretty much all Internet verticals.
I feel more and more like I am re-living Web 1.0 – the Dotcom boom and bust. I was part of building and investing in a VC fund beginning in early 1997 – we caught the wave and the fund did 90%+ IRR net of fees – this is top tier for VC returns. It was useful because I witnessed how a VC fund can be successful. I left for AOL later but my former colleagues – pretty much the same team of extremely smart and talented people – did the same thing with Fund II and it returned $0 because the bubble popped. So I witnessed how a VC firm could fail.
So you can be smart and good but, with a traditional VC fund, timing matters. (Timing matters in all investing but moreso in a fund that must be deployed over a fixed five-year time span.)
Some other indicators of a current bubble: the proliferation of “accelerators”. You had the exact same thing happening during the Web 1.0 bubble – just substitute the name “incubator” for accelerator. Some of these incubators even went public, then became penny stocks, then got delisted, then went bankrupt. They all had promising startups inside which, in retrospect, were interesting ideas or products but not actual businesses, at least not sustainable businesses.
Instead of building businesses, the game was a chase to be acquired or, in Web 1.0, go public. The same is true now.
Economic markets run on fear or greed and we are currently in a “greed” phase. The Facebook IPO will only increase the frenzy. Many people who were at FB at the right place at the right time will believe they are smart and either start new companies or become angel investors, which will make the bubble worse. Again, substitute “AOL” for Facebook and you can see Web 1.0 all over again.
The only difference between the dot-com (Web 1.0) and this bubble (web 2.0) is that web 1.0 included inflated valuations in the public markets. The high prices in public stocks and the ease of going public led to huge valuations in private (VC) markets. When the public market bubble popped, it immediately popped the private market bubble, since the latter’s valuations were based on assumptions of public market multiples.
The Facebook IPO will be the moment when the Web 2.0 bubble officially comes to the public market and it will be the beginning of the end of this cycle. It’s not that FB isn’t an incredibly valuable company – it is – the issue is the psychological impact of the IPO on valuations and exit assumptions in general and, again, on the companies and investors lower down the chain.
Right now, the web 2.0 bubble is “trapped” in the private markets and, because it has been trapped in non-liquid markets, it has been hard to quantify just how big the bubble is. Now, however, the bubble will float up into the public markets. In the full light of the public markets – liquid markets that require disclosure and quarterly updates, etc. — it is a matter of time before valuations correct.
As an aside, many people have argued that we are not in a bubble because the public markets for tech stocks are not inflated. This is ridiculous – just because private tech companies have not had access to the public markets, because they are receiving private financing, does not mean that their valuations are sane. In fact, it is the opposite – a lack of liquidity, transparency and comparables in the private markets leads to the inflation of valuations.
Anyway, since access to the public markets for internet companies has been shut off for many years, we have a huge pent up demand for liquidity in the private venture market. Dozens of tech companies are lined up like trucks in refugee convoy trying to get to the IPO border. Investment bankers are once again at the wheel as the SEC directs traffic and public market investors prepare to dump bags of money off the back of trucks and helicopters.
You can’t outrun reality, however, and every business is a function of its current and future cash flows – at some point, the private and public markets will realize that, for most internet companies, the cash flows don’t currently exist and won’t ever exist.
One might ask why the bubbles hasn’t been worse or faster-inflating. First, a lot of people over 35 remember the dot-com bust – these memories have provided a useful governor on the engine of hype. Second, we are in the worst economy since the Great Depression – which has dragged on growth even in tech investing.
In sum, for all the negativity in this post, I still believe in venture capital, in early-stage investing and in the future of the US (and Brazilian) ecosystems. Markets run in cycles, it is natural. We are near a peak right now — so what?
For entrepreneurs, there will always be a place for creating companies with products/services for which many customers pay. There is as much opportunity to create great businesses as there ever has been in the history of the world.
