VC Decision-making: Investing in an Existing Portfolio of Companies.

Executive Summary: Investing in existing portfolio companies involves a lot of groundwork to be done by the Venture Capital General Partners. Below is an experience recounted by a VC investor, followed by some of my thoughts on the tale well told.

The VC Doubling Down Experience
Fred Wilson has a great post on "doubling down" vis-a-vis portfolio companies:
http://www.avc.com/a_vc/2009/08/doubling-down.html

The Analytical Backgrounders
If you have read a previous generic post linked below, you will definitely enjoy an experienced VC investor sharing his experience above in making the decisions:
1. Creating Value through Operational Improvements: http://randomjunkyramblings.blogspot.com/2009/04/panel-creating-value-through.html
2. Microeconomics, Synergies and Operational Portfolio: http://randomjunkyramblings.blogspot.com/2009/05/microeconomics-synergies-and.html

Identifying a subset of "core"/ "sustainable" (your mileage may vary) investments from a portfolio during tough times is not an easy process even for great investors. The key aspects of Fred's post are:
1>raise funds during tough times, and,
2> choose to pump in more money into the newly identified "core" investments, instead of making new investments.
3> "restructure" existing investments in some way- e.g. strategy, team, cost.

To better understand the VC decision making process, here are some questions you may ask:

1> Fundraising For An Existing Portfolio
- Would you have your "core" investments list, and their follow up round funding needs in hand, when you raised funds?
- Would your fundraising account for possible iterations to this list? E.g. Would your fundraising process include discussions on potential exits and the potential returns to LPs from these exits?

2> Portfolio Picking as Cherry Picking
- Portfolio Company Consultations: Would you choose which investments needed more money from you on a case by case basis? Would this process be any different from board level discussions on company performance, except for more stringent criteria being thrown into the mix?
- Follow on funding Factors: Would the lack of (or unfavorable term sheet conditions in) follow up rounds of funding due to economic conditions force you into considering more investments in the same companies than you normally would?
- Finance Portfolio Constraints: Would you exit firms that had strong potential, but would skew the risk-reward profile of your portfolio?
- Exit Negotiations: What factors would cause you to take a "non core" company off the "for sale" list? i.e. What could cause you to exit the exit negotiations? How many "non core" companies would you have in play for exits at any point of time? Would you keep the window of being part of a follow on syndicated lending team on some "non core" companies?

Another way to quantify this is as follows:
- Company Funding Needs: How may of the newly identified core/ sustainable investment could do without funds from the same VC firm?
- Finance Portfolio Constraints: How many of the investments outside the "core" list had funding needs that the VC firm could not accommodate in the risk-return profile of the reconfigured portfolio, despite strong potential of meeting expected returns?

The Investor Basics
1. (Re)Evaluating financial options can be difficult in tough times over investments you have made which count on an expected future value, but that's par for the course for any investor.
2. The next step is to identify core investments that continue to be strong on performance indicators,and which, in your judgement, will provide strong returns. This too is par for the course for any good investor.

For those who have doubled down in tough times, a simple question to ask would be how many companies you exited went on to provide "spectacular" returns after their exit?

Its NOT So Easy
This only goes on to illustrate that a VC's decision making to exit portfolio ventures is, for starters, pretty difficult on the VC as well.

What do you think?


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The Startup Thought Process Series: Commuter Rants

Series Initation Note: This kicks off a series on my conversations with folks starting digital media companies with the objective of assisting the enterpreneurs.

The Startup: I met an owner close to rolling out a site for commuter rants. Simply put, the site is a forum for commuters to rant about their commute.

Our relatively brief conversation focused on helping him with the vision/ raison d’être for the site. Snippets of the conversation are listed below. These are really interconnected factors, however you need to be able to think through them linearly once, before you iterate through the options and interdependencies. As with a few startups, these answers may change with time, however, it helps to have concrete thoughts about these questions at the start of the journey.

I. Market Potential
The entrepreneur's first area of uncertainty was: how frequently would a commuter rant at his site? We broke that down into market sizing and frequency of usage.

i. Who is the target user of this site? What is the market size?
What kind of commuter? Someone who takes the NJ Transit or Metro North to and fro work? Or does it include someone stuck on the D.C. beltway on a Friday evening? The idea here is to understand an existing unmet need and customer behavior tied to this unmet need.