As for investing: the best advice I ever got in football, maybe in life, was to “Focus only on things you control”. Simple to say, hard to do. The amount we control is far less than we believe moment to moment. The point is: ignore the outside noise, cultivate your core investment thesis and execute against it.
Posted: February 29th, 2012 | Author: Ted Rogers | Filed under: Brazilian Venture Capital, Macro Environment, US Venture Capital | 6 Comments »
Many experts in VC will tell you that venture capital, like politics, is a “local” business. It’s true, of course: the VC needs to know entrepreneurs face-to-face; they need to know the market into which their companies are selling; and they need to build the local networks that lead to quality deal flow. In addition, it’s difficult to effectively assist portfolio companies that are not nearby.
On the other hand, social media and inexpensive voice/video conferencing services enable effective communication over great distances. That, combined with sufficient travel, makes successful, geographically-diverse venture investing very feasible.
In fact, the world of startups, and thus venture capital, is increasingly global. Online media is melding together various markets into one international popular culture – the same YouTube videos go viral in the US, Europe and Brazil; Jeremy Lin is as massive a cultural phenomenon in China as in the US; people in Lebanon follow the same Twitter feeds as people in NY.
Regarding language, for better or worse, English seems to have become a common language of business and culture. This is not unprecedented – for many decades, French was “the language of diplomacy” – if you wanted to travel in international circles, especially diplomatic circles – you needed to learn French. Perhaps someday soon we will all need to know Chinese or Portuguese – many Americans are currently scrambling to learn one or the other – but right now it’s English.
Aside from that, translation services continue to level the playing field. It’s recently become possible to “get by” in most markets despite not knowing the language. Google Translate functions imperfectly but well enough. Other services like MyGengo increase efficiency and accuracy in translation. US personnel in the Middle East use handheld devices to communicate instantly in Farsi or Arabic. A high-quality smartphone app for the rest of us cannot be far behind.
The most intractable barrier to the globalization of startups/VC is bureaucracy. By that I mean anything from shipping to taxes to trade barriers. (Perhaps “logistics” is a better choice than “bureaucracy” but you get the idea.) These barriers, however, cause problems mainly for companies that require physical fulfillment of goods or services. For a great number of companies, this is not an issue. Facebook, Twitter, Google and Skype serve as obvious examples of companies largely unaffected by logistics/bureaucracy.
In sum, the importance of "local" in startups and VC remains but the importance of global perspective has increased. The pace of globalization is accelerating, almost in the same proportion as the pace of technological innovation — it’s as if there's a Moore’s Law in effect for globalization. As such, VC funds that are built for global investing, such as DST, may have the greatest future success.
Posted: September 19th, 2011 | Author: Ted Rogers | Filed under: Macro Environment | No Comments »
The economic crisis in Europe has dominated the headlines in the last week.
In my opinion, Europe faces one of two scenarios. In the first scenario, banks in France and elsewhere that hold bad debt (read: debt from the "PIIGS" — Portugal, Ireland, Italy, Greece and Spain) face collapse but are saved by their governments, who will essentially take ownership of the banks.
If that happens, the economic crisis in Europe will be morph into a steady but serious decline, leading to a period of five to ten years of economic malaise. During that time, countries will struggle to reconcile the economic reality that they cannot afford the welfare programs upon which their citizens have become dependent.
In the other scenario, government action is not sufficient to save major banks and the economic crisis becomes a "crash". Credit vanishes and European economies decline severely, which leads to various nasty but historically predictable outcomes such as political unrest, the rise of far right and far left political parties, etc.
As for the US, we are about to slide into another recession (a "double-dip" recession — the first dip was 2008-2009). Unemployment will grow to well above 10% and we will struggle for another three or four years, as we complete the "great de-leveraging" (reducing our debt) that began in 2008.
We will face our own political reckonings. For example, no President can be re-elected in such an economic environment and Obama is unlikely to be in office come January 2013.
Given this situation, the importance of Brazil and China will only increase. Why are Americans and Europeans pouring into Brazil, learning Portuguese and claiming a new-found love of the country? In addition to being a fantastic place, Brazil is one of the few places on earth that has solid economic growth.
For my friends and family in the US and Europe: hold on and see through this tough time — it will end, as it always does.
For my friends and family in Brazil: let's be thankful for our presence in a great country that holds a special place at this moment in history.
Posted: September 18th, 2011 | Author: Ted Rogers | Filed under: Brazilian Venture Capital, Macro Environment, US Venture Capital | No Comments »
Following up on yesterday's post on valuations in Brazil: the problem of valuing early stage companies is not new and one of the solutions that appeared years ago was the convertible note. The convertible note basically delays the need for valuing the company until the next round of financing, when presumably the company will be more mature and thus more accurately valued. Some VCs swear by convertible notes, others dislike them but they are one solution to a situation where the entrepreneur and investor are too far apart on valuation.
It's easy to find more information about convertible notes online: one of the great things about the venture ecosystem is the amount of quality information available on the blogs of VCs. I highly recommend Fred Wilson's AVC (spend time in the comment section, as well) and Brad Feld's Feld Thoughts. Brad also posts on an excellent site called Ask the VC.
Fred and Brad have weighed in on the convertible note issue multiple times and I recommend checking out what they say.
Posted: September 17th, 2011 | Author: Ted Rogers | Filed under: Brazilian Venture Capital, Macro Environment | 10 Comments »
Three years ago, when I told people that I was doing venture capital in Brazil, they would usually ask “Why?”
Two years ago, when I said the same thing, they would say, “Interesting.”
Now, they say, “I am too."
The influx of venture capital to Brazil, while great for entrepreneurs and our venture ecosystem, seems to have brought with it inflated valuations.
Last week I had a call with an entrepreneur that said he wanted a R$30 million pre-money (pre-investment) valuation for his company. His 2010 revenue? R$1MM. That represents a 30X multiple on revenue – not EBITDA, not net income – revenue.
Very high, I thought, but maybe the growth was so extraordinary that the valuation was justified. I asked, and was told that revenue would be $R20MM. Oh good, “In 2012?," I asked. “2016”, was the answer.
Wow. To understand how ridiculous that is, consider that Google is currently valued at less than 19X trailing income.
It was a friendly call and I never get indignant about business but, in retrospect, that’s not cool. It’s not healthy to expect that valuation and it’s not smart to ask for it (the investor will think that you think they are a fool).
We want to work with driven entrepreneurs building world-changing companies. We will work hard to make those companies hugely successful and drive extraordinary financial returns for our entrepreneurs.
But remember that venture investors like Arpex are also running a business, a business that will fail if we invest at unreasonable valuations.
After the call, I sent an email to my partner saying, “Good company, crazy valuation.” And he shot back, “Too bad — the market is being destroyed before it exists.”
Let’s remember that investment transactions do not need to be zero-sum games, in which one side wins and one side loses. At its best, venture capital is the ultimate win-win proposition for investor and entrepreneur — that can only happen at reasonable valuations.
Posted: June 4th, 2011 | Author: ahurtado | Filed under: Macro Environment, posts | 7 Comments »
I am Anthony Hurtado an American intern at ArpexCapital. Prior to joining ArpexCapital I lived in São Paulo, Brazil where I briefly studied at PUC-SP while interning at Raymond James & Associates. Currently, I am a student at Georgetown University. I will periodically contribute to this blog.
In the US and European ecosystem, a “mobile” revolution, driven by smartphones, is underway. It is unclear, however, whether the same mobile revolution will occur in Brazil: 82% of the Brazilian population uses pre-paid chips in place of mobile plans and Brazil is the second most expensive place for someone to use a cellphone, due to layers of taxes and fragmented industry fees. If you were to look at the decision by Pontomobi, Brazil´s largest mobile marketing company, to bypass Mexico and Argentina and instead expand into Europe due to their more advanced tech infrastructure, you would probably conclude that Brazil’s current boom won’t include mobile.