For sizing, there are several ways to generate the numbers- by geography, by demographics, etc.

ii. What would the growth and usage trends be like?
Would they be like that of Twitter (where 30% of the users tweet once never to return) or like that of Facebook?

II. Business Model and Market Strategy
We are really thinking about distribution channels, partners, customer relationships, core capabilities and revenue models here, all of which can be expressed pithily as:
Would you prefer a B2C model or would you modify the site for a B2B model?

Note: We explicitly kept aside market defensibility to assist in brainstorming.

A> B2C Model
i. How would you grow the B2C site?
Would you eventually develop features tied to hyperlocal search to enable customer stick? E.g. Regulars in a train compartment can connect with each other?

ii. How would you monetize the site?
Through Ads, and possibly, viral content (to help folks cool down, for starters)?

B> B2B Model
i. How would you grow the B2B site?
After an initial push to bring on site users, would you consider tying up with media companies who may leverage feed from this site? E.g. TV Weather and traffic update has a ticker running at the bottom which shows "selected"/ "near real time" commuter "rants"?

ii. How would you monetize the B2B site?
How many media companies would buy into this? What would such features be worth to the media companies?

III. Product Strategy
Would you roll this out as an independent site/ platform? Or,
Would you leverage existing platforms like the iPhone and/ or Facebook?

The questions for you:
1> How would you have looked at this differently?
2> Would you invest?
3> What changes, if any, would change your investment decision?


What do you think?

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Microeconomics, Synergies and Operational Portfolio

A case discussion link below would give you background perspective on this post { Private Equity Case: Dialogic Carve Out from Intel}:
http://randomjunkyramblings.blogspot.com/2009/02/private-equity-case-dialogic-carve-out.html

Synergies
I checked with a technology industry focused private equity investor on whether his investment committee considers synergies across its operational portfolio in its investment decision making. After all, technology is a pretty broad term- do they see an advantage in narrowing their focus?

His rejection of the idea was couched in an excellent example. The investment team would not buy competitors. This was a pretty straight forward discounting of the potential of merger efficiencies, and we can list numerous reasons for it- from strategic ones like the hypercompetitive nature of the technology industry, to investment ones like the heightened risk of a larger company’s underperformance weighing down upon the rest of the portfolio.

Microeconomics
However, this should remind you, as it reminded me, of microeconomics. Does rejecting competitors also mean you would reject complements? Strictly as an investment strategy, wouldn’t investing in complements also increase the correlation across investments?

Investment examples in the technology industry would be:
1. Investing in Facebook and Fun Wall, or investing in Twitter and Twitterdeck.
2. Investing in the Transmeta Crusoe process and a windows power management utility for that processor

Would this mean that the investing team needs to have processes in place to monitor revenue correlations across portfolio companies?

The Venture Capital Context
Lets look at this in the venture capital context, discussed in my post here: {Venture Capital: “If it ain’t broke…” Does the VC Model Need Fixing?}
http://randomjunkyramblings.blogspot.com/2009/02/panel-venture-capital-if-it-aint-broke.html

Investing in startups, especially the very early stage ones, needs to account for some strategy shift. However, sometimes even late stage startups may need to adjust their strategy to account for monetization opportunities in tough economic times.

How would the venture capital firm react if this strategy shift made this investment a complement of anther portfolio investment?


What do you think?


The Usual Disclaimer: This is purely a knowledge sharing resource and I have been careful to protect panelist/ speaker interests. Ethically, context is everything, and I will gladly retract anything that affects the parties mentioned. Call this my mini OpenCourseWare, if you will, where Open signifies life experiences.

Panel: Venture Capital: Navigating the Current Landscape

The panel started off, interestingly, examining the fundamentals of venture capital investing. Any potential investment must demonstrate compelling value and a feasible exit strategy. The panelists talked about how returns in venture capital are seen in bursts, and average out over time. One panelist talked about a batch mate in business school (early 1980s), now a leader of a successful universal banking group, who forecasted that the SnP500 returns would be greater than that of the venture capital industry that decade. The batch-mate turned out to be right.

The panelist also talked about some of their areas of investments- mobile computing, video games and personal genomics.

At lunch, Jim Long mentioned how important it is to bootstrap your venture.

Given the Sequoia presentation from 2008, it was interesting to see panelists responding to the crisis with a “return to fundamentals” theme.

What do you think?