Nevertheless, I have found many reasons to believe in an imminent Brazilian mobile revolution. The chief reason is the Brazilians themselves. In the land where a new iPhone costs anywhere from 2.5-12X more than in the US, sales are up! The new Class C in the last eight years has increased general consumption nearly seven times over. Mobile phones and other tech products make up a significant portion of this new consumption. App-heavy, Android-based phones are the country’s fastest growing cellphones. Despite having sky-high tariffs on smartphones, smartphone sales are up 85%! In the overtaxed mobile environment, 15% of Brazilians already have a smartphone. By 2014 that number is expected to be 45%.
Moreover, while there is an endless amount of legislation and regulation of cellphone minutes, ubiquitous promotions by telecom carriers greatly minimize the actual costs incurred by many Brazilians. These promotions already include the mobile Internet space as seen in, e.g., TIM’s latest promotion of a month’s free Internet when you buy a TIM pre-paid phone.
The question is not whether Brazil will experience the mobile movement but which Brazilian companies will do the best job of harnessing it. With this in mind, Pontomobi´s Europe play now makes sense. It is not that the company is abandoning Brazilian mobile marketing, rather they´re preparing for its next stage, which is currently being realized elsewhere. Their move to the developed markets demonstrates that the Brazilians who progress Brazil´s mobile sector to its next stage may not be in Brazil right now. They will return to Brazil and the mobile revolution, when it hits Brazil, and will combine many European and American (and Asian) lessons with indigenous business and technological standards.
It’s coming: the worldwide mobile revolution will soon hit Brazil, The Country of Tomorrow Today.
Posted: May 7th, 2011 | Author: Ted Rogers | Filed under: Macro Environment, posts | 2 Comments »
In the US, from 1994-1999, the Internet drove the “the greatest legal creation of wealth in history," according to
John Doerr of Kleiner Perkins.
First, broadband. In 2010, less than 20% of Brazilian households had broadband. The Brazilian government’s National Broadband Plan (PNBL)
aims to connect 72% of all households to broadband by 2014. If the PNBL achieves even 40% penetration in three years, it will bring a tsunami of new consumers online and create a wave of opportunity for entrepreneurs.
“Broadband” and “smartphones”, of course, relate to each other: telecom operators now sense an opportunity to provide mobile broadband services to households that never had fixed internet connections.
Third, entrepreneurs. When I began doing business in Brazil, people constantly warned me that Brazil did not have good entrepreneurs. I never believed it, because from the first day I stepped on Brazilian soil in 1999 I saw entrepreneurs navigating crushing inflation, paralyzing interest rates and confiscatory taxes to build successful businesses.
What did concern me, however, was the number of entrepreneurs. If there are only 30 entrepreneurs starting companies in Sao Paulo and Rio de Janeiro, we are all in trouble. A sustainable venture ecosystem needs depth as well as quality.
It’s like Brazil’s soccer program – at the bottom of the pyramid, new players of all ages from all locations constantly enter the system. They compete intensely for years and, eventually, the best players reach the top of the soccer pyramid. The result is a national team that has qualified for every single World Cup and has won five of them, more than any other country.
A venture ecosystem is like that, too. It needs a wide and deep pool of entrepreneurs at the bottom to achieve an Apple, Google and Facebook at the top.
Based on
statistics and, moreover, on anecdotal evidence from universities,
meetups and social media, I’m convinced that Brazil finally has that.
We are in a golden age for venture capital in Brazil, driven by broadband penetration, smartphones and a growing number of entrepreneurs.