The Usual Disclaimer: This is purely a knowledge sharing resource and I have been careful to protect panelist interests. Ethically, context is everything, and I will gladly retract anything that affects the parties mentioned. Call this my mini OpenCourseWare, if you will, where Open signifies life experiences.

Panel: Venture Capital: “If it ain’t broke…” Does the VC Model Need Fixing?

The discussion focused on the parameters within which the VC industry currently operates

A return to fundamentals
The discussion kicked off with a return to fundamentals:
1> Most venture capital firms are not setup to make small investments
2> Venture capital firms are more like asset managers
3> Deal making is not easy: A deal like that of EqualLogic was hard work for all parties involved
4> The venture capital business is fundamentally not about fundamental research for revolutionary technologies, but about applying technology
5> Depending on the industry, the average holding period can be up to 9 years
6> As the market for the pre-IPO company matures, it should grow larger, providing the opportunity for late stage venture capital firms.
7> Exit strategies are critical to the model. Is there a vibrant IPO market? Are there private company sales opportunities?

Investing during the economic downturn
The panelist opinion was that the quality of business plans and management teams gets better as the economy goes down. The panelists emphasized that they are being extremely selective; they are not into throwing 50 bets at the solar power industry.

A panelist pointed out that the CEOs of their portfolio firms were upset by the Sequoia deck. The economic downturn, though, has led them to revisit their breakeven analysis.

Economic cycles and the industry- a perspective
A panelist had an interesting perspective on the economic downturn- the VC firm sells a company to Microsoft in the good times -> Microsoft cuts products and jobs in the bad times -> the resources are back in the VC fold working on the next product.

Venture Capital Fund Management
Funds are structured as financial managers who can find good business managers, as opposed to operational managers making funding decisions.

In January 2009, Kleiner Perkins, raised a so-called “annex fund,” or reserve fund it can tap to support companies it has already backed to help ensure they get through the downturn.
http://venturebeat.com/2009/01/14/kleiner-perkins-forced-to-reach-out-to-new-investors-unheard-of/

Outside of the one off hits, a panelist pointed out that returns in the 4x range would be rare in exits. Valuations were down 50%, B and C round valuations were down 20% and 30 % respectively. Another panelist stated that the venture capital industry was saved from a sever flight of capital by the buyout collapse.

Some the questions that arise:
1. Do lower valuations imply a longer time to complete transactions, and require a better understanding of the potential investment’s core business?
2. Would there be a shakeout in the industry that favors more late stage firms that have strong networks with large, potentially private companies? Would the shakeout lead to a reduction of the number of multistage firms?
3. Would late stage venture capital firms resort to private investment in public equity (small cap companies)? Even at the risk of serious strategy drift?
4. Given the odds of hitting the ball out of the ballpark (and I am not even talking about the odds of innovation), how should a venture capital firm get more selective?
5. Given the context of the Kleiner Perkins Annex fund, would a fund consider trading extensively in a secondary private market only when it is considering liquidating? Would partial portfolio/ strip sales be a serious option? Would some sort of a CDO like market structure be useful in the venture capital industry?
6. How are funds helping the LPs? Is it just via managing the drawdowns?
7. Are more LPs checking on estimates on deal flow and deal sizes to assess the impact of the economic downturn?
8. Are investment charters of old portfolios being modified to provide more flexibility to the venture capital firms?
9. How frequently are LPs assessing their asset allocations strategies and communicating with funds to execute revisions?

What do you think?


The Usual Disclaimer: This is purely a knowledge sharing resource and I have been careful to protect panelist/ speaker interests. Ethically, context is everything, and I will gladly retract anything that affects the parties mentioned. Call this my mini OpenCourseWare, if you will, where Open signifies life experiences.

Interesting Times and Investing in Large Cap Companies- Part 1

Is equity investing in large cap companies during uncertain times similar to venture capital investing if the 3 conditions below are true?
1> Your offer of capital makes you a large shareholder in the company.
E.g. Warren Buffet's investment in Goldman Sachs, with the terms he could bargain for.

2> The capital markets enter a period of volatility that begins to approach uncertainty that venture capital investors face in their investment decisions.
E.g. The VIX crossing 85 in October'08, in the context of applying the Black Scholes model to investing decisions.

3> The capital markets face a liquidity crisis/ credit crunch.

Talking points:
1> Are these three conditions enough?
2> Does the "maturity" of the company mean anything beyond the ability to effect change within the organization, and the time required to effect this change?
3> Is looking at this question purely from the financial investing term sheet perspective inherently flawed?

Now that you have been anchored to the 3 follow up questions above, here are a couple more:
1. Is there a category of distressed company investing that is similar to venture capital investing?
2. Irrespective of how you categorize your investments or investing style, would you consider ending up looking at term sheets as an indicator of the end-of-the-road for that particular investment?

What do you think?

Music Industry, Technology, IP and Piracy: Is there anything in common? Really?

Multiplicity of Approaches.

News articles on the music industry below, indicate a mutiplicity of approaches (could it be serendipity?) being followed by firms to deal with flagging "old media" revenues:
1> http://www.nytimes.com/2008/04/04/technology/04myspace.html?_r=1&ei=5087&em=&en=7e63eb66cebb344e&ex=1207454400&pagewanted=print&oref=slogin
2> http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/04/06/cncarphone106.xml&CMP=ILC-mostviewedbox
3> http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/04/06/ccemi106.xml

The article, and my own experience in Technology Intellectual Property (IP), got me thinking again about the music industry's woes.

My contention is that any firm considering developing IP in emerging markets must think of the markets as hypercompetitive, where they compete with their own shadows. This might dovetail with the experience of some Venture Capital firms in Asia and Africa.

Allocate resources toward making money.

As some one who has created IP, in technology, in an emerging market, my generic stand (and I know this is likely to spark controversy) in that context is that protecting IP is subservient to growth- marketshare, ramping up revenues quickly, etc. Marketing muscle- either the company's own distribution strength, or the company's ability to create a network of stakeholders in its success- is critical towards finding a defensible niche where the company can build customer relationships/ stick. Allocate resources toward making money, instead of fighting a losing battle.

So What? How does this apply?

While the developed economy context is not the same, the first two articles seem to be a sign of parts of the value chain seeking to control the supply chain.
The third article seems to indicate a deepening of a pragmatic approach in the industry. An approach that focuses on developing models for making money off an economic reality, as opposed to fighting an (apparently) losing battle. For project management, I tend to advocate a multiplicity of approaches toward a more robust critical path. However, there are times when a multiplicity of approaches only serves to muddy waters.

Over the past few years, I have faced some flak for flatly advocating the pragmatic approach. What do you think?

Keynote address: Vinod Dham, NEA- Indo-US Ventures

The amazing keynote by Vinod Dham has parallels with a keynote (different conference) by Alan Patricof, Managing Director, Greycroft, with respect to his experience in Venture Capital in Africa. Vinod was bullish about opportunities in India.

His talk raise a query. What is the difference in managing a $200 MM fund in Silicon Valley vs. a $200 MM fund in India?

On the dealmaking end:
1> Do you do more deals?
2> Do you invest in companies that are more late stage?
3> Do you invest in companies that can bring in and ramp up revenue pretty quickly?

From personal experience, Indian startups are able to keep costs pretty low.

On the investing end, what kind of support do you need to provide to startup leadership?

The Indian technology clusters- Mumbai, Delhi, Bangalore, Hyderabad, Chennai- are not as mature as the Silicon Valley cluster.

What do you think?

The Usual Disclaimer: This is purely a knowledge sharing resource. Ethically, context is everything, and I will gladly retract anything that affects the parties mentioned. Call this my mini OpenCourseWare, if you will, where Open signifies life experiences.

Conference Panel: Trends in Private Equity and Venture Capital Sectors in India

Given a trio of PE, VC and IB players in India, the panel met high expectations. Some facets talked about:
1. Debt market in India
2. Constraints in structuring transactions
3. Regulatory environment and red tape
4. Nature of targets (family driven enterprises), time horizons and deal flow networks

Given these factors, I wondered how the firms managed risks- not just financial risks. I queried the panel about their experience with a deal that did not meet experience.

What do you think?

The VC investor, who had significant experience in investing in India provided an interesting insight, that emphasized the efficiencies that the PE/ VC firms can find across funds and investments/ deals.

The response also threw light on the "transaction costs" that mutual fund like SPAC aggregators would face that would make them replicas of publicly traded PE firms.

The panel echoed some of the points made by Alan Patricof, Managing Director, Greycroft, at a conference keynote, with respect to his experience in Venture Capital in Africa.

The Usual Disclaimer: This is purely a knowledge sharing resource. Ethically, context is everything, and I will gladly retract anything that affects the parties mentioned. Call this my mini OpenCourseWare, if you will, where Open signifies life experiences.