Posted: April 25th, 2011 | Author: Ted Rogers | Filed under: Brazilian Venture Capital, Macro Environment, posts, US Venture Capital | No Comments »
Two interesting posts came out yesterday addressing whether the venture market has entered a “Bubble”. Michael Arrington of Techcrunch believes not and contrasts the Bubble of 1999-2000 with today’s market. Fred Wilson takes a careful but, to my reading, contrary view, warning about current imbalances in the early-stage ecosystem.
Instead of opining one way or the other, I’d like to explore how the structure of typical venture capital funds contributes to Bubbles. Specifically, strict investment mandates and short investment periods force VCs to deploy capital even into inflated markets, which makes the markets more inflated.
First, the strict investment mandate: unlike a hedge fund, a VC fund cannot diversify into assets with less inflated valuations or bet against a rising market by, e.g., shorting stocks. The VC must buy (they are “long-only”) shares of companies within a relatively narrow range: if you raised a fund focused on early-stage web businesses in the US, that's what you must invest in. You can’t pivot and invest in, e.g., growth-stage cleantech businesses in Europe, even if that's a healthier market.
Second, most VCs have a limited time period – often only five years – to invest their fund. Therefore, they must participate in the market now, regardless of conditions. If a VC waits for the market to correct, he risks not deploying all of his investors’ (LPs) committed capital during the investment period.
LPs get upset if you don’t deploy their capital. Why? Because they pay you management fees to find good deals and invest, not to watch others invest. More importantly, if you don’t deploy their capital, you throw their asset allocations off balance. If an LP plans to have 6% of its money in venture investments, that’s what it needs to have, not 3%.
Portfolio Theory tells them that returns come from having the proper percentages deployed in different asset classes
NOT from individual investments within those asset classes. So they want their capital commitments invested, regardless of market conditions.
What will happen to the VC that says to his LPs at the end of the investment period, “Sorry, but we caught a bad part of the cycle. Valuations were too high so we only invested 30% of your money”…? I don’t know what will happen, actually, but I do know what won’t happen – the VC won’t receive another dime of capital from that LP and probably not from any other LP in the ecosystem; he won't raise another fund and his asset management firm will eventually cease to exist.
So, is there a Bubble? For many venture fund managers, the answer is, “It doesn’t matter.” They need to invest, regardless of valuations.
ArpexCapital is fortunate to have a bit more flexibility than the average venture fund. Our capital comes from a relatively small group of aligned individuals, including the fund managers. We all communicate regularly about our pipeline, the market and valuations, so we are on the same page about the decisions that the fund takes.
We have a targeted time period in which to invest the capital but not a strictly mandated one: if, at the end of that target period, we have only invested 30% of the fund, no one will complain. We also have more flexibility about the size and stage of our portfolio investments.
We will undoubtedly make mistakes – passing on high return deals and investing in busts – but I hope that our structure allows us to invest without the coercion that a typical fund structure creates.
Posted: January 21st, 2011 | Author: Ted Rogers | Filed under: Brazilian Venture Capital, Macro Environment, posts, US Venture Capital | No Comments »
I was going to write a post on the mad rush of VCs into Brazil and how that will inevitably inflate valuations to unsustainable levels, i.e., bubble now, crash later. But, it is what it is. After all, an asset is worth what someone will pay for it – nothing more, nothing less – so who’s to say what's an unreasonable valuation?
Better, however, to focus on something positive, like the fact that the world has become a global marketplace for web-based startups.
The previous post dealt with the globalization of startups. Experience tells me that a startup should focus locally first and expand internationally only when they have sufficient resources to do it but there are major exceptions to this rule, especially for web-based companies.
As opposed to a device company, or a cleantech business, a web-based company can launch instantly in a geography-independent way (i.e., world-wide), with little additional cost. Physical borders no longer matter. Now, the biggest hurdles are language and culture.
Even the language hurdle, however, is disappearing.
… perhaps three billion people are online, or around half the entire population of the earth… English and Mandarin dominate the online conversation with close to 500 million speakers online and more than a billion offline. Also growing in online influence: Spanish, Arabic, Hindi, and Portuguese. What’s interesting is that these languages also seem poised to drive cultural trends globally. Looking at average GDP and Internet penetration by language, we can map out a geographic playbook for any Internet startup to prioritize how they lay the online smackdown on the planet, and use geographic arbitrage to move the point of innovation, production, and transaction to optimal locations.[emphasis added]
For more info on this topic, see p.5 of this 2009 report on global language trends by MyGengo, a 500 Startups portfolio company.
Dave makes two critical points about language: first, that a startup can use hard data about language, GDP and internet penetration to determine exactly where it wants to focus its company and, second, that startups can access increasingly cheap sources of translation (through, e.g., MyGengo). The language issue is disappearing.
The reduction of the language barrier strengthens the case that startups should consider targeting multiple countries (after analyzing factors like competition, culture, etc.). The startup can use hard data about languages to optimize its geographical markets and then access cheap resources to translate its product into the necessary languages.
Posted: October 13th, 2010 | Author: Ted Rogers | Filed under: Macro Environment, posts, US Venture Capital | No Comments »
I learned a ton over the course of two days. Not so much about the investing side of venture capital but about the fundraising side: people often forget that VCs occupy the same position as entrepreneurs for much of their professional lives, i.e., asking other people for money. This blog (and others) talks a lot about investing, entrepreneurs, the startup ecosystem, etc. but, before a VC can invest, he/she has to raise money. That means pitching to Limited Partners – pension funds, endowments, family offices, wealthy individuals, etc. — and asking them to invest. It's as tough for us as it is for entrepreneurs.
Fundraising from LPs is a whole world unto itself and it changes all the time. Since we (Arpex) are currently raising a fund, I found the real-time information on the current fundraising environment invaluable.
Below, I share some random notes from the conference but, first, an aside: on the first night, I ran into
Brad Pitt (literally). As I opened my door to run to dinner, I almost knocked him over. He was about to knock on my door – he and another guy were looking for someone and had the wrong room (I was 1410, they were looking for 1401). After a brief mutual apology, they moved on to the double-door suite at the end of the hall.
Kind of a strange moment — great conversation starter at dinner…
Now to the venture capital notes:
1. Venture fund managers always have a hard-time raising their first fund but second and especially third funds can be even more difficult. With a first-time fund, you can sell the team, the fund strategy, the vision, etc. In the latter cases, you have to show actual investment results. Given the VC market of the last ten years, that’s a difficult thing to do.
2. Super-angel investing does not work unless there is a massive updraft in the sectors. In other words, you can make a living as an angel investor if companies grow consistently and valuations continue increasing. If not, you are in trouble because a) you don’t have money to bridge your companies during the tough times and b) you will get massively diluted when (if) new investors come in.
3. Leave the entrepreneur alone to run his/her company. If you don’t trust them, fire them and get someone you trust. Otherwise, in the long run, the relationship will fail and so will the company.
4. When discussing specific portfolio companies with Limited Partners, the LPs want to know one thing: the percentage of the total Fund that the portfolio company will realistically return. The benchmark is 50%. In other words, LPs want to hear that a specific company will, upon exit, return half of the committed capital in the Fund.
5. There are signs of life for VC funds trying to raise capital but LPs are waiting to say “yes” until they absolutely have to: in other words, they want to wait to see what other LPs, if any, are going to invest in your fund before they commit.
6. Part of this “wait and see” attitude stems from the knowledge that the VC industry is going through a correction and many funds will disappear. LPs are waiting to see which VC funds will survive.
7. LPs tend to feel more interested in super-angel funds than traditional VC funds but, unless someone with an excellent reputation is running the fund, the LPs still prefer to wait.
8. LPs have adjusted their expectations for returns and feel ok with 10% per year into the future. This means they don’t need/want to take as much risk (e.g., by investing in venture capital funds).
Lots more on the conference in the next post.
